Note 7 - 10% Convertible Redeemable Preferred Stock

We designated 880,000 shares of preferred stock as 10% Convertible Preferred Stock (the “Preferred Stock”). The Preferred Stock has a stated value (the “Stated Value”) of $10.00 per share. The Preferred Stock and any dividends thereon may be converted into shares of our common stock at any time by the holder at a conversion rate, as adjusted (the “Conversion Rate”). The holders of the Preferred Stock are entitled to receive dividends at the rate of ten percent (10%) per annum payable quarterly. Dividends shall not be declared, paid or set aside for any series or other class of stock ranking junior to the Preferred Stock, until all dividends have been paid in full on the Preferred Stock. The dividends on the Preferred Stock are payable, at our option, in cash, if permissible, or in additional shares of common stock. The Preferred Stock is not subject to any anti-dilution provisions other than for stock splits and stock dividends or other similar transactions. The holders of the Preferred Stock shall have the right to vote with our stockholders in any matter. The number of votes that may be cast by a holder of our Preferred Stock shall equal the Stated Value of the Preferred Stock purchased divided by the Conversion Rate. The Preferred Stock shall be redeemable for cash by the holder any time after the three (3) year anniversary from the initial purchase. The Preferred Stock may be converted by us, provided that the variable weighted average price of our common stock has closed at $4.00 per share or greater, for sixty (60) consecutive trading days and during such sixty (60) day period, the shares of common stock issuable upon conversion of the Preferred Stock have either been registered for resale or are issuable without restriction pursuant to Rule 144 of the Securities Act of 1933, as amended.

Pursuant to the terms of the Preferred Stock, since our net revenues for the twelve months ended December 31, 2011 were less than $10 million as reported in our audited financial statements, (i) the holders of our Preferred Stock received a warrant to purchase a number of shares of our common stock equal to fifty percent of the number of shares of common stock issuable upon conversion of the Preferred Stock at the Conversion Rate (the “Make Good Warrants”) and (ii) the Conversion Rate was adjusted to $1.00, subject to adjustments for stock splits and stock dividends (the issuance of the Make Good Warrants and the adjustment to the Conversion Rate is referred to as the “Make Good Adjustment”). The Make Good Warrants expire December 31, 2015 and have an initial exercise price of $1.00 per share and provide for cashless exercise at any time the underlying shares of common stock have not been registered for resale under the Securities Act of 1933 or are issuable without restriction pursuant to Rule 144 of the Securities Act.

During March and April 2011, we sold 759,773 shares of Preferred Stock at a price per share of $10, for gross proceeds of $7,597,730. We paid commissions, legal fees and other expenses of issuance of $828,340, which has been recorded as a discount and deducted from the face value of the Preferred Stock. This discount will be amortized over three years consistent with the initial redemption terms. During the three months ended March 31, 2012, we amortized approximately $68,000 of this discount. At issuance of the Preferred Stock, we attributed a beneficial conversion feature to the Preferred Stock based upon the difference between the Conversion Rate at the time of issuance and the closing price of our common stock on the date of issuance, which was recorded as a discount and deducted from the face value of the Preferred Stock. Pursuant to the Make Good Adjustment of the Conversion Rate to $1.00, at December 31, 2011 the beneficial conversion feature was recalculated as if the $1.00 Conversion Rate was in affect at issuance, and the amortization of the related discount was adjusted for the year ended December 31, 2011, resulting in an unamortized discount at December 31, 2011 of $1.6 million. This discount is amortized over three years consistent with the initial redemption terms, as a charge to additional paid-in capital, due to a deficit in retained earnings and during the three months ended March 31, 2012, we amortized approximately $174,000 to additional paid-in capital. At March 31, 2012, the unamortized Preferred Stock discount balance was $1.9 million.

During the three months ended March 31, 2012, we issued 62,500 shares of our common stock upon conversion of 6,250 shares of our Preferred Stock.

At March 31, 2012, we may be required to issue approximately 7.4 million shares of our common stock if the remaining holders of our Preferred Stock elect to convert. In addition, the holders of our Preferred Stock were issued warrants to purchase approximately 3.8 million shares of our common stock at an exercise price of $1.00 per share pursuant to the Make Good Adjustment. The fair value of the warrants issued represented the fair value of the derivative liability at December 31, 2011 when the warrants were effectively issued.

Since the Preferred Stock may ultimately be redeemed at the option of the holder, the carrying value of the shares, net of unamortized discount and accumulated dividends, has been classified as temporary equity at March 31, 2012.

For the three months ended March 31, 2012 we accrued dividends on the Preferred Stock in the amount of $171,751. This accrued dividend was paid with approximately 286,300 shares of common stock issued in lieu of cash subsequent to March 31, 2012.

The components of our 10% convertible redeemable preferred stock are summarized as follows:

	March 31,			December 31,
	2012			2011
Redeemable preferred stock - face value	$	7,460,230		$	7,522,730
Accrued dividends		171,751			176,620
Unamortized discount		(1,936,972	)		(2,179,094	)
Redeemable preferred stock, net of discount	$	5,695,009		$	5,520,256

Placement Agent Warrants

We issued warrants to the placement agents for the sale of our 10% convertible preferred stock, to purchase 58,352 shares of 10% convertible preferred stock at $10 per share. Since the underlying 10% convertible preferred stock is redeemable by the holder after three years from the date of purchase, we recorded the fair value of the warrants at issuance, as a liability on our balance sheet and we re-value the warrant liability at each reporting date, with changes in fair value recognized in earnings each reporting period. We recognized a change in fair value of the warrant liability at March 31, 2012 of approximately $243,000, resulting in a warrant liability at March 31, 2012 of approximately $245,000.