NOTE 6. SERIES B CONVERTIBLE PREFERRED STOCK

The Company’s Board of Directors has the authority, without further action by the stockholders, to issue up to 1,000,000 shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions of these shares of preferred stock. The Board of Directors has designated 17,000 shares as Series B convertible preferred stock. The Series B preferred stock does not have voting rights.

Commencing on the date of issuance of the Series B preferred stock until the date a registration statement registering the common shares underlying the preferred stock and warrants issued is declared effective by the SEC, the Company was required to pay on each outstanding share of Series B preferred stock a preferential cumulative dividend at an annual rate equal to the product of multiplying $100 per share by the higher of the Wall Street Journal Prime Rate plus 1%, or 9%. In no event was the dividend rate to be greater than 12% per annum. The dividend was payable monthly in arrears in cash on the last day of each month based on the number of shares of Series B preferred stock outstanding as of the first day of that month. In the event the Company did not pay the Series B preferred dividends when due, the conversion price of the Series B preferred shares was reduced to 85% of the otherwise applicable conversion price. The Company did not pay the required monthly Series B preferred dividends since November 30, 2006, which, in part, has caused the conversion price to be reduced. During the nine months ended August 31, 2010, the Company accrued preferred dividends in the amount of $105,733 on the Series B preferred stock. Subsequent to November 30, 2010, the Company received an opinion of outside counsel providing for the removal of the restrictive legend on the Series B preferred stock, which in turn terminated the requirement to accrue the related dividends. Accordingly, no dividends were accrued during the nine months ended August 31, 2011. Total accrued but unpaid preferred dividends recorded in the accompanying condensed consolidated balance sheet as of August 31, 2011 and November 30, 2010 are $580,672, of which $243,835 are recorded in permanent equity with the Series B preferred stock and $336,837 are recorded as a current liability with accounts payable and accrued expenses.

The Series B shares are convertible at any time into common stock at a conversion price determined by dividing the purchase price per share of $100 by the conversion price. The conversion price was originally $0.32 per share. Upon the occurrence of an event of default (as defined in the agreement), the conversion price of the Series B shares shall be reduced to 85% of the then applicable conversion price of such shares. The conversion price is subject to equitable adjustment in the event of any stock splits, stock dividends, recapitalizations and the like. In addition, the conversion price is subject to weighted average anti-dilution adjustments in the event the Company sells common stock or other securities convertible into or exercisable for common stock at a per share price, exercise price or conversion price lower than the conversion price then in effect in any transaction (other than in connection with an acquisition of the securities, assets or business of another company, joint venture and employee stock options). As a result of the Company issuing common stock upon conversion of convertible debentures and upon the exercise of warrants effectively at prices lower than the conversion price, and due to the Company not paying Series B dividends on a monthly basis, the conversion price of the Series B preferred stock has been reduced to $0.0337 per share as of August 31, 2011. The conversion of the Series B preferred stock is limited for each investor to 9.99% of the Company’s common stock outstanding on the date of conversion.

In July 2010, the Company received notice from one of the preferred shareholders that it was converting 4,923 shares of Series B preferred stock. The carrying value of the converted Series B preferred stock was $480,191, consisting of the original proceeds from the issuance of the preferred stock of $492,300 ($100 per share) less allocated issuance costs of $12,109. On the date that the notice was received, the conversion price of the Series B preferred stock was $0.0616. Accordingly, the conversion resulted in the issuance of 7,991,883 shares of common stock.

Effective December 1, 2009, the Company adopted new accounting provisions for determining whether an instrument (or embedded feature) is indexed to an entity’s own stock. These provisions apply to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by standards for accounting for derivative instruments and hedging activities, and to any freestanding financial instruments that are potentially settled in an entity’s own common stock. As of December 1, 2009, there were 16,262 shares of Series B preferred stock that were convertible into 21,341,207 shares of common stock. The Company determined that the conversion feature to allow the holders of the Series B convertible preferred stock to acquire common shares is an embedded derivative that no longer qualifies as equity under the new accounting guidance. As a result of adopting these standards, the Company evaluated the conversion feature as though it was accounted for as a derivative liability since the issuance of the Series B convertible preferred stock in July 2006 and has recorded, as a cumulative effect adjustment on December 1, 2009, a noncurrent derivative liability of $226,217 with a corresponding reduction in other components of equity on that date. The derivative liability is recorded in the accompanying condensed consolidated balance sheet at $255,716 and $79,913 as of August 31, 2011 and November 30, 2010, respectively. The fair value of the conversion feature decreased by $381,517 during the three months ended August 31, 2011, which has been recorded as a gain from the change in the fair value of the derivative liability. The fair value of the conversion feature increased by $175,803 during the nine months ended August 31, 2011, which has been recorded as a loss from the change in the fair value of the derivative liability. The fair value of the conversion feature decreased by $95,204 and $91,298 during the three months and the nine months ended August 31, 2010, which has been recorded as a gain from the change in the fair value of the derivative liability.

The estimate of the fair value of the embedded conversion feature and the underlying assumptions used to determine the estimate are as follows:

	August 31,			May 31,			November 30,			August 31,			May 31,			December 1,
	2011			2011			2010			2010			2010			2009
Fair value of common stock	$	0.0080		$	0.0204		$	0.0037		$	0.0048		$	0.0095		$	0.0106
Conversion price of preferred stock	$	0.0337		$	0.0363		$	0.0525		$	0.0579		$	0.0636		$	0.0762
Risk free interest rate		2.23	%		3.05	%		2.81	%		2.47	%		3.31	%		3.28	%
Expected life		10 Years			10 Years			10 Years			10 Years			10 Years			10 Years
Dividend yield		-			-			-			-			-			-
Volatility		140	%		140	%		140	%		140	%		140	%		150	%

In the event of any dissolution or winding up of the Company, whether voluntary or involuntary, holders of each outstanding share of Series B preferred stock shall be entitled to be paid second in priority to the Series I preferred stock holders out of the assets of the Company available for distribution to stockholders, an amount equal to $100 per share of Series B convertible preferred stock held plus any declared but unpaid dividends. After such payment has been made in full, such holders of Series B convertible preferred stock shall be entitled to no further participation in the distribution of the assets of the Company.