THIS NOTE AND THE SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION HEREOF HAVE
NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “ACT”), OR
APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE SOLD, TRANSFERRED, OR OTHERWISE
DISPOSED OF IN THE ABSENCE OF SUCH REGISTRATION OR RECEIPT BY THE MAKER OF AN
OPINION OF COUNSEL IN THE FORM, SUBSTANCE AND SCOPE REASONABLY SATISFACTORY TO
THE MAKER THAT THIS NOTE AND THE SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION
HEREOF MAY BE SOLD, TRANSFERRED, OR OTHERWISE DISPOSED OF, UNDER AN EXEMPTION
FROM REGISTRATION UNDER THE ACT AND SUCH STATE SECURITIES LAWS.

 

MERCHANDISE CREATIONS, INC.

 

Secured Convertible Demand Promissory Note

due December 7, 2009

 

No. CN-06-01

$8,000,000

Dated: December 7, 2006

 

For value received, Merchandise Creations, Inc., a Nevada corporation (the
“Maker”), hereby promises to pay, ON DEMAND, to the order of Vision Opportunity
Master Fund, Ltd. (together with its successors, representatives, and permitted
assigns, the “Holder”), in accordance with the terms hereinafter provided, the
principal amount of Eight Million Dollars ($8,000,000), together with interest
thereon. Concurrently with the issuance of this Note, the Maker is issuing
separate secured convertible demand promissory notes (the “Other Notes”) to
separate purchasers (the “Other Holders”) pursuant to the Purchase Agreement (as
defined in Section 1.1 hereof). This Note and the Other Notes are sometimes
referred to as the “Notes”.

All payments under or pursuant to this Note shall be made in United States
Dollars in immediately available funds to the Holder at the address of the
Holder first set forth above or at such other place as the Holder may designate
from time to time in writing to the Maker or by wire transfer of funds to the
Holder’s account, instructions for which are attached hereto as Exhibit A. The
outstanding principal balance of this Note shall be due and payable on December
7, 2009 (the “Maturity Date”) or at such earlier time as provided herein.

ARTICLE I

 

Section 1.1        Purchase Agreement. This Note has been executed and delivered
pursuant to the Note and Warrant Purchase Agreement dated as of December 7, 2006
(the “Purchase Agreement”) by and among the Maker and the purchasers listed
therein. Capitalized terms used and not otherwise defined herein shall have the
meanings set forth for such terms in the Purchase Agreement.

 

 

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Section 1.2        Interest. Beginning on the issuance date of this Note (the
“Issuance Date”), the outstanding principal balance of this Note shall bear
interest, in arrears, at a rate per annum equal to five percent (5%), payable in
cash quarterly commencing on March 1, 2007 and on the first business day of each
following three-month period. Interest shall be computed on the basis of a
360-day year of twelve (12) 30-day months and shall accrue commencing on the
Issuance Date. Furthermore, upon the occurrence of an Event of Default (as
defined in Section 2.1 hereof), then to the extent permitted by law, the Maker
will pay interest in cash to the Holder, payable on demand, on the outstanding
principal balance of the Note from the date of the Event of Default until such
Event of Default is cured at the rate of the lesser of fifteen percent (15%) and
the maximum applicable legal rate per annum.

Section 1.3        Security Agreement. The obligations of the Maker hereunder
are secured by a continuing security interest in all of the assets of the Maker
pursuant to the terms of a security agreement dated as of December 7, 2006 by
and among the Maker, on the one hand, and the Holder and the Other Holders, on
the other hand.

Section 1.4       Payment on Non-Business Days. Whenever any payment to be made
shall be due on a Saturday, Sunday or a public holiday under the laws of the
State of New York, such payment may be due on the next succeeding business day
and such next succeeding day shall be included in the calculation of the amount
of accrued interest payable on such date.

Section 1.5       Transfer. This Note may be transferred or sold, subject to the
provisions of Section 4.8 of this Note, or pledged, hypothecated or otherwise
granted as security by the Holder.

Section 1.6       Replacement. Upon receipt of a duly executed, notarized and
unsecured written statement from the Holder with respect to the loss, theft or
destruction of this Note (or any replacement hereof) and a standard indemnity,
or, in the case of a mutilation of this Note, upon surrender and cancellation of
such Note, the Maker shall issue a new Note, of like tenor and amount, in lieu
of such lost, stolen, destroyed or mutilated Note.

ARTICLE II

 

EVENTS OF DEFAULT; REMEDIES

 

Section 2.1        Events of Default. The occurrence of any of the following
events shall be an “Event of Default” under this Note:

(a)          the Maker shall fail to make any principal or interest payments on
the date such payments are due and such default is not fully cured within three
(3) business days after the occurrence thereof; or

(b)          the failure of the registration statement (the “Registration
Statement”) providing for the resale of shares of the Maker’s common stock,
$0.001 par value per share (the “Common Stock”) issuable upon conversion of this
Note to be declared effective by the Securities and Exchange Commission on or
prior to the date which is one hundred eighty (180) days after the Issuance
Date; or

 

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(c)          the suspension from listing, without subsequent listing on any one
of, or the failure of the Common Stock to be listed or quoted on at least one of
the OTC Bulletin Board, the American Stock Exchange, the Nasdaq Global Market,
the Nasdaq Capital Market or The New York Stock Exchange, Inc. for a period of
seven (7) consecutive Trading Days; or

(d)          the Maker’s notice to the Holder, including by way of public
announcement, at any time, of its inability to comply (including for any of the
reasons described in Section 3.8(a) hereof) or its intention not to comply with
proper requests for conversion of this Note into shares of Common Stock; or

(e)          the Maker shall fail to (i) timely deliver the shares of Common
Stock upon conversion of the Note, (ii) file the Registration Statement in
accordance with the terms of the Registration Rights Agreement or (iii) make the
payment of any fees and/or liquidated damages under this Note, the Purchase
Agreement or the Registration Rights Agreement, which failure in the case of
items (i) and (iii) of this Section 2.1(e) is not remedied within ten (10)
business days after the incurrence thereof and, solely with respect to item
(iii) above, after the Holder delivers written notice to the Maker of the
incurrence thereof; or

(f)           while the Registration Statement is required to be maintained
effective pursuant to the terms of the Registration Rights Agreement, the
effectiveness of the Registration Statement lapses for any reason (including,
without limitation, the issuance of a stop order) or is unavailable to the
Holder for sale of the Registrable Securities (as defined in the Registration
Rights Agreement) in accordance with the terms of the Registration Rights
Agreement, and such lapse or unavailability continues for a period of ten (10)
consecutive Trading Days, provided that the Maker has not exercised its rights
pursuant to Section 3(n) of the Registration Rights Agreement; or

(g)          default shall be made in the performance or observance of (i) any
covenant, condition or agreement contained in this Note (other than as set forth
in clause (f) of this Section 2.1) and such default is not fully cured within
five (5) business days after the Holder delivers written notice to the Maker of
the occurrence thereof or (ii) any covenant, condition or agreement contained in
the Purchase Agreement, the Other Notes, the Registration Rights Agreement or
any other Transaction Document which is not covered by any other provisions of
this Section 2.1 and such default is not fully cured within five (5) business
days after the Holder delivers written notice to the Maker of the occurrence
thereof; or

(h)          any material representation or warranty made by the Maker herein or
in the Purchase Agreement, the Registration Rights Agreement, the Other Notes or
any other Transaction Document shall prove to have been false or incorrect or
breached in a material respect on the date as of which made and the Holder
delivers written notice to the Maker of the occurrence thereof; or

(i)           the Maker shall (A) default in any payment of any amount or
amounts of principal of or interest on any Indebtedness (other than the
Indebtedness hereunder) the aggregate principal amount of which Indebtedness is
in excess of $100,000 or (B) default in the observance or performance of any
other agreement or condition relating to any Indebtedness or contained in any
instrument or agreement evidencing, securing or relating thereto, or any other

 

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event shall occur or condition exist, the effect of which default or other event
or condition is to cause, or to permit the holder or holders or beneficiary or
beneficiaries of such Indebtedness to cause with the giving of notice if
required, such Indebtedness to become due prior to its stated maturity; or

(j)           the Maker shall (i) apply for or consent to the appointment of, or
the taking of possession by, a receiver, custodian, trustee or liquidator of
itself or of all or a substantial part of its property or assets, (ii) make a
general assignment for the benefit of its creditors, (iii) commence a voluntary
case under the United States Bankruptcy Code (as now or hereafter in effect) or
under the comparable laws of any jurisdiction (foreign or domestic), (iv) file a
petition seeking to take advantage of any bankruptcy, insolvency, moratorium,
reorganization or other similar law affecting the enforcement of creditors’
rights generally, (v) acquiesce in writing to any petition filed against it in
an involuntary case under United States Bankruptcy Code (as now or hereafter in
effect) or under the comparable laws of any jurisdiction (foreign or domestic),
(vi) issue a notice of bankruptcy or winding down of its operations or issue a
press release regarding same, or (vii) take any action under the laws of any
jurisdiction (foreign or domestic) analogous to any of the foregoing; or

(k)          a proceeding or case shall be commenced in respect of the Maker,
without its application or consent, in any court of competent jurisdiction,
seeking (i) the liquidation, reorganization, moratorium, dissolution, winding
up, or composition or readjustment of its debts, (ii) the appointment of a
trustee, receiver, custodian, liquidator or the like of it or of all or any
substantial part of its assets in connection with the liquidation or dissolution
of the Maker or (iii) similar relief in respect of it under any law providing
for the relief of debtors, and such proceeding or case described in clause (i),
(ii) or (iii) shall continue undismissed, or unstayed and in effect, for a
period of thirty (30) days or any order for relief shall be entered in an
involuntary case under United States Bankruptcy Code (as now or hereafter in
effect) or under the comparable laws of any jurisdiction (foreign or domestic)
against the Maker or action under the laws of any jurisdiction (foreign or
domestic) analogous to any of the foregoing shall be taken with respect to the
Maker and shall continue undismissed, or unstayed and in effect for a period of
thirty (30) days; or

(l)           the failure of the Maker to instruct its transfer agent to remove
any legends from shares of Common Stock eligible to be sold under Rule 144 of
the Securities Act and issue such unlegended certificates to the Holder within
five (5) business days of the Holder’s request so long as the Holder has
provided reasonable assurances to the Maker that such shares of Common Stock can
be sold pursuant to Rule 144; or

(m)         the failure of the Maker to pay any amounts due to the Holder herein
or any other Transaction Document within five (5) business days of the date such
payments are due and such default is not fully cured within two (2) business
days after the Holder delivers written notice to the Maker of the occurrence
thereof; or

 

(n)

the occurrence of an Event of Default under the Other Notes.

Section 2.2        Remedies Upon An Event of Default. If an Event of Default
shall have occurred and shall be continuing, the Holder of this Note may at any
time at its option, (a)

 

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declare the entire unpaid principal balance of this Note, together with all
interest accrued hereon, due and payable, and thereupon, the same shall be
accelerated and so due and payable, without presentment, demand, protest, or
notice, all of which are hereby expressly unconditionally and irrevocably waived
by the Maker; provided, however, that upon the occurrence of an Event of Default
described in (i) Sections 2.1 (j) or (k), the outstanding principal balance and
accrued interest hereunder shall be automatically due and payable and (ii)
Sections 2.1 (b)-(i), (l) and (m), demand the prepayment of this Note pursuant
to Section 3.7 hereof, (b) demand that the principal amount of this Note then
outstanding shall be converted into shares of Common Stock at a Conversion Price
per share calculated pursuant to Section 3.1 hereof assuming that the date that
the Event of Default occurs is the Conversion Date (as defined in Section 3.1
hereof), or (c) exercise or otherwise enforce any one or more of the Holder’s
rights, powers, privileges, remedies and interests under this Note, the Purchase
Agreement, the Registration Rights Agreement or applicable law. No course of
delay on the part of the Holder shall operate as a waiver thereof or otherwise
prejudice the right of the Holder. No remedy conferred hereby shall be exclusive
of any other remedy referred to herein or now or hereafter available at law, in
equity, by statute or otherwise.

ARTICLE III

 

CONVERSION; ANTIDILUTION; PREPAYMENT

 

 

Section 3.1

Conversion Option.

 

(a)          At any time on or after the Issuance Date, this Note shall be
convertible (in whole or in part), at the option of the Holder (the “Conversion
Option”), into such number of fully paid and non-assessable shares of Common
Stock (the “Conversion Rate”) as is determined by dividing (x) that portion of
the outstanding principal balance under this Note as of such date that the
Holder elects to convert by (y) the Conversion Price (as defined in Section
3.2(a) hereof) then in effect on the date on which the Holder faxes a notice of
conversion (the “Conversion Notice”), duly executed, to the Maker (facsimile
number (972) 987-5880, Attn.: Chief Executive Officer) (the “Voluntary
Conversion Date”), provided, however, that the Conversion Price shall be subject
to adjustment as described in Section 3.6 of this Note. The Holder shall deliver
this Note to the Maker at the address designated in the Purchase Agreement at
such time that this Note is fully converted. With respect to partial conversions
of this Note, the Maker shall keep written records of the amount of this Note
converted as of each Conversion Date.

(b)          On the Mandatory Conversion Date (as defined below), the
outstanding principal amount of this Note plus all accrued and unpaid interest
shall automatically be, at the sole option of the Holder, (A) converted into a
number of fully paid and nonassessable shares of Common Stock equal to the
quotient of (y) the principal amount of this Note plus all accrued and unpaid
interest outstanding on the Mandatory Conversion Date divided by (z) the
Conversion Price in effect on the Mandatory Conversion Date, or (B) exchanged
for an amount in cash equal to the principal amount of this Note plus all
accrued and unpaid interest outstanding on the Mandatory Conversion Date, by
providing five business (5) days prior written notice of such Mandatory
Conversion Date. As used herein, a “Mandatory Conversion Date” shall be the date
that the Maker consummates a PIPE transaction in which it receives gross
proceeds of at least $12,000,000; provided, that (A) the registration statement
providing for the resale of the shares

 

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of Common Stock issuable upon conversion of this Note is effective and has been
effective, without lapse or suspension of any kind, for a period thirty (30)
consecutive calendar days immediately preceding the Mandatory Conversion Date,
(B) trading in the Common Stock shall not have been suspended by the Securities
and Exchange Commission or the OTC Bulletin Board (or other exchange or market
on which the Common Stock is trading), (C) the Maker is in material compliance
with the terms and conditions of this Note and the other Transaction Documents,
(D) the issuance of shares of Common Stock on the Mandatory Conversion Date
pursuant to such mandatory conversion does not violate the provisions of Section
3.4 hereof, and (E) the Maker is not in possession of any material non-public
information. Notwithstanding the foregoing to the contrary, the Mandatory
Conversion Date shall be extended for as long as a Triggering Event (as defined
in Section 3.7(f) hereof) shall have occurred and be continuing. The Mandatory
Conversion Date and the Voluntary Conversion Date collectively are referred to
in this Note as the “Conversion Date.”

 

 

Section 3.2

Conversion Price.

 

(a)          The term “Conversion Price” shall mean $2.25 (post 20-for-1 forward
stock split to be effected on December 11, 2006), subject to adjustment under
Section 3.6 hereof.

(b)          Notwithstanding any of the foregoing to the contrary, if during any
period (a “Black-out Period”), a Holder is unable to trade any Common Stock
issued or issuable upon conversion of this Note immediately due to the
postponement of filing or delay or suspension of effectiveness of the
Registration Statement or because the Maker has otherwise informed such Holder
that an existing prospectus cannot be used at that time in the sale or transfer
of such Common Stock (provided that such postponement, delay, suspension or fact
that the prospectus cannot be used is not due to factors solely within the
control of the Holder of this Note or due to the Maker exercising its rights
under Section 3(n) of the Registration Rights Agreement), such Holder shall have
the option but not the obligation on any Conversion Date within ten (10) Trading
Days following the expiration of the Black-out Period of using the Conversion
Price applicable on such Conversion Date or any Conversion Price selected by
such Holder that would have been applicable had such Conversion Date been at any
earlier time during the Black-out Period or within the ten (10) Trading Days
thereafter. In no event shall the Black-out Period have any effect on the
Maturity Date of this Note.

 

Section 3.3

Mechanics of Conversion.

 

(a)          Not later than three (3) Trading Days after any Conversion Date
(the “Delivery Date”), the Maker or its designated transfer agent, as
applicable, shall issue and deliver to the Depository Trust Company (“DTC”)
account on the Holder’s behalf via the Deposit Withdrawal Agent Commission
System (“DWAC”) as specified in the Conversion Notice, registered in the name of
the Holder or its designee, for the number of shares of Common Stock to which
the Holder shall be entitled. In the alternative, not later than the Delivery
Date, the Maker shall deliver to the applicable Holder by express courier a
certificate or certificates which shall be free of restrictive legends and
trading restrictions (other than those required by Section 5.1 of the Purchase
Agreement) representing the number of shares of Common Stock being acquired upon
the conversion of this Note. If in the case of any Conversion Notice such

 

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certificate or certificates are not delivered to or as directed by the
applicable Holder by the Delivery Date, the Holder shall be entitled by written
notice to the Maker at any time on or before its receipt of such certificate or
certificates thereafter, to rescind such conversion, in which event the Maker
shall immediately return this Note tendered for conversion, whereupon the Maker
and the Holder shall each be restored to their respective positions immediately
prior to the delivery of such notice of revocation, except that any amounts
described in Sections 3.3(b) and (c) shall be payable through the date notice of
rescission is given to the Maker.

(b)          The Maker understands that a delay in the delivery of the shares of
Common Stock upon conversion of this Note beyond the Delivery Date could result
in economic loss to the Holder. If the Maker fails to deliver to the Holder such
shares via DWAC or a certificate or certificates pursuant to this Section
hereunder by the Delivery Date, the Maker shall pay to such Holder, in cash, an
amount per Trading Day for each Trading Day until such shares are delivered via
DWAC or certificates are delivered, together with interest on such amount at a
rate of 10% per annum, accruing until such amount and any accrued interest
thereon is paid in full, equal to the greater of (A) (i) 1% of the aggregate
principal amount of the Notes requested to be converted for the first five (5)
Trading Days after the Delivery Date and (ii) 2% of the aggregate principal
amount of the Notes requested to be converted for each Trading Day thereafter
and (B) $2,000 per day (which amount shall be paid as liquidated damages and not
as a penalty). Nothing herein shall limit a Holder’s right to pursue actual
damages for the Maker’s failure to deliver certificates representing shares of
Common Stock upon conversion within the period specified herein and such Holder
shall have the right to pursue all remedies available to it at law or in equity
(including, without limitation, a decree of specific performance and/or
injunctive relief). Notwithstanding anything to the contrary contained herein,
the Holder shall be entitled to withdraw a Conversion Notice, and upon such
withdrawal the Maker shall only be obligated to pay the liquidated damages
accrued in accordance with this Section 3.3(b) through the date the Conversion
Notice is withdrawn.

(c)          In addition to any other rights available to the Holder, if the
Maker fails to cause its transfer agent to transmit to the Holder a certificate
or certificates representing the shares of Common Stock issuable upon conversion
of this Note on or before the Delivery Date, and if after such date the Holder
is required by its broker to purchase (in an open market transaction or
otherwise) shares of Common Stock to deliver in satisfaction of a sale by the
Holder of the shares of Common Stock issuable upon conversion of this Note which
the Holder anticipated receiving upon such exercise (a “Buy-In”), then the Maker
shall (1) pay in cash to the Holder the amount by which (x) the Holder’s total
purchase price (including brokerage commissions, if any) for the shares of
Common Stock so purchased exceeds (y) the amount obtained by multiplying (A) the
number of shares of Common Stock issuable upon conversion of this Note that the
Maker was required to deliver to the Holder in connection with the conversion at
issue times (B) the price at which the sell order giving rise to such purchase
obligation was executed, and (2) at the option of the Holder, either reinstate
the portion of the Note and equivalent number of shares of Common Stock for
which such conversion was not honored or deliver to the Holder the number of
shares of Common Stock that would have been issued had the Maker timely complied
with its conversion and delivery obligations hereunder. For example, if the
Holder purchases Common Stock having a total purchase price of $11,000 to cover
a Buy-In with respect to an attempted conversion of shares of Common Stock with
an aggregate sale price giving rise to such purchase obligation of $10,000,
under clause (1) of the immediately

 

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preceding sentence the Maker shall be required to pay the Holder $1,000. The
Holder shall provide the Maker written notice indicating the amounts payable to
the Holder in respect of the Buy-In, together with applicable confirmations and
other evidence reasonably requested by the Maker. Nothing herein shall limit a
Holder’s right to pursue any other remedies available to it hereunder, at law or
in equity including, without limitation, a decree of specific performance and/or
injunctive relief with respect to the Maker’s failure to timely deliver
certificates representing shares of Common Stock upon conversion of this Note as
required pursuant to the terms hereof.

Section 3.4     Ownership Cap and Certain Conversion Restriction.
Notwithstanding anything to the contrary set forth in Section 3 of this Note, at
no time may the Holder convert all or a portion of this Note if the number of
shares of Common Stock to be issued pursuant to such conversion would exceed,
when aggregated with all other shares of Common Stock owned by the Holder at
such time, the number of shares of Common Stock which would result in the Holder
beneficially owning (as determined in accordance with Section 13(d) of the
Exchange Act and the rules thereunder) more than 9.9% of all of the Common Stock
outstanding at such time; provided, however, that upon the Holder providing the
Maker with sixty-one (61) days notice (pursuant to Section 4.1 hereof) (the
“Waiver Notice”) that the Holder would like to waive this Section 3.4 with
regard to any or all shares of Common Stock issuable upon conversion of this
Note, this Section 3.4 will be of no force or effect with regard to all or a
portion of the Note referenced in the Waiver Notice.

 

Section 3.5

Intentionally Omitted.

 

 

Section 3.6

Adjustment of Conversion Price.

(a)          The Conversion Price shall be subject to adjustment from time to
time as follows:

(i)           Adjustments for Stock Splits and Combinations. If the Maker shall
at any time or from time to time after the Issuance Date, effect a stock split
of the outstanding Common Stock, the applicable Conversion Price in effect
immediately prior to the stock split shall be proportionately decreased (other
than with respect to the 20-for-1 forward stock split to be effected on December
11, 2006). If the Maker shall at any time or from time to time after the
Issuance Date, combine the outstanding shares of Common Stock, the applicable
Conversion Price in effect immediately prior to the combination shall be
proportionately increased. Any adjustments under this Section 3.6(a)(i) shall be
effective at the close of business on the date the stock split or combination
occurs.

(ii)          Adjustments for Certain Dividends and Distributions. If the Maker
shall at any time or from time to time after the Issuance Date, make or issue or
set a record date for the determination of holders of Common Stock entitled to
receive a dividend or other distribution payable in shares of Common Stock,
then, and in each event, the applicable Conversion Price in effect immediately
prior to such event shall be decreased as of the time of such issuance or, in
the event such record date shall have been fixed, as of the close of business on
such record date, by multiplying, the applicable Conversion Price then in effect
by a fraction:

 

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(1)          the numerator of which shall be the total number of shares of
Common Stock issued and outstanding immediately prior to the time of such
issuance or the close of business on such record date; and

(2)          the denominator of which shall be the total number of shares of
Common Stock issued and outstanding immediately prior to the time of such
issuance or the close of business on such record date plus the number of shares
of Common Stock issuable in payment of such dividend or distribution.

(iii)         Adjustment for Other Dividends and Distributions. If the Maker
shall at any time or from time to time after the Issuance Date, make or issue or
set a record date for the determination of holders of Common Stock entitled to
receive a dividend or other distribution payable in other than shares of Common
Stock, then, and in each event, an appropriate revision to the applicable
Conversion Price shall be made and provision shall be made (by adjustments of
the Conversion Price or otherwise) so that the holders of this Note shall
receive upon conversions thereof, in addition to the number of shares of Common
Stock receivable thereon, the number of securities of the Maker which they would
have received had this Note been converted into Common Stock on the date of such
event and had thereafter, during the period from the date of such event to and
including the Conversion Date, retained such securities (together with any
distributions payable thereon during such period), giving application to all
adjustments called for during such period under this Section 3.6(a)(iii) with
respect to the rights of the holders of this Note and the Other Notes; provided,
however, that if such record date shall have been fixed and such dividend is not
fully paid or if such distribution is not fully made on the date fixed therefor,
the Conversion Price shall be adjusted pursuant to this paragraph as of the time
of actual payment of such dividends or distributions.

(iv)         Adjustments for Reclassification, Exchange or Substitution. If the
Common Stock issuable upon conversion of this Note at any time or from time to
time after the Issuance Date shall be changed to the same or different number of
shares of any class or classes of stock, whether by reclassification, exchange,
substitution or otherwise (other than by way of a stock split or combination of
shares or stock dividends provided for in Sections 3.6(a)(i), (ii) and (iii), or
a reorganization, merger, consolidation, or sale of assets provided for in
Section 3.6(a)(v)), then, and in each event, an appropriate revision to the
Conversion Price shall be made and provisions shall be made (by adjustments of
the Conversion Price or otherwise) so that the Holder shall have the right
thereafter to convert this Note into the kind and amount of shares of stock and
other securities receivable upon reclassification, exchange, substitution or
other change, by holders of the number of shares of Common Stock into which such
Note might have been converted immediately prior to such reclassification,
exchange, substitution or other change, all subject to further adjustment as
provided herein.

(v)          Adjustments for Reorganization, Merger, Consolidation or Sales of
Assets. If at any time or from time to time after the Issuance Date there shall
be a capital reorganization of the Maker (other than by way of a stock split or
combination of shares or stock dividends or distributions provided for in
Section 3.6(a)(i), (ii) and (iii), or a reclassification, exchange or
substitution of shares provided for in Section 3.6(a)(iv)), or a merger or
consolidation of the Maker with or into another corporation where the holders of
outstanding voting securities prior to such merger or consolidation do not own
over fifty percent (50%) of the

 

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outstanding voting securities of the merged or consolidated entity, immediately
after such merger or consolidation, or the sale of all or substantially all of
the Maker’s properties or assets to any other person (an “Organic Change”), then
as a part of such Organic Change, (A) if the surviving entity in any such
Organic Change is a public company that is registered pursuant to the Securities
Exchange Act of 1934, as amended, and its common stock is listed or quoted on a
national exchange or the OTC Bulletin Board, an appropriate revision to the
Conversion Price shall be made and provision shall be made (by adjustments of
the Conversion Price or otherwise) so that the Holder shall have the right
thereafter to convert such Note into the kind and amount of shares of stock and
other securities or property of the Maker or any successor corporation resulting
from Organic Change, and (B) if the surviving entity in any such Organic Change
is not a public company that is registered pursuant to the Securities Exchange
Act of 1934, as amended, or its common stock is not listed or quoted on a
national exchange or the OTC Bulletin Board, the Holder shall have the right to
demand prepayment pursuant to Section 3.7(b) hereof. In any such case,
appropriate adjustment shall be made in the application of the provisions of
this Section 3.6(a)(v) with respect to the rights of the Holder after the
Organic Change to the end that the provisions of this Section 3.6(a)(v)
(including any adjustment in the applicable Conversion Price then in effect and
the number of shares of stock or other securities deliverable upon conversion of
this Note and the Other Notes) shall be applied after that event in as nearly an
equivalent manner as may be practicable.

(vi)         Adjustments for Issuance of Additional Shares of Common Stock. In
the event the Maker, shall, at any time, from time to time, issue or sell any
additional shares of common stock (otherwise than as provided in the foregoing
subsections (i) through (v) of this Section 3.6(a) or pursuant to Common Stock
Equivalents (hereafter defined) granted or issued prior to the Issuance Date)
(“Additional Shares of Common Stock”), at a price per share less than the
Conversion Price then in effect or without consideration, then the Conversion
Price upon each such issuance shall be reduced to a price equal to the
consideration per share paid for such Additional Shares of Common Stock.

(vii)       Issuance of Common Stock Equivalents. The provisions of this Section
3.6(a)(vii) shall apply if (a) the Maker, at any time after the Issuance Date,
shall issue any securities convertible into or exchangeable for, directly or
indirectly, Common Stock (“Convertible Securities”), other than the Notes, or
(b) any rights or warrants or options to purchase any such Common Stock or
Convertible Securities (collectively, the “Common Stock Equivalents”) shall be
issued or sold. If the price per share for which Additional Shares of Common
Stock may be issuable pursuant to any such Common Stock Equivalent shall be less
than the applicable Conversion Price then in effect, or if, after any such
issuance of Common Stock Equivalents, the price per share for which Additional
Shares of Common Stock may be issuable thereafter is amended or adjusted, and
such price as so amended shall be less than the applicable Conversion Price in
effect at the time of such amendment or adjustment, then the applicable
Conversion Price upon each such issuance or amendment shall be adjusted as
provided in the first sentence of subsection (vi) of this Section 3.6(a). No
adjustment shall be made to the Conversion Price upon the issuance of Common
Stock pursuant to the exercise, conversion or exchange of any Convertible
Security or Common Stock Equivalent where an adjustment to the Conversion Price
was made as a result of the issuance or purchase of any Convertible Security or
Common Stock Equivalent.

 

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(viii)      Consideration for Stock. In case any shares of Common Stock or any
Common Stock Equivalents shall be issued or sold:

(1)          in connection with any merger or consolidation in which the Maker
is the surviving corporation (other than any consolidation or merger in which
the previously outstanding shares of Common Stock of the Maker shall be changed
to or exchanged for the stock or other securities of another corporation), the
amount of consideration therefor shall be, deemed to be the fair value, as
determined reasonably and in good faith by the Board of Directors of the Maker,
of such portion of the assets and business of the nonsurviving corporation as
such Board may determine to be attributable to such shares of Common Stock,
Convertible Securities, rights or warrants or options, as the case may be; or

(2)          in the event of any consolidation or merger of the Maker in which
the Maker is not the surviving corporation or in which the previously
outstanding shares of Common Stock of the Maker shall be changed into or
exchanged for the stock or other securities of another corporation, or in the
event of any sale of all or substantially all of the assets of the Maker for
stock or other securities of any corporation, the Maker shall be deemed to have
issued a number of shares of its Common Stock for stock or securities or other
property of the other corporation computed on the basis of the actual exchange
ratio on which the transaction was predicated, and for a consideration equal to
the fair market value on the date of such transaction of all such stock or
securities or other property of the other corporation. If any such calculation
results in adjustment of the applicable Conversion Price, or the number of
shares of Common Stock issuable upon conversion of the Notes, the determination
of the applicable Conversion Price or the number of shares of Common Stock
issuable upon conversion of the Notes immediately prior to such merger,
consolidation or sale, shall be made after giving effect to such adjustment of
the number of shares of Common Stock issuable upon conversion of the Notes. In
the event Common Stock is issued with other shares or securities or other assets
of the Maker for consideration which covers both, the consideration computed as
provided in this Section 3.6(viii) shall be allocated among such securities and
assets as determined in good faith by the Board of Directors of the Maker.

(b)          Record Date. In case the Maker shall take record of the holders of
its Common Stock for the purpose of entitling them to subscribe for or purchase
Common Stock or Convertible Securities, then the date of the issue or sale of
the shares of Common Stock shall be deemed to be such record date.

(c)          Certain Issues Excepted. Anything herein to the contrary
notwithstanding, the Maker shall not be required to make any adjustment to the
Conversion Price in connection with (i) securities issued (other than for cash)
in connection with a merger, acquisition, or consolidation, (ii) securities
issued pursuant to the conversion or exercise of convertible or exercisable
securities issued or outstanding on or prior to the date of the Purchase
Agreement or issued pursuant to the Purchase Agreement (so long as the
conversion or exercise price in such securities are not amended to lower such
price and/or adversely affect the Holders), (iii) securities issued in
connection with bona fide strategic license agreements or other partnering
arrangements so long as such issuances are not for the purpose of raising
capital, (v) Common Stock issued or the issuance or grants of options to
purchase Common Stock pursuant to the Maker’s stock option plans and employee
stock purchase plans outstanding as they exist on the

 

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Issuance Date, and (vi) any warrants issued to the placement agent and its
designees for the transactions contemplated by the Purchase Agreement.

 

(d)          No Impairment. The Maker shall not, by amendment of its Certificate
of Incorporation or through any reorganization, transfer of assets,
consolidation, merger, dissolution, issue or sale of securities or any other
voluntary action, avoid or seek to avoid the observance or performance of any of
the terms to be observed or performed hereunder by the Maker, but will at all
times in good faith, assist in the carrying out of all the provisions of this
Section 3.6 and in the taking of all such action as may be necessary or
appropriate in order to protect the Conversion Rights of the Holder against
impairment. In the event a Holder shall elect to convert any Notes as provided
herein, the Maker cannot refuse conversion based on any claim that such Holder
or any one associated or affiliated with such Holder has been engaged in any
violation of law, violation of an agreement to which such Holder is a party or
for any reason whatsoever, unless, an injunction from a court, or notice,
restraining and or adjoining conversion of all or of said Notes shall have
issued and the Maker posts a surety bond for the benefit of such Holder in an
amount equal to one hundred ten percent (110%) of the amount of the Notes the
Holder has elected to convert, which bond shall remain in effect until the
completion of arbitration/litigation of the dispute and the proceeds of which
shall be payable to such Holder (as liquidated damages) in the event it obtains
judgment.

 

(e)          Certificates as to Adjustments. Upon occurrence of each adjustment
or readjustment of the Conversion Price or number of shares of Common Stock
issuable upon conversion of this Note pursuant to this Section 3.6, the Maker at
its expense shall promptly compute such adjustment or readjustment in accordance
with the terms hereof and furnish to the Holder a certificate setting forth such
adjustment and readjustment, showing in detail the facts upon which such
adjustment or readjustment is based. The Maker shall, upon written request of
the Holder, at any time, furnish or cause to be furnished to the Holder a like
certificate setting forth such adjustments and readjustments, the applicable
Conversion Price in effect at the time, and the number of shares of Common Stock
and the amount, if any, of other securities or property which at the time would
be received upon the conversion of this Note. Notwithstanding the foregoing, the
Maker shall not be obligated to deliver a certificate unless such certificate
would reflect an increase or decrease of at least one percent (1%) of such
adjusted amount.

(f)           Issue Taxes. The Maker shall pay any and all issue and other
taxes, excluding federal, state or local income taxes, that may be payable in
respect of any issue or delivery of shares of Common Stock on conversion of this
Note pursuant thereto; provided, however, that the Maker shall not be obligated
to pay any transfer taxes resulting from any transfer requested by the Holder in
connection with any such conversion.

(g)          Fractional Shares. No fractional shares of Common Stock shall be
issued upon conversion of this Note. In lieu of any fractional shares to which
the Holder would otherwise be entitled, the Maker shall pay cash equal to the
product of such fraction multiplied by the average of the Closing Bid Prices of
the Common Stock for the five (5) consecutive Trading Days immediately preceding
the Conversion Date. The term “Closing Bid Price” shall mean, on any particular
date (i) the last closing bid price per share of the Common Stock on such date
on the OTC Bulletin Board or another registered national stock exchange on which
the Common Stock is then listed, or if there is no such price on such date, then
the last closing bid

 

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price on such exchange or quotation system on the date nearest preceding such
date, or (ii) if the Common Stock is not listed then on the OTC Bulletin Board
or any registered national stock exchange, the last trading price for a share of
Common Stock in the over-the-counter market, as reported by the OTC Bulletin
Board or in the National Quotation Bureau Incorporated or similar organization
or agency succeeding to its functions of reporting prices) at the close of
business on such date, or (iii) if the Common Stock is not then reported by the
OTC Bulletin Board or the National Quotation Bureau Incorporated (or similar
organization or agency succeeding to its functions of reporting prices), then
the average of the “Pink Sheet” quotes for the relevant conversion period, as
determined in good faith by the Holder, or (iv) if the Common Stock is not then
publicly traded the fair market value of a share of Common Stock as determined
by the Holder and reasonably acceptable to the Maker.

(h)          Reservation of Common Stock. The Maker shall at all times when this
Note shall be outstanding, reserve and keep available out of its authorized but
unissued Common Stock, such number of shares of Common Stock as shall from time
to time be sufficient to effect the conversion of this Note; provided that the
number of shares of Common Stock so reserved shall at no time be less than one
hundred fifty percent (150%) of the number of shares of Common Stock for which
this Note is at any time convertible. The Maker shall, from time to time in
accordance with Nevada law, increase the authorized number of shares of Common
Stock if at any time the unissued number of authorized shares shall not be
sufficient to satisfy the Maker’s obligations under this Section 3.6(h).

(i)           Regulatory Compliance. If any shares of Common Stock to be
reserved for the purpose of conversion of this Note require registration or
listing with or approval of any governmental authority, stock exchange or other
regulatory body under any federal or state law or regulation or otherwise before
such shares may be validly issued or delivered upon conversion, the Maker shall,
at its sole cost and expense, in good faith and as expeditiously as possible,
endeavor to secure such registration, listing or approval, as the case may be.

 

 

Section 3.7

Prepayment.

(a)          Prepayment Upon an Event of Default. Notwithstanding anything to
the contrary contained herein, upon the occurrence of an Event of Default
described in Sections 2.1(b)-(k) hereof, the Holder shall have the right, at
such Holder’s option, to require the Maker to prepay in cash all or a portion of
this Note at a price equal to one hundred ten percent (110%) of the aggregate
principal amount of this Note plus all accrued and unpaid interest applicable at
the time of such request. Nothing in this Section 3.7(a) shall limit the
Holder’s rights under Section 2.2 hereof.

(b)          Prepayment Option Upon Major Transaction. In addition to all other
rights of the Holder contained herein, simultaneous with the occurrence of a
Major Transaction (as defined below), the Holder shall have the right, at the
Holder’s option, to require the Maker to prepay in cash all or a portion of the
Holder’s Notes at a price equal to one hundred ten percent (110%) of the
aggregate principal amount of this Note plus all accrued and unpaid interest
(the “Major Transaction Prepayment Price”).

 

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(c)          Prepayment Option Upon Triggering Event. In addition to all other
rights of the Holder contained herein, after a Triggering Event (as defined
below), the Holder shall have the right, at the Holder’s option, to require the
Maker to prepay all or a portion of this Note in cash at a price equal to one
hundred twenty percent (120%) of the aggregate principal amount of this Note
plus all accrued and unpaid interest (the “Triggering Event Prepayment Price,”
and, collectively with the Major Transaction Prepayment Price, the “Prepayment
Price”).

 

(d)

Intentionally Omitted.

(e)          “Major Transaction.” A “Major Transaction” shall be deemed to have
occurred at such time as any of the following events:

(i)           the consolidation, merger or other business combination of the
Maker with or into another Person (as defined in Section 4.13 hereof) (other
than (A) pursuant to a migratory merger effected solely for the purpose of
changing the jurisdiction of incorporation of the Maker or (B) a consolidation,
merger or other business combination in which holders of the Maker’s voting
power immediately prior to the transaction continue after the transaction to
hold, directly or indirectly, the voting power of the surviving entity or
entities necessary to elect a majority of the members of the board of directors
(or their equivalent if other than a corporation) of such entity or entities);

(ii)          the sale or transfer of more than fifty percent (50%) of the
Maker’s assets (based on the fair market value as determined in good faith by
the Maker’s Board of Directors) other than inventory in the ordinary course of
business in one or a related series of transactions;

(iii)         closing of a purchase, tender or exchange offer made to the
holders of more than fifty percent (50%) of the outstanding shares of Common
Stock in which more than fifty percent (50%) of the outstanding shares of Common
Stock were tendered and accepted; or

(iv)         a change in more than fifty percent (50%) of the current members of
the Company’s Board of Directors as of the Issuance Date.

(f)         “Triggering Event.” A “Triggering Event” shall be deemed to have
occurred at such time as any of the following events:

(i)             so long as any Notes are outstanding, the effectiveness of the
Registration Statement, after it becomes effective, (i) lapses for any reason
(including, without limitation, the issuance of a stop order) or (ii) is
unavailable to the Holder for sale of the shares of Common Stock, and such lapse
or unavailability continues for a period of twenty (20) consecutive Trading
Days, and the shares of Common Stock into which the Holder’s Notes can be
converted cannot be sold in the public securities market pursuant to Rule 144(k)
under the Securities Act, provided that the cause of such lapse or
unavailability is not due to factors primarily within the control of the Holder
of the Notes; and provided further that a Triggering Event shall not have
occurred if and to the extent the Maker exercised its rights set forth in
Section 3(n) of the Registration Rights Agreement;

 

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(ii)            the suspension from listing, without subsequent listing on any
one of, or the failure of the Common Stock to be listed on at least one of the
OTC Bulletin Board, the American Stock Exchange, the Nasdaq Global Market, the
Nasdaq Capital Market or The New York Stock Exchange, Inc., for a period of ten
(10) consecutive Trading Days;

(iii)          the Maker’s notice to the Holder or any Other Holder, including
by way of public announcement, at any time, of its inability to comply
(including for any of the reasons described in Section 3.8) or its intention not
to comply with proper requests for conversion of any Notes into shares of Common
Stock; or

(iv)           the Maker’s failure to comply with a Conversion Notice tendered
in accordance with the provisions of this Note within ten (10) Trading Days
after the receipt by the Maker of the Conversion Notice; or

(v)            the Maker deregisters its shares of Common Stock and as a result
such shares of Common Stock are no longer publicly traded; or

(vi)           the Maker consummates a “going private” transaction and as a
result the Common Stock is no longer registered under Sections 12(b) or 12(g) of
the Exchange Act; or

(vii)         the Maker breaches any representation, warranty, covenant or other
term or condition of the Purchase Agreement, this Note or any other agreement,
document, certificate or other instrument delivered in connection with the
transactions contemplated thereby or hereby, except to the extent that such
breach would not have a Material Adverse Effect (as defined in the Purchase
Agreement) and except, in the case of a breach of a covenant which is curable,
only if such breach continues for a period of a least twenty (20) business days.

 

(g)

Intentionally Omitted.

 

(h)          Mechanics of Prepayment at Option of Holder Upon Major Transaction.
No sooner than fifteen (15) days nor later than ten (10) days prior to the
consummation of a Major Transaction, but not prior to the public announcement of
such Major Transaction, the Maker shall deliver written notice thereof via
facsimile and overnight courier (“Notice of Major Transaction”) to the Holder of
this Note and the Other Holders. At any time after receipt of a Notice of Major
Transaction (or, in the event a Notice of Major Transaction is not delivered at
least ten (10) days prior to a Major Transaction, at any time within ten (10)
days prior to a Major Transaction), the Holder of this Note and the Other
Holders of the Other Notes then outstanding may require the Maker to prepay,
effective immediately prior to the consummation of such Major Transaction, all
or any portion of this Note then outstanding by delivering written notice
thereof via facsimile and overnight courier (“Notice of Prepayment at Option of
Holder Upon Major Transaction”) to the Maker, which Notice of Prepayment at
Option of Holder Upon Major Transaction shall indicate (i) the principal amount
of this Note that the Holder is electing to have prepaid and (ii) the applicable
Major Transaction Prepayment Price, as calculated pursuant to Section 3.7(b)
above.

 

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(i)           Mechanics of Prepayment at Option of Holder Upon Triggering Event.
Within two (2) business days after the occurrence of a Triggering Event, the
Maker shall deliver written notice thereof via facsimile and overnight courier
(“Notice of Triggering Event”) to the Holder and the Other Holders. At any time
after the earlier of the Holder’s receipt of a Notice of Triggering Event and
the Holder becoming aware of a Triggering Event, the Holder of this Note and the
Other Holders of the Other Notes then outstanding may require the Maker to
prepay all or any portion of this Note then outstanding by delivering written
notice thereof via facsimile and overnight courier (“Notice of Prepayment at
Option of Holder Upon Triggering Event”) to the Maker, which Notice of
Prepayment at Option of Holder Upon Triggering Event shall indicate (i) the
amount of the Note that the Holder is electing to have prepaid and (ii) the
applicable Triggering Event Prepayment Price, as calculated pursuant to Section
3.7(c) above. The Holder shall only be permitted to require the Maker to prepay
this Note pursuant to Section 3.7 hereof for the greater of a period of ten (10)
days after receipt by the Holder of a Notice of Triggering Event or for so long
as such Triggering Event is continuing.

(j)           Payment of Prepayment Price. Upon the Maker’s receipt of a
Notice(s) of Prepayment at Option of Holder Upon Triggering Event or a Notice(s)
of Prepayment at Option of Holder Upon Major Transaction from the Holder or the
Other Holders, the Maker shall immediately notify the Holder and the Other
Holders by facsimile of the Maker’s receipt of such Notice(s) of Prepayment at
Option of Holder Upon Triggering Event or Notice(s) of Prepayment at Option of
Holder Upon Major Transaction and the Holder and each Other Holder which has
sent such a notice shall promptly submit to the Maker the Holder’s certificates
representing this Note and the Other Notes which the Holder or Other Holder has
elected to have prepaid. The Maker shall deliver the applicable Triggering Event
Prepayment Price to the Holder within five (5) business days after the Maker’s
receipt of a Notice of Prepayment at Option of Holder Upon Triggering Event and,
in the case of a prepayment pursuant to Section 3.7(h), the Maker shall deliver
the applicable Major Transaction Prepayment Price immediately prior to the
consummation of the Major Transaction; provided that the Holder’s original Note
shall have been so delivered to the Maker; provided further that if the Maker is
unable to prepay all of the Notes to be prepaid, the Maker shall prepay an
amount from the Holder and each Other Holder of this Note and the Other Notes
being prepaid equal to such holder’s pro-rata amount (based on the number of
Notes held by such holder relative to the number of Notes outstanding) of all
Notes being prepaid. If the Maker shall fail to prepay all of the Notes
submitted for prepayment (other than pursuant to a dispute as to the arithmetic
calculation of the Prepayment Price), in addition to any remedy such holder of
the Notes may have under this Note and the Purchase Agreement, the applicable
Prepayment Price payable in respect of such Notes not prepaid shall bear
interest at the rate of two percent (2%) per month (prorated for partial months)
until paid in full. Until the Maker pays such unpaid applicable Prepayment Price
in full to a holder of the Notes submitted for prepayment, such holder shall
have the option (the “Void Optional Prepayment Option”) to, in lieu of
prepayment, require the Maker to promptly return to such holder(s) all of the
Notes that were submitted for prepayment by such holder(s) under this Section
3.7 and for which the applicable Prepayment Price has not been paid, by sending
written notice thereof to the Maker via facsimile (the “Void Optional Prepayment
Notice”). Upon the Maker’s receipt of such Void Optional Prepayment Notice(s)
and prior to payment of the full applicable Prepayment Price to such holder, (i)
the Notice(s) of Prepayment at Option of Holder Upon Triggering Event or the
Notice(s) of Prepayment at Option of Holder Upon Major Transaction, as the case
may be, shall be null and void with respect to those Notes submitted for

 

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prepayment and for which the applicable Prepayment Price has not been paid, (ii)
the Maker shall immediately return any Notes submitted to the Maker by each
holder for prepayment under this Section 3.7(j) and for which the applicable
Prepayment Price has not been paid and (iii) the Conversion Price of such
returned Notes shall be adjusted to the lesser of (A) the Conversion Price as in
effect on the date on which the Void Optional Prepayment Notice(s) is delivered
to the Maker and (B) the lowest Closing Bid Price during the period beginning on
the date on which the Notice(s) of Prepayment of Option of Holder Upon Major
Transaction or the Notice(s) of Prepayment at Option of Holder Upon Triggering
Event, as the case may be, is delivered to the Maker and ending on the date on
which the Void Optional Prepayment Notice(s) is delivered to the Maker; provided
that no adjustment shall be made if such adjustment would result in an increase
of the Conversion Price then in effect. A holder’s delivery of a Void Optional
Prepayment Notice and exercise of its rights following such notice shall not
effect the Maker’s obligations to make any payments which have accrued prior to
the date of such notice. Payments provided for in this Section 3.7 shall have
priority to payments to other stockholders in connection with a Major
Transaction.

 

Section 3.8

Inability to Fully Convert.

(a)          Holder’s Option if Maker Cannot Fully Convert. If, upon the Maker’s
receipt of a Conversion Notice, the Maker cannot issue shares of Common Stock
registered for resale under the Registration Statement for any reason,
including, without limitation, because the Maker (w) does not have a sufficient
number of shares of Common Stock authorized and available, (x) is otherwise
prohibited by applicable law or by the rules or regulations of any stock
exchange, interdealer quotation system or other self-regulatory organization
with jurisdiction over the Maker or any of its securities from issuing all of
the Common Stock which is to be issued to the Holder pursuant to a Conversion
Notice or (y) fails to have a sufficient number of shares of Common Stock
registered for resale under the Registration Statement, then the Maker shall
issue as many shares of Common Stock as it is able to issue in accordance with
the Holder’s Conversion Notice and, with respect to the unconverted portion of
this Note, the Holder, solely at Holder’s option, can elect to:

(i)           require the Maker to prepay that portion of this Note for which
the Maker is unable to issue Common Stock in accordance with the Holder’s
Conversion Notice (the “Mandatory Prepayment”) at a price per share equal to the
Triggering Event Prepayment Price as of such Conversion Date (the “Mandatory
Prepayment Price”);

(ii)          if the Maker’s inability to fully convert is pursuant to Section
3.8(a)(x) above, require the Maker to issue restricted shares of Common Stock in
accordance with such holder’s Conversion Notice;

(iii)         void its Conversion Notice and retain or have returned, as the
case may be, this Note that was to be converted pursuant to the Conversion
Notice (provided that the Holder’s voiding its Conversion Notice shall not
effect the Maker’s obligations to make any payments which have accrued prior to
the date of such notice);

(iv)         exercise its Buy-In rights pursuant to and in accordance with the
terms and provisions of Section 3.3(c) of this Note.

 

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(b)          Mechanics of Fulfilling Holder’s Election. The Maker shall
immediately send via facsimile to the Holder, upon receipt of a facsimile copy
of a Conversion Notice from the Holder which cannot be fully satisfied as
described in Section 3.8(a) above, a notice of the Maker’s inability to fully
satisfy the Conversion Notice (the “Inability to Fully Convert Notice”). Such
Inability to Fully Convert Notice shall indicate (i) the reason why the Maker is
unable to fully satisfy such holder’s Conversion Notice, (ii) the amount of this
Note which cannot be converted and (iii) the applicable Mandatory Prepayment
Price. The Holder shall notify the Maker of its election pursuant to Section
3.8(a) above by delivering written notice via facsimile to the Maker (“Notice in
Response to Inability to Convert”).

(c)          Payment of Prepayment Price. If the Holder shall elect to have its
Notes prepaid pursuant to Section 3.8(a)(i) above, the Maker shall pay the
Mandatory Prepayment Price to the Holder within thirty (30) days of the Maker’s
receipt of the Holder’s Notice in Response to Inability to Convert, provided
that prior to the Maker’s receipt of the Holder’s Notice in Response to
Inability to Convert the Maker has not delivered a notice to the Holder stating,
to the satisfaction of the Holder, that the event or condition resulting in the
Mandatory Prepayment has been cured and all Conversion Shares issuable to the
Holder can and will be delivered to the Holder in accordance with the terms of
this Note. If the Maker shall fail to pay the applicable Mandatory Prepayment
Price to the Holder on the date that is one (1) business day following the
Maker’s receipt of the Holder’s Notice in Response to Inability to Convert
(other than pursuant to a dispute as to the determination of the arithmetic
calculation of the Prepayment Price), in addition to any remedy the Holder may
have under this Note and the Purchase Agreement, such unpaid amount shall bear
interest at the rate of two percent (2%) per month (prorated for partial months)
until paid in full. Until the full Mandatory Prepayment Price is paid in full to
the Holder, the Holder may (i) void the Mandatory Prepayment with respect to
that portion of the Note for which the full Mandatory Prepayment Price has not
been paid, (ii) receive back such Note, and (iii) require that the Conversion
Price of such returned Note be adjusted to the lesser of (A) the Conversion
Price as in effect on the date on which the Holder voided the Mandatory
Prepayment and (B) the lowest Closing Bid Price during the period beginning on
the Conversion Date and ending on the date the Holder voided the Mandatory
Prepayment.

(d)          Pro-rata Conversion and Prepayment. In the event the Maker receives
a Conversion Notice from the Holder and the Other Holders on the same day and
the Maker can convert and prepay some, but not all, of this Note and the Other
Notes pursuant to this Section 3.8, the Maker shall convert and prepay from the
Holder and each Other Holder electing to have its Other Notes converted and
prepaid at such time an amount equal to the Holder or such Other Holder’s
pro-rata amount (based on the principal amount of this Note held by the Holder
or the Other Notes held by the Other Holder relative to the principal amount of
the Notes and Other Notes outstanding) of all the Notes and the Other Notes
being converted and prepaid at such time.

Section 3.9        No Rights as Shareholder. Nothing contained in this Note
shall be construed as conferring upon the Holder, prior to the conversion of
this Note, the right to vote or to receive dividends or to consent or to receive
notice as a shareholder in respect of any meeting of shareholders for the
election of directors of the Maker or of any other matter, or any other rights
as a shareholder of the Maker.

 

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ARTICLE IV

MISCELLANEOUS

Section 4.1    Notices. Any notice, demand, request, waiver or other
communication required or permitted to be given hereunder shall be in writing
and shall be effective (a) upon hand delivery, telecopy or facsimile at the
address or number designated in the Purchase Agreement (if delivered on a
business day during normal business hours where such notice is to be received),
or the first business day following such delivery (if delivered other than on a
business day during normal business hours where such notice is to be received)
or (b) on the second business day following the date of mailing by express
courier service, fully prepaid, addressed to such address, or upon actual
receipt of such mailing, whichever shall first occur. The Maker will give
written notice to the Holder at least ten (10) days prior to the date on which
the Maker takes a record (x) with respect to any dividend or distribution upon
the Common Stock, (y) with respect to any pro rata subscription offer to holders
of Common Stock or (z) for determining rights to vote with respect to any
Organic Change, dissolution, liquidation or winding-up and in no event shall
such notice be provided to the Holder prior to such information being made known
to the public. The Maker will also give written notice to the Holder at least
ten (10) days prior to the date on which any Organic Change, dissolution,
liquidation or winding-up will take place and in no event shall such notice be
provided to the Holder prior to such information being made known to the public.
The Maker shall promptly notify the Holder of this Note of any notices sent or
received, or any actions taken with respect to the Other Notes.

Section 4.2        Governing Law. This Note shall be governed by and construed
in accordance with the internal laws of the State of New York, without giving
effect to any of the conflicts of law principles which would result in the
application of the substantive law of another jurisdiction. This Note shall not
be interpreted or construed with any presumption against the party causing this
Note to be drafted.

Section 4.3        Headings. Article and section headings in this Note are
included herein for purposes of convenience of reference only and shall not
constitute a part of this Note for any other purpose.

Section 4.4       Remedies, Characterizations, Other Obligations, Breaches and
Injunctive Relief. The remedies provided in this Note shall be cumulative and in
addition to all other remedies available under this Note, at law or in equity
(including, without limitation, a decree of specific performance and/or other
injunctive relief), no remedy contained herein shall be deemed a waiver of
compliance with the provisions giving rise to such remedy and nothing herein
shall limit a Holder’s right to pursue actual damages for any failure by the
Maker to comply with the terms of this Note. Amounts set forth or provided for
herein with respect to payments, conversion and the like (and the computation
thereof) shall be the amounts to be received by the Holder thereof and shall
not, except as expressly provided herein, be subject to any other obligation of
the Maker (or the performance thereof). The Maker acknowledges that a breach by
it of its obligations hereunder will cause irreparable and material harm to the
Holder and that the remedy at law for any such breach may be inadequate.
Therefore the Maker agrees that, in the event of any such breach or threatened
breach, the Holder shall be entitled, in addition to all other available rights
and remedies, at law or in equity, to seek and obtain such equitable

 

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relief, including but not limited to an injunction restraining any such breach
or threatened breach, without the necessity of showing economic loss and without
any bond or other security being required.

Section 4.5       Enforcement Expenses. The Maker agrees to pay all costs and
expenses of enforcement of this Note, including, without limitation, reasonable
attorneys’ fees and expenses.

Section 4.6        Binding Effect. The obligations of the Maker and the Holder
set forth herein shall be binding upon the successors and assigns of each such
party, whether or not such successors or assigns are permitted by the terms
hereof.

Section 4.7        Amendments. This Note may not be modified or amended in any
manner except in writing executed by the Maker and the Holder.

Section 4.8      Compliance with Securities Laws. The Holder of this Note
acknowledges that this Note is being acquired solely for the Holder’s own
account and not as a nominee for any other party, and for investment, and that
the Holder shall not offer, sell or otherwise dispose of this Note. This Note
and any Note issued in substitution or replacement therefor shall be stamped or
imprinted with a legend in substantially the following form:

“THIS NOTE AND THE SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION HEREOF HAVE
NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “ACT”), OR
APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE SOLD OR TRANSFERRED IN THE
ABSENCE OF SUCH REGISTRATION OR RECEIPT BY THE MAKER OF AN OPINION OF COUNSEL IN
THE FORM, SUBSTANCE AND SCOPE REASONABLY SATISFACTORY TO THE MAKER THAT THIS
NOTE AND THE SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION HEREOF HAVE MAY BE
SOLD, TRANSFERRED, HYPOTHECATED OR OTHERWISE DISPOSED OF, UNDER AN EXEMPTION
FROM REGISTRATION UNDER THE ACT AND SUCH STATE SECURITIES LAWS.”

 

Section 4.9       Consent to Jurisdiction. Each of the Maker and the Holder (i)
hereby irrevocably submits to the exclusive jurisdiction of the United States
District Court sitting in the Southern District of New York and the courts of
the State of New York located in New York county for the purposes of any suit,
action or proceeding arising out of or relating to this Note and (ii) hereby
waives, and agrees not to assert in any such suit, action or proceeding, any
claim that it is not personally subject to the jurisdiction of such court, that
the suit, action or proceeding is brought in an inconvenient forum or that the
venue of the suit, action or proceeding is improper. Each of the Maker and the
Holder consents to process being served in any such suit, action or proceeding
by mailing a copy thereof to such party at the address in effect for notices to
it under the Purchase Agreement and agrees that such service shall constitute
good and sufficient

 

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service of process and notice thereof. Nothing in this Section 4.9 shall affect
or limit any right to serve process in any other manner permitted by law. Each
of the Maker and the Holder hereby agree that the prevailing party in any suit,
action or proceeding arising out of or relating to this Note shall be entitled
to reimbursement for reasonable legal fees from the non-prevailing party.

Section 4.10     Parties in Interest. This Note shall be binding upon, inure to
the benefit of and be enforceable by the Maker, the Holder and their respective
successors and permitted assigns.

Section 4.11     Failure or Indulgence Not Waiver. No failure or delay on the
part of the Holder in the exercise of any power, right or privilege hereunder
shall operate as a waiver thereof, nor shall any single or partial exercise of
any such power, right or privilege preclude other or further exercise thereof or
of any other right, power or privilege.

Section 4.12     Maker Waivers. Except as otherwise specifically provided
herein, the Maker and all others that may become liable for all or any part of
the obligations evidenced by this Note, hereby waive presentment, demand, notice
of nonpayment, protest and all other demands’ and notices in connection with the
delivery, acceptance, performance and enforcement of this Note, and do hereby
consent to any number of renewals of extensions of the time or payment hereof
and agree that any such renewals or extensions may be made without notice to any
such persons and without affecting their liability herein and do further consent
to the release of any person liable hereon, all without affecting the liability
of the other persons, firms or Maker liable for the payment of this Note, AND DO
HEREBY WAIVE TRIAL BY JURY.

(a)          No delay or omission on the part of the Holder in exercising its
rights under this Note, or course of conduct relating hereto, shall operate as a
waiver of such rights or any other right of the Holder, nor shall any waiver by
the Holder of any such right or rights on any one occasion be deemed a waiver of
the same right or rights on any future occasion.

(b)          THE MAKER ACKNOWLEDGES THAT THE TRANSACTION OF WHICH THIS NOTE IS A
PART IS A COMMERCIAL TRANSACTION, AND TO THE EXTENT ALLOWED BY APPLICABLE LAW,
HEREBY WAIVES ITS RIGHT TO NOTICE AND HEARING WITH RESPECT TO ANY PREJUDGMENT
REMEDY WHICH THE HOLDER OR ITS SUCCESSORS OR ASSIGNS MAY DESIRE TO USE.

Section 4.13      Definitions. For the purposes hereof, the following terms
shall have the following meanings:

 

“Person” means an individual or a corporation, partnership, trust, incorporated
or unincorporated association, joint venture, limited liability company, joint
stock company, government (or an agency or political subdivision thereof) or
other entity of any kind.

 

“Trading Day” means (a) a day on which the Common Stock is traded on the OTC
Bulletin Board, or (b) if the Common Stock is not traded on the OTC Bulletin
Board, a day on which the Common Stock is quoted in the over-the-counter market
as reported by the National Quotation Bureau Incorporated (or any similar
organization or agency succeeding its functions of reporting prices); provided,
however, that in the event that the Common Stock is not

 

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listed or quoted as set forth in (a) or (b) hereof, then Trading Day shall mean
any day except Saturday, Sunday and any day which shall be a legal holiday or a
day on which banking institutions in the State of New York are authorized or
required by law or other government action to close.

 

 

[REMAINDER OF NOTE INTENTIONALLY LEFT BLANK]

 

 

 

 

 

 

 

 

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MERCHANDISE CREATIONS, INC.

 

By: ______________________________

Name:

Title:

 

 

 

 

 

 

 

 

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EXHIBIT A

 

WIRE INSTRUCTIONS

 

Payee: _____________________________________________________

Bank: _____________________________________________________

Address:

_____________________________________________________

_____________________________________________________

Bank No.: __________________________________________________

Account No.: _______________________________________________

Account Name: ______________________________________________

 

 

 

 

 

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FORM OF

NOTICE OF CONVERSION

(To be Executed by the Registered Holder in order to Convert the Note)

The undersigned hereby irrevocably elects to convert $ ________________ of the
principal amount of the above Note No. ___ into shares of Common Stock of
Merchandise Creations, Inc. (the “Maker”) according to the conditions hereof, as
of the date written below.

Date of Conversion _________________________________________________________

Applicable Conversion Price __________________________________________________

Number of shares of Common Stock beneficially owned or deemed beneficially owned
by the Holder on the Date of Conversion: _________________________

Signature___________________________________________________________________

[Name]

Address:

__________________________________________________________________

__________________________________________________________________

 

 

 

 

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