THIS AMENDED AND RESTATED 8% SENIOR SECURED CONVERTIBLE NOTE AMENDS AND RESTATES
THE 8% SENIOR SECURED CONVERTIBLE NOTE ORIGINALLY ISSUED PURSUANT TO THE
SECURITIES PURCHASE AGREEMENT, DATED AS OF MARCH 5, 2008, BY AND BETWEEN BLUE
HOLDINGS, INC., A NEVADA CORPORATION, AND THE PURCHASER NAMED THEREIN.

NEITHER THIS SECURITY NOR THE SECURITIES INTO WHICH THIS SECURITY IS CONVERTIBLE
HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE
SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM
REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES
ACT”), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN
EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN
AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION
REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE
SECURITIES LAWS. THIS SECURITY AND THE SECURITIES ISSUABLE UPON CONVERSION OF
THIS SECURITY MAY BE PLEDGED IN CONNECTION WITH A BONA FIDE MARGIN ACCOUNT OR
OTHER LOAN SECURED BY SUCH SECURITIES.

Original Issue Date: March 5, 2008
Original Conversion Price (subject to adjustment herein): $0.40

$2,500,000

BLUE HOLDINGS, INC.
AMENDED AND RESTATED 8% SENIOR SECURED CONVERTIBLE NOTE

THIS NOTE is one of a series of duly authorized and validly issued 8% Senior
Secured Convertible Notes of Blue Holdings, Inc., a Nevada corporation (the
“Company”), having its principal place of business at 4901 Zambrano Street,
Commerce, California 90040, designated as its 8% Senior Secured Convertible
Notes (this Note, the “Note” and, collectively with the other Notes of such
series, the “Notes”).

FOR VALUE RECEIVED, the Company promises to pay to GEMINI MASTER FUND, LTD. or
its registered assigns (the “Holder”), or shall have paid pursuant to the terms
hereunder, the principal sum of $2,500,000 on September 1, 2010 (the “Maturity
Date”) or such earlier date as this Note is required or permitted to be repaid
as provided hereunder, or such later date as may be permitted by the Holder as
set forth in Section 2 hereof, and to pay interest to the Holder on the
aggregate unconverted and then outstanding principal amount of this Note in
accordance with the provisions hereof.

The Company’s and its Subsidiaries’ obligations under this Note and the other
Transaction Documents are secured by the Collateral (as defined in the Security
Agreement, including without limitation all Intellectual Property Rights)
pursuant to the terms of the Security Documents and the obligations under this
Note are guaranteed by the Company’s Subsidiaries pursuant to the Subsidiary
Guarantee.
 
 
1

--------------------------------------------------------------------------------

 
 
This Note is subject to the following additional provisions:

Section 1. Definitions. For the purposes hereof, in addition to the terms
defined elsewhere in this Note (a) capitalized terms not otherwise defined
herein shall have the meanings set forth in the Purchase Agreement and (b) the
following terms shall have the following meanings:

“Alternate Consideration” shall have the meaning set forth in Section 5(e).

“Amendment” means that certain Amendment Agreement, dated as of July 30, 2008,
amending this Note (among other things).

“Bankruptcy Event” means any of the following events: (a) the Company or any
Significant Subsidiary (as such term is defined in Rule 1-02(w) of Regulation
S-X) thereof commences a case or other proceeding under any bankruptcy,
reorganization, arrangement, adjustment of debt, relief of debtors, dissolution,
insolvency or liquidation or similar law of any jurisdiction relating to the
Company or any Significant Subsidiary thereof; (b) there is commenced against
the Company or any Significant Subsidiary thereof any such case or proceeding
that is not dismissed within 60 days after commencement; (c) the Company or any
Significant Subsidiary thereof is adjudicated insolvent or bankrupt or any order
of relief or other order approving any such case or proceeding is entered; (d)
the Company or any Significant Subsidiary thereof suffers any appointment of any
custodian or the like for it or any substantial part of its property that is not
discharged or stayed within 60 calendar days after such appointment; (e) the
Company or any Significant Subsidiary thereof makes a general assignment for the
benefit of creditors; (f) the Company or any Significant Subsidiary thereof
calls a meeting of its creditors with a view to arranging a composition,
adjustment or restructuring of its debts; or (g) the Company or any Significant
Subsidiary thereof, by any act or failure to act, expressly indicates its
consent to, approval of or acquiescence in any of the foregoing or takes any
corporate or other action for the purpose of effecting any of the foregoing.

“Base Conversion Price” shall have the meaning set forth in Section 5(b).

“Business Day” means any day except any Saturday, any Sunday, any day which
shall be a federal legal holiday in the United States or any day on which
banking institutions in the State of New York are authorized or required by law
or other governmental action to close.

“Buy-In” shall have the meaning set forth in Section 4(d)(v).

“Change of Control Transaction” means the occurrence after the date hereof of
any of (i) an acquisition after the date hereof by an individual or legal entity
or “group” (as described in Rule 13d-5(b)(1) promulgated under the Exchange Act)
of effective control (whether through legal or beneficial ownership of capital
stock of the Company, by contract or otherwise) of in excess of 33% of the
voting securities of the Company (other than by means of conversion or exercise
of the Notes and the Securities issued together with the Notes) (for
clarification, retention of the current ownership by Paul Guez shall not be
deemed a Change of Control Transaction), or (ii) the Company merges into or
consolidates with any other Person, or any Person merges into or consolidates
with the Company and, after giving effect to such transaction, the stockholders
of the Company immediately prior to such transaction own less than 66% of the
aggregate voting power of the Company or the successor entity of such
transaction, or (iii) the Company sells or transfers all or substantially all of
its assets to another Person and the stockholders of the Company immediately
prior to such transaction own less than 66% of the aggregate voting power of the
acquiring entity immediately after the transaction, or (iv) a replacement at one
time or within a three year period of more than one-half of the members of the
Company’s board of directors which is not approved by a majority of those
individuals who are members of the board of directors on the date hereof (or by
those individuals who are serving as members of the board of directors on any
date whose nomination to the board of directors was approved by a majority of
the members of the board of directors who are members on the date hereof), or
(v) the execution by the Company of an agreement to which the Company is a party
or by which it is bound, providing for any of the events set forth in clauses
(i) through (iv) above.
 
 
2

--------------------------------------------------------------------------------

 
 
“Conversion Date” shall have the meaning set forth in Section 4(a).

“Conversion Price” shall have the meaning set forth in Section 4(b).

“Conversion Shares” means, collectively, the shares of Common Stock issued or
issuable upon conversion or redemption of this Note in accordance with the terms
hereof, including without limitation shares of Common Stock issued or issuable
as interest hereunder or as damages under the Transaction Documents.

“Note Register” shall have the meaning set forth in Section 2(c).

“Dilutive Issuance” shall have the meaning set forth in Section 5(b).

“Dilutive Issuance Notice” shall have the meaning set forth in Section 5(b).

“Equity Conditions” means, during the period in question, (i) the Company shall
have duly honored all conversions and redemptions scheduled to occur or
occurring by virtue of one or more Notices of Conversion of the Holder, if any,
(ii) the Company shall have paid all liquidated damages and other amounts owing
to the Holder in respect of this Note, (iii) all of the shares of Common Stock
issued or issuable pursuant to the Transaction Documents may be sold by the
Holder pursuant to either (a) Section (b)(1)(i) of Rule 144 and the Company has
been subject to the reporting requirements of Section 13 or 15(d) of the
Exchange Act for the then preceding 90 days and has filed all reports required
to be filed thereunder during the then preceding 12 months (or such shorter
period that the Company was required to file such reports) or (b) an effective
Registration Statement (and the Company believes, in good faith, that such
effectiveness will continue uninterrupted for the foreseeable future), (iv) the
Common Stock is trading on a Trading Market and all of the shares issuable
pursuant to the Transaction Documents are listed or quoted for trading on such
Trading Market (and the Company believes, in good faith, that trading of the
Common Stock on a Trading Market will continue uninterrupted for the foreseeable
future), (v) there is a sufficient number of authorized but unissued and
otherwise unreserved shares of Common Stock for the issuance of all of the
shares issuable pursuant to the Transaction Documents, (vi) there is no existing
Event of Default or no existing event which, with the passage of time or the
giving of notice, would constitute an Event of Default, (vii) the issuance of
the shares in question (or, in the case of an Optional or Monthly Redemption,
the shares issuable upon conversion in full of the Optional or Monthly
Redemption Amount) to the Holder would not violate the limitations set forth in
Section 4(c) below, (viii) there has been no public announcement of a pending or
proposed Fundamental Transaction or Change of Control Transaction that has not
been consummated, (ix) the Holder is not in possession of any information
provided by the Company that constitutes, or may constitute, material non-public
information, and (x) the closing bid price per share of Common Stock on the
Trading Market for each of the ten (10) Trading Days immediately preceding the
applicable date in question shall be greater than $0.30.
 
 
3

--------------------------------------------------------------------------------

 
 
“Event of Default” shall have the meaning set forth in Section 8.

“Factor Indebtedness” means indebtedness to the Company’s factor which has
provided or is providing factoring financing secured by, or pursuant to the sale
of, accounts receivable and inventory of the Company or its subsidiaries.

  “Forced Conversion” shall have the meaning set forth in Section 6(d).

“Forced Conversion Date” shall have the meaning set forth in Section 6(d).

“Forced Conversion Notice” shall have the meaning set forth in Section 6(d).

“Forced Conversion Notice Date” shall have the meaning set forth in Section
6(d).

“Fundamental Transaction” shall have the meaning set forth in Section 5(e).

“Guez Note” means that certain 8% Senior Convertible Note issued or to be issued
by the Company to Paul Guez in the principal amount of $1,618,093.15.

“Late Fees” shall have the meaning set forth in Section 2(d).

“Mandatory Default Amount” means the sum of (i) the greater of (A) 125% of the
outstanding principal amount of this Note, plus 100% of accrued and unpaid
interest hereon, or (B) the outstanding principal amount of this Note, plus all
accrued and unpaid interest hereon, divided by the lesser of the Conversion
Price and the Market Redemption Price on the date the Mandatory Default Amount
is either (a) demanded (if demand or notice is required to create an Event of
Default) or otherwise due or (b) paid in full, whichever has a lower price,
multiplied by the VWAP on the date the Mandatory Default Amount is either (x)
demanded or otherwise due or (y) paid in full, whichever has a higher VWAP, and
(ii) all other amounts, costs, expenses and liquidated damages due in respect of
this Note.

“Market Pricing Period” means the 10 consecutive Trading Day period used in
determining the Market Redemption Price.
 
 
4

--------------------------------------------------------------------------------

 
 
“Market Redemption Price” means 85% of the average of the closing bid prices for
the 10 consecutive Trading Days immediately preceding the date as of which the
Market Redemption Price is being determined (subject to appropriate and
equitable adjustment for any stock dividend, stock split, stock combination or
other similar event affecting the Common Stock during such 10 Trading Day
period).

“Monthly Redemption” means the redemption of this Note pursuant to Section 6(b)
hereof.
 
“Monthly Redemption Amount” means, as to a Monthly Redemption, 1/24th of the
original principal amount of this Note (as modified by the Amendment), plus all
accrued but unpaid interest, liquidated damages and any other amounts then owing
to the Holder in respect of this Note.

“Monthly Redemption Date” means the first day of each calendar month, commencing
on the first day of the first full calendar month occurring after the date which
is six (6) months following the Original Issue Date on which this Note was
issued, and terminating upon the full redemption of 100% of the principal amount
of this Note.

“Monthly Redemption Notice” shall have the meaning set forth in Section 6(b)
hereof.
 
“New York Courts” shall have the meaning set forth in Section 9(d).

“Notice of Conversion” shall have the meaning set forth in Section 4(a).

“Optional Redemption” shall have the meaning set forth in Section 6(a).

“Optional Redemption Amount” means the sum of (i) 120% of the then outstanding
principal amount of this Note, (ii) all accrued but unpaid interest thereon, and
(iii) all liquidated damages and other amounts due in respect of this Note.

“Optional Redemption Date” shall have the meaning set forth in Section 6(a).

“Optional Redemption Notice” shall have the meaning set forth in Section 6(a).

“Optional Redemption Notice Date” shall have the meaning set forth in Section
6(a).

“Original Issue Date” means the date of the first issuance of this Note,
regardless of any transfers of this Note and regardless of the number of
instruments which may be issued to evidence this Note.

“Permitted Indebtedness” means (a) the indebtedness evidenced by the Notes, (b)
the Indebtedness existing on the initial Closing Date and set forth on Schedule
3.1(aa) attached to the Purchase Agreement, (c) lease obligations and purchase
money indebtedness of up to $100,000, in the aggregate, incurred in connection
with the acquisition of capital assets and lease obligations with respect to
newly acquired or leased assets, (d) Factor Indebtedness, and (e) indebtedness
that (i) is expressly subordinate to the Notes pursuant to a written
subordination agreement with the Purchasers that is acceptable to each Purchaser
in its sole and absolute discretion and (ii) matures at a date later than the
Maturity Date.
 
 
5

--------------------------------------------------------------------------------

 
 
“Permitted Lien” means the individual and collective reference to the following:
(a) Liens for taxes, assessments and other governmental charges or levies not
yet due or Liens for taxes, assessments and other governmental charges or levies
being contested in good faith and by appropriate proceedings for which adequate
reserves (in the good faith judgment of the management of the Company) have been
established in accordance with GAAP; (b) Liens imposed by law which were
incurred in the ordinary course of the Company’s business, such as carriers’,
warehousemen’s and mechanics’ Liens, statutory landlords’ Liens, and other
similar Liens arising in the ordinary course of the Company’s business, and
which (x) do not individually or in the aggregate materially detract from the
value of such property or assets or materially impair the use thereof in the
operation of the business of the Company and its consolidated Subsidiaries or
(y) are being contested in good faith by appropriate proceedings, which
proceedings have the effect of preventing for the foreseeable future the
forfeiture or sale of the property or asset subject to such Lien; (c) Liens
incurred in connection with Permitted Indebtedness under clauses (a), (b), (c)
and (d) thereunder, provided that such Liens are not secured by assets of the
Company or its Subsidiaries other than the assets so acquired, leased or
factored against.
 
“Purchase Agreement” means the Securities Purchase Agreement, dated as of March
5, 2008, among the Company and the original Holders, as amended, modified or
supplemented from time to time in accordance with its terms.

“Registration Statement” means an effective registration statement under the
Securities Act that registers the resale of all Conversion Shares of the Holder,
names the Holder as a “selling stockholder” therein, and contains a current
prospectus not subject to any blackout, suspension or stop order.

“Securities Act” means the Securities Act of 1933, as amended, and the rules and
regulations promulgated thereunder.

“Share Delivery Date” shall have the meaning set forth in Section 4(d).

“Shareholder Approval” shall have the meaning set forth in the Amendment.

“Subsidiary” shall have the meaning set forth in the Purchase Agreement.

“Threshold Period” shall have the meaning set forth in Section 6(d).

“Trading Day” means a day on which the principal Trading Market is open for
business.

“Trading Market” means the following markets or exchanges on which the Common
Stock is listed or quoted for trading on the date in question: the American
Stock Exchange, the Nasdaq Capital Market, the Nasdaq Global Market, the Nasdaq
Global Select Market, the New York Stock Exchange or the OTC Bulletin Board.
 
 
6

--------------------------------------------------------------------------------

 
 
“Transaction Documents” shall have the meaning set forth in the Purchase
Agreement.

“VWAP” means, for any date, the price determined by the first of the following
clauses that applies: (a) if the Common Stock is then listed or quoted on a
Trading Market, the daily volume weighted average price of the Common Stock for
such date (or the nearest preceding date) on the Trading Market on which the
Common Stock is then listed or quoted for trading as reported by Bloomberg L.P.
(based on a Trading Day from 9:30 a.m. (New York City time) to 4:02 p.m. (New
York City time)); (b)  if the OTC Bulletin Board is not a Trading Market, the
volume weighted average price of the Common Stock for such date (or the nearest
preceding date) on the OTC Bulletin Board; (c) if the Common Stock is not then
quoted for trading on the OTC Bulletin Board and if prices for the Common Stock
are then reported in the “Pink Sheets” published by Pink Sheets, LLC (or a
similar organization or agency succeeding to its functions of reporting prices),
the most recent bid price per share of the Common Stock so reported; or (d) in
all other cases, the fair market value of a share of Common Stock as determined
by an independent appraiser selected in good faith by the Holder and reasonably
acceptable to the Company.

Section 2. Interest; No Prepayment.
 
a)  Interest Rate. Interest shall accrue daily on the outstanding principal
amount of this Note at a rate per annum equal to 8%.

b)  Payment of Interest. On each Monthly Redemption Date and on the Maturity
Date, the Company shall pay to the Holder any accrued but unpaid interest
hereunder on the aggregate unconverted and then outstanding principal amount of
this Note, and on each Conversion Date and Optional Redemption Date the Company
shall pay to the Holder any accrued but unpaid interest hereunder on that
portion of the principal amount then being converted or redeemed, as the case
may be. The amount of interest payable on each Monthly Redemption Date,
Conversion Date, Maturity Date and Optional Redemption Date (“Interest Amount”)
shall be added to and included in the principal amount being so converted or
redeemed on such date.
 
c)  Interest Calculations. Interest shall be calculated on the basis of a
360-day year, consisting of twelve 30 calendar day periods, and shall accrue
daily commencing on the Original Issue Date until payment in full of the
outstanding principal, together with all accrued and unpaid interest, liquidated
damages and other amounts which may become due hereunder, has been made.
Interest hereunder will be paid to the Person in whose name this Note is
registered on the records of the Company regarding registration and transfers of
this Note (the “Note Register”). Except as otherwise provided herein, if at any
time the Company pays interest partially in cash and partially in shares of
Common Stock to the holders of the Notes, then such payment of cash shall be
distributed ratably among the holders of the then-outstanding Notes based on
their (or their predecessor’s) initial purchases of Notes pursuant to the
Purchase Agreement.
 
 
7

--------------------------------------------------------------------------------

 
 
d)  Late Fees. All overdue accrued and unpaid interest to be paid hereunder
shall entail a late fee at an interest rate equal to the lesser of 20% per annum
or the maximum rate permitted by applicable law (“Late Fees”) which shall accrue
daily from the date such interest is due hereunder through and including the
date of actual payment in full.

e)  No Prepayment. Except as otherwise set forth in this Note, the Company may
not prepay any portion of the principal amount of this Note without the prior
written consent of the Holder.

Section 3. Registration of Transfers and Exchanges.
 
a)  Different Denominations. This Note is exchangeable for an equal aggregate
principal amount of Notes of different authorized denominations, as requested by
the Holder surrendering the same. No service charge will be payable for such
exchange.
 
b)  Investment Representations. This Note has been issued subject to certain
investment representations of the original Holder set forth in the Purchase
Agreement and may be transferred or exchanged only in compliance with the
Purchase Agreement and applicable federal and state securities laws and
regulations.

c)  Reliance on Note Register. Prior to due presentment for transfer to the
Company of this Note, the Company and any agent of the Company may treat the
Person in whose name this Note is duly registered on the Note Register as the
owner hereof for the purpose of receiving payment as herein provided and for all
other purposes, whether or not this Note is overdue, and neither the Company nor
any such agent shall be affected by notice to the contrary.

Section 4. Conversion.
 
a)  Voluntary Conversion. At any time after the Original Issue Date until this
Note is no longer outstanding, this Note shall be convertible, in whole or in
part, into shares of Common Stock at the option of the Holder, at any time and
from time to time (subject to the conversion limitations set forth in
Section 4(c) hereof). The Holder shall effect conversions by delivering to the
Company a Notice of Conversion, the form of which is attached hereto as Annex A
(a “Notice of Conversion”), specifying therein the principal amount of this Note
to be converted and the future date (which may be the same date as the date such
notice is deemed effective pursuant to Section 9(a)) on which such conversion
shall be effected (such date, the “Conversion Date”). If no Conversion Date is
specified in a Notice of Conversion, the Conversion Date shall be the date that
such Notice of Conversion is deemed delivered hereunder. To effect conversions
hereunder, the Holder shall not be required to physically surrender this Note to
the Company unless the entire principal amount of this Note, plus all accrued
and unpaid interest thereon, has been so converted. Conversions hereunder shall
have the effect of lowering the outstanding principal amount of this Note in an
amount equal to the applicable conversion. The Holder and the Company shall
maintain records showing the principal amount(s) converted and the date of such
conversion(s). In the event of any dispute or discrepancy, the records of the
Holder shall be controlling and determinative in the absence of manifest error.
The Holder, and any assignee by acceptance of this Note, acknowledge and agree
that, by reason of the provisions of this paragraph, following conversion of a
portion of this Note, the unpaid and unconverted principal amount of this Note
may be less than the amount stated on the face hereof.
 
 
8

--------------------------------------------------------------------------------

 
 
b)  Conversion Price. The conversion price shall be equal to $0.40, subject to
adjustment herein (the “Conversion Price”).

c)  Conversion Limitations.

i.  Issuance Limitations. Notwithstanding anything herein to the contrary, if
the Company has not obtained Shareholder Approval, then the Company may not
issue, upon conversion of this Note or the issuance of shares of Common Stock
for the payment of principal, interest or liquidated damages, a number of shares
of Common Stock which, when aggregated with any shares of Common Stock issued on
or after the Original Issue Date and prior to such Conversion Date (A) in
connection with the conversion of any Notes issued pursuant to the Purchase
Agreement or as payment of principal, interest or liquidated damages, (B) in
connection with the exercise of any Warrants issued pursuant to the Purchase
Agreement and (C) in connection with any warrants issued to any registered
broker-dealer as a fee in connection with the issuance of the Securities
pursuant to the Purchase Agreement, would exceed 19.99% of the number of shares
of Common Stock outstanding on the Trading Day immediately preceding the date of
the Purchase Agreement (subject to adjustment for forward and reverse stock
splits, recapitalizations and the like) (such number of shares, the “Issuable
Maximum”). Each Holder shall be entitled to a portion of the Issuable Maximum
equal to the quotient obtained by dividing (x) the original principal amount of
the Holder’s Note by (y) the aggregate original principal amount of all Notes
issued to all Holders under the Purchase Agreement. In addition, each Holder may
allocate its pro-rata portion of the Issuable Maximum among Notes and Warrants
held by it in its sole discretion. Such portion shall be adjusted upward ratably
in the event a Holder no longer holds any Notes or Warrants and the amount of
shares issued to the Holder pursuant to the Holder’s Notes and Warrants was less
than the Holder’s pro-rata share of the Issuable Maximum. In determining the
issuance limitation contained in this paragraph in connection with any
conversions or redemptions pursuant to Section 6 below, the number of Warrant
Shares issuable upon exercise of all the Warrants (and shares of Common Stock
underlying any warrants issued to any registered broker-dealer as a fee in
connection with the issuance of the Securities pursuant to the Purchase
Agreement) shall be applied first against the Issuable Maximum (and shall be
deemed to have been issued for such purposes).

ii.  Holder’s Restriction on Conversion. The Company shall not effect any
conversion of this Note, and a Holder shall not have the right to convert any
portion of this Note, to the extent that after giving effect to the conversion
set forth on the applicable Notice of Conversion, the Holder (together with the
Holder’s Affiliates, and any other person or entity acting as a group together
with the Holder or any of the Holder’s Affiliates) would beneficially own in
excess of the Beneficial Ownership Limitation (as defined below).  For purposes
of the foregoing sentence, the number of shares of Common Stock beneficially
owned by the Holder and its Affiliates shall include the number of shares of
Common Stock issuable upon conversion of this Note with respect to which such
determination is being made, but shall exclude the number of shares of Common
Stock which are issuable upon (A) conversion of the remaining, unconverted
principal amount of this Note beneficially owned by the Holder or any of its
Affiliates and (B) exercise or conversion of the unexercised or unconverted
portion of any other securities of the Company subject to a limitation on
conversion or exercise analogous to the limitation contained herein (including,
without limitation, any other Notes or the Warrants) beneficially owned by the
Holder or any of its Affiliates.  Except as set forth in the preceding sentence,
for purposes of this Section 4(c), beneficial ownership shall be calculated in
accordance with Section 13(d) of the Exchange Act and the rules and regulations
promulgated thereunder. To the extent that the limitation contained in this
paragraph applies, the determination of whether this Note is convertible (in
relation to other securities owned by the Holder together with any Affiliates)
and of which principal amount of this Note is convertible shall be in the sole
discretion of the Holder, and the submission of a Notice of Conversion shall be
deemed to be the Holder’s determination of whether this Note may be converted
(in relation to other securities owned by the Holder together with any
Affiliates) and which principal amount of this Note is convertible, in each case
subject to the Beneficial Ownership Limitation. To ensure compliance with this
restriction, the Holder will be deemed to represent to the Company each time it
delivers a Notice of Conversion that such Notice of Conversion has not violated
the restrictions set forth in this paragraph and the Company shall have no
obligation to verify or confirm the accuracy of such determination. In addition,
a determination as to any group status as contemplated above shall be determined
in accordance with Section 13(d) of the Exchange Act and the rules and
regulations promulgated thereunder. For purposes of this paragraph, in
determining the number of outstanding shares of Common Stock, the Holder may
rely on the number of outstanding shares of Common Stock as stated in the most
recent of the following: (A) the Company’s most recent periodic or annual
report, as the case may be; (B) a more recent public announcement by the
Company; or (C) a more recent notice by the Company or the Company’s transfer
agent setting forth the number of shares of Common Stock outstanding.  Upon the
written or oral request of a Holder, the Company shall within three Trading Days
confirm orally and in writing to the Holder the number of shares of Common Stock
then outstanding. In any case, the number of outstanding shares of Common Stock
shall be determined after giving effect to the conversion or exercise of
securities of the Company, including this Note, by the Holder or its Affiliates
since the date as of which such number of outstanding shares of Common Stock was
reported. The “Beneficial Ownership Limitation” shall be 4.9% of the number of
shares of the Common Stock outstanding immediately after giving effect to the
issuance of shares of Common Stock issuable upon conversion of this Note held by
the Holder. By written notice to the Company, the Holder may at any time and
from time to time increase or decrease the Beneficial Ownership Limitation to
any other percentage specified in such notice (or specify that the Beneficial
Ownership Limitation shall no longer be applicable), provided, however, that (A)
any such increase (or inapplicability) shall not be effective until the
sixty-first (61st) day after such notice is delivered to the Company, and (B)
any such increase or decrease shall apply only to the Holder and not to any
other holder of Notes. The provisions of this paragraph shall be construed and
implemented in a manner otherwise than in strict conformity with the terms of
this paragraph to correct this paragraph (or any portion hereof) which may be
defective or inconsistent with the intended Beneficial Ownership Limitation
herein contained or to make changes or supplements necessary or desirable to
properly give effect to such limitation. The limitations contained in this
paragraph shall apply to a successor holder of this Note.
 
 
9

--------------------------------------------------------------------------------

 
 
d)  Mechanics of Conversion.
 
i.  Conversion Shares Issuable Upon Conversion of Principal Amount. The number
of Conversion Shares issuable upon a conversion hereunder shall be determined by
the quotient obtained by dividing (x) the outstanding principal amount of this
Note to be converted plus any accrued but unpaid interest thereon, by (y) the
Conversion Price.
 
ii.  Delivery of Certificate Upon Conversion. Not later than three Trading Days
after each Conversion Date (the “Share Delivery Date”), the Company shall
deliver, or cause to be delivered, to the Holder a certificate or certificates
representing the Conversion Shares which, on or after the Legend Removal Date,
shall be free of restrictive legends and trading restrictions (other than those
which may then be required by the Purchase Agreement) representing the number of
Conversion Shares being acquired upon the conversion of this Note. After
September 30, 2008 (provided the Holder is not an affiliate of the Company and
the Holder may sell such Conversion Shares pursuant to Section (b)(1) of Rule
144), the Company shall use commercially reasonable efforts to deliver any
certificate(s) or shares required to be delivered by the Company under this
Section 4 electronically through the Depository Trust Company or another
established clearing corporation performing similar functions.
 
iii.  Failure to Deliver Certificates. If in the case of any Notice of
Conversion such certificate(s) or shares are not delivered to or as directed by
the applicable Holder by the third Trading Day after the Conversion Date, the
Holder shall be entitled to elect by written notice to the Company at any time
on or before its receipt of such certificate or certificates, to rescind such
Conversion, in which event the Company shall promptly return to the Holder any
original Note delivered to the Company and the Holder shall promptly return to
the Company the Common Stock certificates representing the principal amount of
this Note unsuccessfully tendered for conversion to the Company.
 
 
10

--------------------------------------------------------------------------------

 
 
iv.  Obligation Absolute; Partial Liquidated Damages. The Company’s obligations
to issue and deliver the Conversion Shares upon conversion of this Note in
accordance with the terms hereof are absolute and unconditional, irrespective of
any action or inaction by the Holder to enforce the same, any waiver or consent
with respect to any provision hereof, the recovery of any judgment against any
Person or any action to enforce the same, or any setoff, counterclaim,
recoupment, limitation or termination, or any breach or alleged breach by the
Holder or any other Person of any obligation to the Company or any violation or
alleged violation of law by the Holder or any other Person, and irrespective of
any other circumstance which might otherwise limit such obligation of the
Company to the Holder in connection with the issuance of such Conversion Shares;
provided, however, that such delivery shall not operate as a waiver by the
Company of any such action the Company may have against the Holder. In the event
the Holder of this Note shall elect to convert any or all of the outstanding
principal amount hereof, the Company may not refuse conversion based on any
claim that the Holder or anyone associated or affiliated with the Holder has
been engaged in any violation of law, agreement or for any other reason, unless
an injunction from a court, on notice to the Holder, restraining and or
enjoining conversion of all or part of this Note shall have been sought and
obtained, and the Company posts a surety bond for the benefit of the Holder in
the amount of 100% of the outstanding principal amount of this Note, which is
subject to the injunction, which bond shall remain in effect until the
completion of arbitration/litigation of the underlying dispute and the proceeds
of which shall be payable to the Holder to the extent it obtains judgment. In
the absence of such injunction, the Company shall issue Conversion Shares or, if
applicable, cash, upon a properly noticed conversion. If the Company fails for
any reason to deliver to the Holder such certificate(s) or shares pursuant to
Section 4(d)(ii) by the second Trading Day after the Share Delivery Date, the
Company shall pay to the Holder, in cash, as liquidated damages and not as a
penalty, for each $1,000 of principal amount being converted, $10 per Trading
Day (increasing to $17.50 per Trading Day on the fifth Trading Day after such
liquidated damages begin to accrue) for each Trading Day after such second
Trading Day after the Share Delivery Date until such certificates are delivered.
Nothing herein shall limit a Holder’s right to pursue actual damages or declare
an Event of Default pursuant to Section 8 hereof for the Company’s failure to
deliver Conversion Shares within the period specified herein and the Holder
shall have the right to pursue all remedies available to it hereunder, at law or
in equity including, without limitation, a decree of specific performance and/or
injunctive relief. The exercise of any such rights shall not prohibit the Holder
from seeking to enforce damages pursuant to any other Section hereof or under
applicable law.
 
v.  Compensation for Buy-In on Failure to Timely Deliver Certificates Upon
Conversion. In addition to any other rights available to the Holder, if the
Company fails for any reason to deliver to the Holder such certificate(s) or
shares by the Share Delivery Date pursuant to Section 4(d)(ii), and if after
such Share Delivery Date the Holder is required by its brokerage firm to
purchase (in an open market transaction or otherwise), or the Holder’s brokerage
firm otherwise purchases, shares of Common Stock to deliver in satisfaction of a
sale by the Holder of the Conversion Shares which the Holder was entitled to
receive upon the conversion relating to such Share Delivery Date (a “Buy-In”),
then the Company shall (A) pay in cash to the Holder (in addition to any other
remedies available to or elected by the Holder) the amount by which (x) the
Holder’s total purchase price (including any brokerage commissions) for the
Common Stock so purchased exceeds (y) the product of (1) the aggregate number of
shares of Common Stock that the Holder was entitled to receive from the
conversion at issue multiplied by (2) the actual sale price at which the sell
order giving rise to such purchase obligation was executed (including any
brokerage commissions) and (B) at the option of the Holder, either reissue (if
surrendered) this Note in a principal amount equal to the principal amount of
the attempted conversion or deliver to the Holder the number of shares of Common
Stock that would have been issued if the Company had timely complied with its
delivery requirements under Section 4(d)(ii). 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 this Note with respect to
which the actual sale price of the Conversion Shares (including any brokerage
commissions) giving rise to such purchase obligation was a total of $10,000
under clause (A) of the immediately preceding sentence, the Company shall be
required to pay the Holder $1,000. The Holder shall provide the Company written
notice indicating the amounts payable to the Holder in respect of the Buy-In
and, upon request of the Company, evidence of the amount of such loss. 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 Company’s
failure to timely deliver certificates representing shares of Common Stock upon
conversion of this Note as required pursuant to the terms hereof.
 
 
11

--------------------------------------------------------------------------------

 
 
vi.  Reservation of Shares Issuable Upon Conversion. The Company covenants that
it will at all times reserve and keep available out of its authorized and
unissued shares of Common Stock for the sole purpose of issuance upon conversion
of this Note and payment of interest on this Note, each as herein provided, free
from preemptive rights or any other actual contingent purchase rights of Persons
other than the Holder (and the other holders of the Notes), not less than such
aggregate number of shares of the Common Stock as shall (subject to the terms
and conditions set forth in the Purchase Agreement) be issuable (taking into
account the adjustments of Section 5) upon the conversion of the outstanding
principal amount of this Note and payment of interest hereunder. The Company
covenants that all shares of Common Stock that shall be so issuable shall, upon
issue, be duly authorized, validly issued, fully paid and nonassessable and, if
the Registration Statement is then effective under the Securities Act, shall be
registered for public sale in accordance with such Registration Statement.

vii.  Fractional Shares. No fractional shares or scrip representing fractional
shares shall be issued upon the conversion of this Note. As to any fraction of a
share which the Holder would otherwise be entitled to purchase upon such
conversion, the Company shall at its election, either pay a cash adjustment in
respect of such final fraction in an amount equal to such fraction multiplied by
the Conversion Price or round up to the next whole share.
 
 
12

--------------------------------------------------------------------------------

 
 
viii.  Transfer Taxes. The issuance of certificates for shares of the Common
Stock on conversion of this Note shall be made without charge to the Holder
hereof for any documentary stamp or similar taxes that may be payable in respect
of the issue or delivery of such certificates, provided that the Company shall
not be required to pay any tax that may be payable in respect of any transfer
involved in the issuance and delivery of any such certificate upon conversion in
a name other than that of the Holder of this Note and the Company shall not be
required to issue or deliver such certificates unless or until the person or
persons requesting the issuance thereof shall have paid to the Company the
amount of such tax or shall have established to the satisfaction of the Company
that such tax has been paid.

Section 5. Certain Adjustments.
 
a)  Stock Dividends and Stock Splits. If the Company, at any time while this
Note is outstanding: (A) pays a stock dividend or otherwise makes a distribution
or distributions payable in shares of Common Stock on shares of Common Stock or
any Common Stock Equivalents (which, for avoidance of doubt, shall not include
any shares of Common Stock issued by the Company upon conversion of, or payment
of interest on, the Notes); (B) subdivides outstanding shares of Common Stock
into a larger number of shares; (C) combines (including by way of a reverse
stock split) outstanding shares of Common Stock into a smaller number of shares;
or (D) issues, in the event of a reclassification of shares of the Common Stock,
any shares of capital stock of the Company, then the Conversion Price shall be
multiplied by a fraction of which the numerator shall be the number of shares of
Common Stock (excluding any treasury shares of the Company) outstanding
immediately before such event and of which the denominator shall be the number
of shares of Common Stock outstanding immediately after such event. Any
adjustment made pursuant to this Section shall become effective immediately
after the record date for the determination of stockholders entitled to receive
such dividend or distribution and shall become effective immediately after the
effective date in the case of a subdivision, combination or re-classification.
 
b)  Subsequent Equity Sales. If, at any time while this Note is outstanding, the
Company or any Subsidiary, as applicable, sells or grants any option to purchase
or sells or grants any right to reprice, or otherwise disposes of or issues (or
announces any sale, grant or any option to purchase or other disposition), any
Common Stock or Common Stock Equivalents entitling any Person to acquire shares
of Common Stock at an effective price per share that is lower than the then
Conversion Price (such lower price, the “Base Conversion Price” and such
issuances, collectively, a “Dilutive Issuance”) (if the holder of the Common
Stock or Common Stock Equivalents so issued shall at any time, whether by
operation of purchase price adjustments, reset provisions, floating conversion,
exercise or exchange prices or otherwise, or due to warrants, options or rights
per share which are issued in connection with such issuance, be entitled to
receive shares of Common Stock at an effective price per share that is lower
than the Conversion Price, such issuance shall be deemed to have occurred for
less than the Conversion Price on such date of the Dilutive Issuance), then the
Conversion Price shall be reduced to equal the Base Conversion Price. Such
adjustment shall be made whenever such Common Stock or Common Stock Equivalents
are issued. Notwithstanding the foregoing, no adjustment will be made under this
Section 5(b) in respect of an Exempt Issuance or in the event that such
adjustment will result in the issuance of more than 42,000,000 shares of Common
Stock (as appropriately and equitably adjusted for stock splits, stock dividends
and similar events) when aggregated with any shares of Common Stock issued on or
after the initial Closing Date and prior to the Maturity Date (A) in connection
with the conversion of any Notes or as payment of principal, interest or
liquidated damages, (B) in connection with the exercise of any Warrants issued
pursuant to the Purchase Agreement, and (C) in connection with any warrants
issued to any registered broker-dealer as a fee in connection with the issuance
of the Securities pursuant to the Purchase Agreement. If the Company enters into
a Variable Rate Transaction or MFN Transaction, despite the prohibition set
forth in the Purchase Agreement, the Company shall be deemed to have issued
Common Stock or Common Stock Equivalents at the lowest possible conversion price
at which such securities may be converted or exercised. The Company shall notify
the Holder in writing, no later than 1 Business Day following the issuance of
any Common Stock or Common Stock Equivalents subject to this Section 5(b),
indicating therein the applicable issuance price, or applicable reset price,
exchange price, conversion price and other pricing terms (such notice, the
“Dilutive Issuance Notice”). For purposes of clarification, whether or not the
Company provides a Dilutive Issuance Notice pursuant to this Section 5(b), upon
the occurrence of any Dilutive Issuance, the Holder is entitled to receive a
number of Conversion Shares based upon the Base Conversion Price on or after the
date of such Dilutive Issuance, regardless of whether the Holder accurately
refers to the Base Conversion Price in the Notice of Conversion.
 
 
13

--------------------------------------------------------------------------------

 
 
c)  Subsequent Rights Offerings. If the Company, at any time while the Note is
outstanding, shall issue rights, options or warrants to all holders of Common
Stock (and not to the Holders in their capacity as holders of Notes) entitling
them to subscribe for or purchase shares of Common Stock at a price per share
that is lower than the VWAP on the record date referenced below, then the
Conversion Price shall be multiplied by a fraction of which the denominator
shall be the number of shares of the Common Stock outstanding on the date of
issuance of such rights or warrants plus the number of additional shares of
Common Stock offered for subscription or purchase, and of which the numerator
shall be the number of shares of the Common Stock outstanding on the date of
issuance of such rights or warrants plus the number of shares which the
aggregate offering price of the total number of shares issued (assuming delivery
to the Company in full of all consideration payable upon exercise of such
rights, options or warrants) would purchase at such VWAP. Such adjustment shall
be made whenever such rights or warrants are issued, and shall become effective
immediately after the record date for the determination of stockholders entitled
to receive such rights, options or warrants.
 
 
14

--------------------------------------------------------------------------------

 
 
d)  Pro Rata Distributions. If the Company, at any time while this Note is
outstanding, distributes to all holders of Common Stock (and not to the Holders
in their capacity as holders of Notes) evidences of its indebtedness or assets
(including cash and cash dividends) or rights or warrants to subscribe for or
purchase any security (other than the Common Stock, which shall be subject to
Section 5(b)), then in each such case the Conversion Price shall be adjusted by
multiplying such Conversion Price in effect immediately prior to the record date
fixed for determination of stockholders entitled to receive such distribution by
a fraction of which the denominator shall be the VWAP determined as of the
record date mentioned above, and of which the numerator shall be such VWAP on
such record date less the then fair market value at such record date of the
portion of such assets or evidence of indebtedness so distributed applicable to
1 outstanding share of the Common Stock as determined by the Board of Directors
of the Company in good faith. In either case the adjustments shall be described
in a statement delivered to the Holder describing the portion of assets or
evidences of indebtedness so distributed or such subscription rights applicable
to 1 share of Common Stock. Such adjustment shall be made whenever any such
distribution is made and shall become effective immediately after the record
date mentioned above.
 
e)  Fundamental Transaction. If, at any time while this Note is outstanding, (A)
the Company effects any merger or consolidation of the Company with or into
another Person, (B) the Company effects any sale of all or substantially all of
its assets in one transaction or a series of related transactions, (C) any
tender offer or exchange offer (whether by the Company or another Person) is
completed pursuant to which holders of Common Stock are permitted to tender or
exchange their shares for other securities, cash or property, or (D) the Company
effects any reclassification of the Common Stock or any compulsory share
exchange pursuant to which the Common Stock is effectively converted into or
exchanged for other securities, cash or property (in any such case, a
“Fundamental Transaction”), then, upon any subsequent conversion of this Note,
the Holder shall have the right to receive, for each Conversion Share that would
have been issuable upon such conversion immediately prior to the occurrence of
such Fundamental Transaction, the same kind and amount of securities, cash or
property as it would have been entitled to receive upon the occurrence of such
Fundamental Transaction if it had been, immediately prior to such Fundamental
Transaction, the holder of 1 share of Common Stock (the “Alternate
Consideration”). For purposes of any such conversion, the determination of the
Conversion Price shall be appropriately adjusted to apply to such Alternate
Consideration based on the amount of Alternate Consideration issuable in respect
of 1 share of Common Stock in such Fundamental Transaction, and the Company
shall apportion the Conversion Price among the Alternate Consideration in a
reasonable manner reflecting the relative value of any different components of
the Alternate Consideration. If holders of Common Stock are given any choice as
to the securities, cash or property to be received in a Fundamental Transaction,
then the Holder shall be given the same choice as to the Alternate Consideration
it receives upon any conversion of this Note following such Fundamental
Transaction. To the extent necessary to effectuate the foregoing provisions, any
successor to the Company or surviving entity in such Fundamental Transaction
shall issue to the Holder a new Note consistent with the foregoing provisions
and evidencing the Holder’s right to convert such Note into Alternate
Consideration. The terms of any agreement pursuant to which a Fundamental
Transaction is effected shall include terms requiring any such successor or
surviving entity to comply with the provisions of this Section 5(e) and insuring
that this Note (or any such replacement security) will be similarly adjusted
upon any subsequent transaction analogous to a Fundamental Transaction.
 
 
15

--------------------------------------------------------------------------------

 
 
f)  Calculations. All calculations under this Section 5 shall be made to the
nearest cent or the nearest 1/100th of a share, as the case may be. For purposes
of this Section 5, the number of shares of Common Stock deemed to be issued and
outstanding as of a given date shall be the sum of the number of shares of
Common Stock (excluding any treasury shares of the Company) issued and
outstanding.

g)  Notice to the Holder.

i.  Adjustment to Conversion Price. Whenever the Conversion Price is adjusted
pursuant to any provision of this Section 5, the Company shall promptly deliver
to each Holder a notice setting forth the Conversion Price after such adjustment
and setting forth a brief statement of the facts requiring such adjustment.
 
ii.  Notice to Allow Conversion by Holder. If (A) the Company shall declare a
dividend (or any other distribution in whatever form) on the Common Stock, (B)
the Company shall declare a special nonrecurring cash dividend on or a
redemption of the Common Stock, (C) the Company shall authorize the granting to
all holders of the Common Stock of rights or warrants to subscribe for or
purchase any shares of capital stock of any class or of any rights, (D) the
approval of any stockholders of the Company shall be required in connection with
any reclassification of the Common Stock, any consolidation or merger to which
the Company is a party, any sale or transfer of all or substantially all of the
assets of the Company, of any compulsory share exchange whereby the Common Stock
is converted into other securities, cash or property or (E) the Company shall
authorize the voluntary or involuntary dissolution, liquidation or winding up of
the affairs of the Company, then, in each case, the Company shall cause to be
filed at each office or agency maintained for the purpose of conversion of this
Note, and shall cause to be delivered to the Holder at its last address as it
shall appear upon the Note Register, at least 20 calendar days prior to the
applicable record or effective date hereinafter specified, a notice stating (x)
the date on which a record is to be taken for the purpose of such dividend,
distribution, redemption, rights or warrants, or if a record is not to be taken,
the date as of which the holders of the Common Stock of record to be entitled to
such dividend, distributions, redemption, rights or warrants are to be
determined or (y) the date on which such reclassification, consolidation,
merger, sale, transfer or share exchange is expected to become effective or
close, and the date as of which it is expected that holders of the Common Stock
of record shall be entitled to exchange their shares of the Common Stock for
securities, cash or other property deliverable upon such reclassification,
consolidation, merger, sale, transfer or share exchange, provided that the
failure to deliver such notice or any defect therein or in the delivery thereof
shall not affect the validity of the corporate action required to be specified
in such notice. The Holder is entitled to convert this Note during the 20-day
period commencing on the date of such notice through the effective date of the
event triggering such notice.
 
 
16

--------------------------------------------------------------------------------

 
 
Section 6. Redemption and Forced Conversion.

a)  Optional Redemption at Election of Company. Subject to the provisions of
this Section 6, at any time after six months following the Original Issue Date,
the Company may deliver a notice to the Holder (an “Optional Redemption Notice”
and the date such notice is deemed delivered hereunder, the “Optional Redemption
Notice Date”) of its irrevocable election to redeem the entire outstanding
principal amount of this Note for cash in an amount equal to the Optional
Redemption Amount on the 20th Trading Day following the Optional Redemption
Notice Date (such date, the “Optional Redemption Date” and such redemption, the
“Optional Redemption”). The Optional Redemption Amount is payable in full on the
Optional Redemption Date. The Company may only effect an Optional Redemption if
each of the Equity Conditions shall have been met (unless waived in writing by
the Holder) on each Trading Day during the period commencing on the Optional
Redemption Notice Date through the Optional Redemption Date and through and
including the date payment of the Optional Redemption Amount is actually made in
full. If any of the Equity Conditions shall cease to be satisfied at any time
during the 20 Trading Day period, then the Holder may elect to nullify the
Optional Redemption Notice by notice to the Company, in which case the Optional
Redemption Notice shall be null and void, ab initio. The Company covenants and
agrees that it will honor all Notices of Conversion tendered from the time of
delivery of the Optional Redemption Notice through the date all amounts owing
thereon are due and paid in full, and to the extent elected by the Holder, any
such conversions effected during such period shall be applied against principal
amount otherwise payable on the Optional Redemption Date. If the Company elects
to redeem this Note it must redeem all outstanding Notes.

b)  Monthly Redemption. On each Monthly Redemption Date, the Company shall
redeem the Monthly Redemption Amount (the “Monthly Redemption”). The Monthly
Redemption Amount payable on each Monthly Redemption Date shall be paid in cash;
provided, however, as to any Monthly Redemption and upon 15 Trading Days’ prior
written irrevocable notice (the “Monthly Redemption Notice”), in lieu of a cash
redemption payment the Company may elect to pay all or part of a Monthly
Redemption Amount in Conversion Shares based on a conversion price equal to the
lesser of (i) the then Conversion Price and (ii) the Market Redemption Price;
provided, further, that the Company may not pay the Monthly Redemption Amount in
Conversion Shares unless from the date the Holder receives the duly delivered
Monthly Redemption Notice through and until the date such Monthly Redemption is
paid in full, the Equity Conditions have been satisfied, unless waived in
writing by the Holder. The Holder may convert, pursuant to Section 4(a), any
principal amount of this Note at any time prior to the date that the Monthly
Redemption Amount, plus accrued but unpaid interest, liquidated damages and any
other amounts then owing to the Holder are due and paid in full. At the Holder’s
election, any conversions of the principal amount of this Note pursuant to
Section 4(a) may be applied against either the next upcoming Monthly Redemption
Amount(s) due or the last principal amounts of this Note scheduled to be
redeemed hereunder, in reverse time order from the Maturity Date. In the event
that the Holder elects to have conversions of the principal amount of this Note
pursuant to Section 4(a) applied against the next upcoming Monthly Redemption
Amount(s) due, then on such Monthly Redemption Date the Monthly Redemption
Amount shall consist of any remaining portion of the principal amount due on
such Monthly Redemption date plus all accrued and unpaid interest on the entire
outstanding principal amount of this Note as of such date. The Company covenants
and agrees that it will honor all Notices of Conversion tendered up until such
amounts are paid in full. The Company’s determination to pay a Monthly
Redemption in cash, shares of Common Stock or a combination thereof shall be
applied ratably to all of the holders of the then outstanding Notes based on
their (or their predecessor’s) initial purchases of Notes pursuant to the
Purchase Agreement. If a Registration Statement is effective covering the resale
of the Conversion Shares by the Holder, at any time the Company delivers a
notice to the Holder of its election to pay the Monthly Redemption Amount in
shares of Common Stock, the Company shall file a prospectus supplement pursuant
to Rule 424 disclosing such election. Notwithstanding anything herein to the
contrary, until such time as the Company has obtained Shareholder Approval and
it is deemed effective, in no event shall the Company issue any Conversion
Shares upon a Monthly Redemption hereunder.
 
 
17

--------------------------------------------------------------------------------

 
 
c)  Redemption Procedure. The payment of cash pursuant to an Optional Redemption
shall be payable on the Optional Redemption Date. If any portion of the payment
pursuant to an Optional Redemption shall not be paid by the Company by the
applicable due date, interest shall accrue thereon at an interest rate equal to
the lesser of 20% per annum or the maximum rate permitted by applicable law
until such amount is paid in full. Notwithstanding anything herein contained to
the contrary, if any portion of the Optional Redemption Amount remains unpaid
after such date, the Holder may elect, by written notice to the Company given at
any time thereafter, to invalidate such Optional Redemption, ab initio, and,
with respect to the Company’s failure to honor the Optional Redemption, the
Company shall have no further right to exercise such Optional Redemption. The
payment of cash or Common Stock pursuant to a Monthly Redemption shall be
payable on the Monthly Redemption Date. If any portion of the payment pursuant
to a Monthly Redemption shall not be paid by the Company by the applicable due
date, interest shall accrue thereon at an interest rate equal to the lesser of
20% per annum or the maximum rate permitted by applicable law until such amount
is paid in full.
 
d)  Forced Conversion. Notwithstanding anything herein to the contrary, if after
one year following the initial Closing Date, the VWAP for any 20 out of 30
consecutive Trading Days (such 30 Trading Day period being the “Threshold
Period”) exceeds $0.80 (subject to appropriate and equitable adjustment for
reverse and forward stock splits, stock dividends, stock combinations and other
similar transactions of the Common Stock that occur after such Closing Date),
then the Company may, within 1 Trading Day after the end of any such Threshold
Period, deliver a written notice to the Holder (a “Forced Conversion Notice” and
the date such notice is delivered to the Holder, the “Forced Conversion Notice
Date”) to cause the Holder to convert all or part of the then outstanding
principal amount of this Note plus, if so specified in the Forced Conversion
Notice, accrued but unpaid interest, liquidated damages and other amounts owing
to the Holder under this Note, at the Conversion Price on or prior to the tenth
Trading Day following the Holder’s receipt of such Forced Conversion Notice
(such date, the “Forced Conversion Date”). The Company may not deliver a Forced
Conversion Notice, and any Forced Conversion Notice delivered by the Company
shall not be effective, unless all of the Equity Conditions are met (unless
waived in writing by the Holder) on each Trading Day occurring during the
applicable Threshold Period through and including the later of the Forced
Conversion Date and the Trading Day after the date such Conversion Shares
pursuant to such conversion are delivered to the Holder. Any Forced Conversion
shall be applied ratably to all Holders based on their initial purchases of
Notes pursuant to the Purchase Agreement, provided that any voluntary
conversions by a Holder shall be applied against the Holder’s pro rata
allocation, thereby decreasing the aggregate amount forcibly converted hereunder
if only a portion of this Note is forcibly converted. For purposes of
clarification, a Forced Conversion shall be subject to all of the provisions of
Section 4, including, without limitation, the provision requiring payment of
liquidated damages and limitations on conversions.
 
 
18

--------------------------------------------------------------------------------

 
 
Section 7. Negative Covenants. As long as any portion of this Note remains
outstanding, unless the holders of at least a majority in principal amount of
the then outstanding Notes shall have otherwise given prior written consent, the
Company shall not, and shall not permit any of its subsidiaries (whether or not
a Subsidiary on any Closing Date) to, directly or indirectly:

a)  other than Permitted Indebtedness or as set forth on Schedule 7(a) enter
into, create, incur, assume, guarantee or suffer to exist any indebtedness for
borrowed money of any kind, including but not limited to, a guarantee, on or
with respect to any of its property or assets now owned or hereafter acquired or
any interest therein or any income or profits therefrom;
 
b)  other than Permitted Liens, enter into, create, incur, assume or suffer to
exist any Liens of any kind, on or with respect to any of its property or assets
now owned or hereafter acquired or any interest therein or any income or profits
therefrom;

c)  amend its charter documents, including, without limitation, its articles of
incorporation and bylaws, in any manner that materially and adversely affects
any rights of the Holder;

d)  repay, repurchase or offer to repay, repurchase or otherwise acquire more
than a de minimis number of shares of its Common Stock or Common Stock
Equivalents other than (a) as to the Conversion Shares or Warrant Shares as
permitted or required under the Transaction Documents, (b) as to repurchases of
Common Stock or Common Stock Equivalents of departing employees of the Company,
provided that such repurchases shall not exceed an aggregate of $150,000 for all
employees during the term of this Note, and (c) as set forth on Schedule 7(d);
 
 
19

--------------------------------------------------------------------------------

 
 
e)  repay, repurchase or offer to repay, repurchase or otherwise acquire any
Indebtedness (except for the Notes in accordance with the terms of the Notes),
other than regularly scheduled principal and interest payments as such terms are
in effect as of the initial Closing Date or as set forth on Schedule 7(e);

f)  pay cash dividends or distributions on any equity securities of the Company;

g)  enter into any transaction with any Affiliate of the Company which would be
required to be disclosed in any public filing with the Commission, unless such
transaction is made on an arm’s-length basis and expressly approved by a
majority of the disinterested directors of the Company (even if less than a
quorum otherwise required for board approval);

h)  amend the Guez Note, or enter into any agreement which has the effect of
effectively modifying the Guez Note, without the Holder’s prior written consent;
or

i)  enter into any agreement with respect to any of the foregoing.
 
Section 8. Events of Default.

a)  “Event of Default” means, wherever used herein, any of the following events
(whatever the reason for such event and whether such event shall be voluntary or
involuntary or effected by operation of law or pursuant to any judgment, decree
or order of any court, or any order, rule or regulation of any administrative or
governmental body):

i.  any default in the payment of (A) the principal amount of any Note or (B)
interest, liquidated damages and other amounts owing to a Holder on any Note, as
and when the same shall become due and payable (whether on a Conversion Date or
the Maturity Date or by acceleration or otherwise) which default is not cured
within 3 Trading Days;
 
ii.  the Company shall fail to observe or perform any other covenant or
agreement contained in the Notes (other than a breach by the Company of its
obligations to deliver shares of Common Stock to the Holder upon conversion,
which breach is addressed in clause (xiii) below) which failure is not cured, if
possible to cure, within the earlier to occur of (A) 5 Trading Days after notice
of such failure sent by the Holder or by any other Holder and (B) 10 Trading
Days after the Company has become or should have become aware of such failure
(except as waived in the Amendment);

iii.  a default or event of default (subject to any grace or cure period
provided in the applicable agreement, document or instrument) shall occur under
(A) any of the Transaction Documents or (B) any other material agreement, lease,
document or instrument to which the Company or any Subsidiary is obligated (and
not covered by clause (vi) below) (except as waived in the Amendment);
 
 
20

--------------------------------------------------------------------------------

 
 
iv.  any representation or warranty made in this Note, any other Transaction
Document, any written statement pursuant hereto or thereto or any other report,
financial statement or certificate made or delivered to the Holder or any other
Holder shall be untrue or incorrect in any material respect as of the date when
made or deemed made (except as waived in the Amendment);

v.  the Company or any Significant Subsidiary shall be subject to a Bankruptcy
Event;
 
vi.  the Company or any Subsidiary shall default on any of its obligations under
any mortgage, credit agreement or other facility, indenture agreement, factoring
agreement or other instrument under which there may be issued, or by which there
may be secured or evidenced, any indebtedness for borrowed money or money due
under any long term leasing or factoring arrangement that (a) involves an
obligation greater than $100,000, whether such indebtedness now exists or shall
hereafter be created, and (b) results in such indebtedness becoming or being
declared due and payable prior to the date on which it would otherwise become
due and payable;

vii.  if the Common Stock shall not be eligible for listing or quotation for
trading on a Trading Market and shall not be eligible to resume listing or
quotation for trading thereon within five Trading Days;

viii.  the Company shall be a party to any Change of Control Transaction or
Fundamental Transaction or shall agree to sell or dispose of all or in excess of
33% of its assets in one transaction or a series of related transactions
(whether or not such sale would constitute a Change of Control Transaction);

ix.  if at any time after September 30, 2008 the Company is not subject to the
reporting requirements of Section 13 or 15(d) of the Exchange Act or has failed
to file all reports required to be filed thereunder during the then preceding 12
months (or such shorter period that the Company was required to file such
reports);

x.  if any of the Security Documents or Subsidiary Guaranties ceases to be in
full force and effect (including failure to create a valid and perfected second
priority lien on and security interest in all the Collateral (as defined in the
Security Agreement) and Intellectual Property Rights of the Company and its
Subsidiaries) at any time for any reason;

xi.  any material adverse change in the condition, value or operation of a
material portion of the Collateral or Intellectual Property Rights;
 
 
21

--------------------------------------------------------------------------------

 
 
xii.  if Glenn Palmer ceases to serve full time as the President and Chief
Executive Officer of the Company and perform the duties consistent with such
positions for similarly situated companies, provided that if such cessation is
due to Glenn Palmer’s death, permanent disability, voluntary termination or
termination by the Company for cause, then (A) an Event of Default shall not be
deemed to have occurred unless and until the Company shall have failed to retain
a full-time replacement reasonably acceptable to the Holder within 90 days
following such death, permanent disability, voluntary termination or termination
by the Company for cause, and (B) following any such acceptable replacement this
clause shall apply to such replacement in lieu of Glenn Palmer;

xiii.  the Company shall fail for any reason to deliver certificates to a Holder
prior to the seventh Trading Day after a Conversion Date or any Forced
Conversion Date pursuant to Section 4(d) or the Company shall provide at any
time notice to the Holder, including by way of public announcement, of the
Company’s intention to not honor requests for conversions of any Notes in
accordance with the terms hereof; or

xiv.  any monetary judgment, writ or similar final process shall be entered or
filed against the Company, any subsidiary or any of their respective property or
other assets for more than $100,000, and such judgment, writ or similar final
process shall remain unvacated, unbonded or unstayed for a period of 45 calendar
days; provided, however, that any judgment which is covered by insurance or an
indemnity from a creditworthy party (such creditworthiness as reasonably
determined by the Holder) shall not be included in calculating the amount of
such judgment, writ or final process so long as the Company provides the Holder
a written statement from such insurer or indemnity provider (which written
statement shall be reasonably satisfactory to the Holder) to the effect that
such judgment is covered by insurance or an indemnity and the Company will
receive the proceeds of such insurance or indemnity within 45 calendar days of
the issuance of such judgment.

b)  Remedies Upon Event of Default. If any Event of Default occurs, the
outstanding principal amount of this Note, plus accrued but unpaid interest,
liquidated damages and other amounts owing in respect thereof through the date
of acceleration, shall become, at the Holder’s election (which the Holder shall
not make more than the later of 30 calendar days after the date (a) such Event
of Default is cured or otherwise resolved and (b) the Holder is aware of such
cure or resolution), immediately due and payable in cash at the Mandatory
Default Amount. After the occurrence and during the continuance of any Event of
Default, the interest rate on this Note shall accrue at an interest rate equal
to the lesser of 20% per annum or the maximum rate permitted under applicable
law. Upon the payment in full of the Mandatory Default Amount, the Holder shall
promptly surrender this Note to or as directed by the Company. In connection
with such acceleration described herein, the Holder need not provide, and the
Company hereby waives, any presentment, demand, protest or other notice of any
kind, and the Holder may immediately and without expiration of any grace period
enforce any and all of its rights and remedies hereunder and all other remedies
available to it under applicable law. Such acceleration may be rescinded and
annulled by Holder at any time prior to payment hereunder and the Holder shall
have all rights as a holder of the Note until such time, if any, as the Holder
receives full payment pursuant to this Section 8(b). No such rescission or
annulment shall affect any subsequent Event of Default or impair any right
consequent thereon.
 
 
22

--------------------------------------------------------------------------------

 
 
Section 9. Miscellaneous.
 
a)  Notices. Any and all notices or other communications or deliveries to be
provided by the Holder hereunder, including, without limitation, any Notice of
Conversion, shall be in writing and delivered personally, by facsimile, or sent
by a nationally recognized overnight courier service, addressed to the Company,
at the address set forth above, or such other facsimile number or address as the
Company may specify for such purpose by notice to the Holder delivered in
accordance with this Section 9. Any and all notices or other communications or
deliveries to be provided by the Company hereunder shall be in writing and
delivered personally, by facsimile, or sent by a nationally recognized overnight
courier service addressed to each Holder at the facsimile number or address of
the Holder appearing on the books of the Company, or if no such facsimile number
or address appears, at the principal place of business of the Holder. Any notice
or other communication or deliveries hereunder shall be deemed given and
effective on the earliest of (i) the date of transmission, if such notice or
communication is delivered via facsimile at the facsimile number specified in
this Section 9 prior to 5:30 p.m. (New York City time), (ii) the date
immediately following the date of transmission, if such notice or communication
is delivered via facsimile at the facsimile number specified in this Section 9
between 5:30 p.m. (New York City time) and 11:59 p.m. (New York City time) on
any date, (iii) the second Business Day following the date of mailing, if sent
by U.S. nationally recognized overnight courier service, or (iv) upon actual
receipt by the party to whom such notice is required to be given. The address
for such notices and communications shall be as set forth on the signature pages
attached to the Purchase Agreement.
 
b)  Absolute Obligation. Except as expressly provided herein, no provision of
this Note shall alter or impair the obligation of the Company, which is absolute
and unconditional, to pay the principal of, liquidated damages and accrued
interest, as applicable, on this Note at the time, place, and rate, and in the
coin or currency, herein prescribed. This Note is a direct debt obligation of
the Company. This Note ranks pari passu with all other Notes now or hereafter
issued under the terms set forth herein. 
 
c)  Lost or Mutilated Note. If this Note shall be mutilated, lost, stolen or
destroyed, the Company shall execute and deliver, in exchange and substitution
for and upon cancellation of a mutilated Note, or in lieu of or in substitution
for a lost, stolen or destroyed Note, a new Note for the principal amount of
this Note so mutilated, lost, stolen or destroyed, but only upon receipt of
evidence of such loss, theft or destruction of such Note, and of the ownership
hereof, reasonably satisfactory to the Company.
 
 
23

--------------------------------------------------------------------------------

 
 
d)  Governing Law. All questions concerning the construction, validity,
enforcement and interpretation of this Note shall be governed by and construed
and enforced in accordance with the internal laws of the State of New York,
without regard to the principles of conflict of laws thereof. Each party agrees
that all legal proceedings concerning the interpretation, enforcement and
defense of the transactions contemplated by any of the Transaction Documents
(whether brought against a party hereto or its respective Affiliates, directors,
officers, shareholders, employees or agents) shall be commenced in the state and
federal courts sitting in the City of New York, Borough of Manhattan (the “New
York Courts”). Each party hereto hereby irrevocably submits to the exclusive
jurisdiction of the New York Courts for the adjudication of any dispute
hereunder or in connection herewith or with any transaction contemplated hereby
or discussed herein (including with respect to the enforcement of any of the
Transaction Documents), and hereby irrevocably waives, and agrees not to assert
in any suit, action or proceeding, any claim that it is not personally subject
to the jurisdiction of such New York Courts, or such New York Courts are
improper or inconvenient venue for such proceeding. Each party hereby
irrevocably waives personal service of process and consents to process being
served in any such suit, action or proceeding by mailing a copy thereof via
registered or certified mail or overnight delivery (with evidence of delivery)
to such party at the address in effect for notices to it under this Note and
agrees that such service shall constitute good and sufficient service of process
and notice thereof. Nothing contained herein shall be deemed to limit in any way
any right to serve process in any other manner permitted by applicable law. Each
party hereto hereby irrevocably waives, to the fullest extent permitted by
applicable law, any and all right to trial by jury in any legal proceeding
arising out of or relating to this Note or the transactions contemplated hereby.
If either party shall commence an action or proceeding to enforce any provisions
of this Note, then the prevailing party in such action or proceeding shall be
reimbursed by the other party for its attorney’s fees and other costs and
expenses reasonably incurred in the investigation, preparation and prosecution
of such action or proceeding.
 
e)  Waiver. Any waiver by the Company or the Holder of a breach of any provision
of this Note shall not operate as or be construed to be a waiver of any other
breach of such provision or of any breach of any other provision of this Note.
The failure of the Company or the Holder to insist upon strict adherence to any
term of this Note on one or more occasions shall not be considered a waiver or
deprive that party of the right thereafter to insist upon strict adherence to
that term or any other term of this Note. Any waiver by the Company or the
Holder must be in writing.
 
f)  Severability. If any provision of this Note is invalid, illegal or
unenforceable, the balance of this Note shall remain in effect, and if any
provision is inapplicable to any Person or circumstance, it shall nevertheless
remain applicable to all other Persons and circumstances. If it shall be found
that any interest or other amount deemed interest due hereunder violates the
applicable law governing usury, the applicable rate of interest due hereunder
shall automatically be lowered to equal the maximum rate of interest permitted
under applicable law. The Company covenants (to the extent that it may lawfully
do so) that it shall not at any time insist upon, plead, or in any manner
whatsoever claim or take the benefit or advantage of, any stay, extension or
usury law or other law which would prohibit or forgive the Company from paying
all or any portion of the principal of or interest on this Note as contemplated
herein, wherever enacted, now or at any time hereafter in force, or which may
affect the covenants or the performance of this indenture, and the Company (to
the extent it may lawfully do so) hereby expressly waives all benefits or
advantage of any such law, and covenants that it will not, by resort to any such
law, hinder, delay or impeded the execution of any power herein granted to the
Holder, but will suffer and permit the execution of every such as though no such
law has been enacted.
 
 
24

--------------------------------------------------------------------------------

 
 
g)  Next Business Day. Whenever any payment or other obligation hereunder shall
be due on a day other than a Business Day, such payment shall be made on the
next succeeding Business Day.

h)  Headings. The headings contained herein are for convenience only, do not
constitute a part of this Note and shall not be deemed to limit or affect any of
the provisions hereof.

i)  Assumption.  Any successor to the Company or any surviving entity in a
Fundamental Transaction shall (i) assume, prior to such Fundamental Transaction,
all of the obligations of the Company under this Note and the other Transaction
Documents pursuant to written agreements in form and substance satisfactory to
the Holder (such approval not to be unreasonably withheld or delayed) and (ii)
issue to the Holder a new Note of such successor entity evidenced by a written
instrument substantially similar in form and substance to this Note, including,
without limitation, having a principal amount and interest rate equal to the
principal amount and the interest rate of this Note and having similar ranking
to this Note, which shall be satisfactory to the Holder (any such approval not
to be unreasonably withheld or delayed).  The provisions of this Section 9(i)
shall apply similarly and equally to successive Fundamental Transactions and
shall be applied without regard to any limitations of this Note.

j)  Usury. This Note shall be subject to the anti-usury limitations contained in
the Purchase Agreement.

*********************
 
 
25

--------------------------------------------------------------------------------

 
 
IN WITNESS WHEREOF, the Company has caused this Note to be duly executed by a
duly authorized officer as of the date first above indicated.
 

       
BLUE HOLDINGS, INC.
 
   
   
  By:        

--------------------------------------------------------------------------------

Name: Glenn S. Palmer     Title: CEO   Facsimile No. for delivery of Notices:
323-726

 
 
26

--------------------------------------------------------------------------------

 
 
ANNEX A

NOTICE OF CONVERSION
 

The undersigned hereby elects to convert principal under the 8% Senior Secured
Convertible Note due September 1, 2010 of Blue Holdings, Inc., a Nevada
corporation (the Company”), into shares of common stock (the “Common Stock”), of
the Company according to the conditions hereof, as of the date written below. If
shares of Common Stock are to be issued in the name of a person other than the
undersigned, the undersigned will pay all transfer taxes payable with respect
thereto and is delivering herewith such certificates and opinions as reasonably
requested by the Company in accordance therewith. No fee will be charged to the
holder for any conversion, except for such transfer taxes, if any.

By the delivery of this Notice of Conversion the undersigned represents and
warrants to the Company that its ownership of the Common Stock does not exceed
the amounts specified under Section 4 of this Note, as determined in accordance
with Section 13(d) of the Exchange Act.

The undersigned agrees to comply with the prospectus delivery requirements under
the applicable securities laws in connection with any transfer of the aforesaid
shares of Common Stock pursuant to any prospectus.

Conversion calculations:   
Date to Effect Conversion: _______________________________________

Principal Amount of Note to be Converted: ___________________________

Interest Accrued on Account
of Conversion at Issue: __________________________________________
 
Number of shares of Common Stock to be issued: ______________________
____________________________________________________________
 
Signature: ____________________________________________________
 
Name: _______________________________________________________
 
Address for Delivery of Common Stock Certificates: ____________________
____________________________________________________
____________________________________________________

Or

DWAC Instructions:

Broker No: ______________
Account No: _____________
 
 
27

--------------------------------------------------------------------------------

 
 
Schedule 7(a)

The Company is party to that certain Revolving Promissory Note dated August 7,
2006 with Paul Guez pursuant to which Mr. Guez advances and may continue to
advance funds to the Company from time to time under the terms currently in
effect. The Company repays these funds from time to time in the ordinary course.
The Company and Mr. Guez are operating under a one-year extension of the term of
the Revolving Promissory Note under the same terms as reflected in the Revolving
Promissory Note. There are no amounts outstanding under the Revolving Promissory
Note as of July 30, 2007.

The Company intends to enter into an 8% Senior Convertible Note with Paul Guez
in the principal amount of $1,618,093.15 on terms substantially similar to those
set forth in this Note except that the note to be issued to Paul Guez shall be
unsecured and shall be subordinate in payment to the Notes.
 

Schedule 7(d)

The Company intends to rescind the conversion on March 5, 2008 of $1,400,000 of
indebtedness under the Revolving Promissory Note dated August 7, 2006 with Paul
Guez into 1,750,000 shares of the Company’s common stock. Mr. Guez will cancel
$700,000 of outstanding indebtedness under the Revolving Promissory Note and the
Company will issue to Mr. Guez an 8% Senior Convertible Note in the principal
amount of $1,618,093.15 (which will include $700,000 of remaining indebtedness
under the Revolving Promissory Note), such that upon the issuance of the 8%
Senior Convertible Note, no amounts shall be outstanding under the Revolving
Promissory Note other that new amounts advanced under the Note after July 30,
2008.

 
Schedule 7(e)

The Company is party to that certain Revolving Promissory Note dated August 7,
2006 with Paul Guez pursuant to which Mr. Guez advances and may continue to
advance funds to the Company from time to time under the terms currently in
effect. The Company repays these funds from time to time in the ordinary course.
The Company and Mr. Guez are operating under a one-year extension of the term of
the Revolving Promissory Note under the same terms as reflected in the Revolving
Promissory Note. There are no amounts outstanding under the Revolving Promissory
Note as of July 30, 2007.

The Company intends to enter into an 8% Senior Convertible Note with Paul Guez
in the principal amount of $1,618,093.15 on terms substantially similar to those
set forth in this Note except that the note to be issued to Paul Guez shall be
unsecured and shall be subordinate in payment to the Notes.
 
 
28

--------------------------------------------------------------------------------