exv4w1






Exhibit 4.1



THE SECURITIES REPRESENTED HEREBY MAY NOT BE TRANSFERRED UNLESS (I) SUCH SECURITIES HAVE BEEN
REGISTERED FOR SALE PURSUANT TO THE SECURITIES ACT OF 1933, AS AMENDED, (II) SUCH SECURITIES MAY BE
SOLD PURSUANT TO RULE 144(K), OR (III) THE COMPANY HAS RECEIVED AN OPINION OF COUNSEL REASONABLY
SATISFACTORY TO IT THAT SUCH TRANSFER MAY LAWFULLY BE MADE WITHOUT REGISTRATION UNDER THE
SECURITIES ACT OF 1933 OR QUALIFICATION UNDER APPLICABLE STATE SECURITIES LAWS.




SECOND AMENDED AND RESTATED SENIOR SECURED CONVERTIBLE NOTE




			
	 	 	 
	$                    
	 	November 28, 2006     





THIS SECOND AMENDED AND RESTATED SENIOR SECURED CONVERTIBLE NOTE (this “Note”) executed by
Zila, Inc., a Delaware corporation (“Company”), amends, restates and replaces that certain
Amended and Restated Senior Secured Note, dated as of November 28, 2006 (the “Restated
Note”), in the principal amount of                     , executed by Company in favor of
                                        (the “Holder”) which amended, restated and replaced that certain 6%
Senior Secured Convertible Note, dated as of November 28, 2006 (the “Original Note”), in
the principal amount of                     , executed by Company in favor of the Holder. This Note,
the Restated Note and the Original Note constitute a single, ongoing obligation of the Company.




          FOR VALUE RECEIVED, the Company hereby unconditionally promises to pay to the order of the
Holder, having an address at                                         , at such address or at such other place as
may be designated in writing by the Holder, or its assigns, the aggregate principal sum of                     
Million United States Dollars ($                    )1, together with interest from June 3, 2008
on the unpaid principal balance of this Note outstanding at a rate equal to seven percent (7%) per
annum (computed on the basis of the actual number of days elapsed in a 360-day year) and continuing
on the outstanding principal until this Note is converted into Common Stock as provided herein or
indefeasibly and irrevocably paid in full by the Company. Notwithstanding the preceding sentence,
the Company shall have the right, at its option, to pay interest at a rate equal to eight percent
(8%) per annum (computed on the basis of the actual number of days elapsed in a 360-day year) in
the form of duly authorized, fully paid and nonassessable shares of Common Stock (the “PIK
Shares”). Each PIK Share shall have a value equal to 90% of the average closing bid price per
share of the Common Stock for the ten (10) Trading Days immediately prior to the relevant Interest
Payment Date. Interest on this Note shall accrue and shall be payable quarterly on each January
31, April 30, July 31, and October 31 for the preceding quarter (each, an “Interest Payment Date”),
commencing on October 31, 2007. Subject to the other provisions of this Note, the principal of
this Note and all accrued and unpaid






 




			
	1	 	Existing principal amount as of June 3, 2008.




 









 









interest hereon shall mature and become due and payable on July 31, 2010 (the “Stated
Maturity Date”). Except as provided herein, all payments of principal and interest by the
Company under this Note shall be made in United States dollars in immediately available funds to an
account specified by the Holder. In no event shall any interest charged, collected or reserved
under this Note exceed the maximum rate then permitted by applicable law and if any such payment is
paid by the Company, then such excess sum shall be credited by the Holder as a payment of
principal.




          Upon the occurrence and during the continuation of any Event of Default hereunder, all amounts
outstanding hereunder shall bear interest at an annual rate of fifteen percent (15%). For purposes
of any of the covenants set forth in Sections 5(a)(xiii) and 5(a)(xiv) only, any Event of Default
caused by a breach of any such covenant shall be cured and shall no longer continue upon the
satisfaction by the Company of such covenant for the next succeeding quarter, to the extent
applicable. In no event shall any interest charged, collected or reserved under this Note exceed
the maximum rate then permitted by applicable law and if any such payment is paid by the Company,
then such excess sum shall be credited by the Holder as a payment of principal.




          This Note is one of a series of Notes (the “Company Notes”) of like tenor in an
aggregate principal amount of Twelve Million One and 20/100 United States Dollars ($12,000,001.20)
issued by the Company pursuant to the terms of the Purchase Agreement (as defined below) and
amended and restated pursuant to the terms of the Amendment Agreement (as defined below) and
further amended and restated pursuant to the terms of the Second Amendment Agreement (as defined
below).




     1. Definitions. Capitalized terms used herein shall have the respective meanings
ascribed thereto in the Purchase Agreement unless otherwise defined herein. Unless the context
otherwise requires, when used herein the following terms shall have the meaning indicated:



          “Additional Rights” has the meaning set forth in Section 4 hereof.




          “Affiliate” shall mean, with respect to any Person, any other Person which directly or
indirectly through one or more intermediaries Controls, is controlled by, or is under common
control with, such Person.




          “Amendment Agreement” means the Amendment Agreement, dated August 13, 2007, among the
Company, the Investors party thereto and Balyasny Asset Management, L.P.




          “Board” shall mean the Board of Directors of Company.




          “Business Day” other than a Saturday or Sunday, on which banks in New York City are
open for the general transaction of business.




          “Cash Equivalents” means (a) marketable direct obligations issued by, or
unconditionally guaranteed by, the United States Government or issued by any agency thereof and
backed by the full faith and credit of the United States, in each case maturing within one year
from the date of acquisition; (b) certificates of deposit, time deposits, eurodollar time deposits
or overnight bank deposits having maturities of six months or less from the date of acquisition
issued by any commercial bank organized under the laws of the United States or any




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state thereof having combined capital and surplus of not less than $500,000,000; (c)
commercial paper of an issuer rated at least A-1 by Standard & Poor’s Ratings Services (“S&P”) or
P-1 by Moody’s Investors Service, Inc. (“Moody’s”), or carrying an equivalent rating by a
nationally recognized rating agency, if both of the two named rating agencies cease publishing
ratings of commercial paper issuers generally, and maturing within six months from the date of
acquisition; (d) repurchase obligations of any commercial bank satisfying the requirements of
clause (b) of this definition, having a term of not more than 30 days, with respect to securities
issued or fully guaranteed or insured by the United States government; (e) securities with
maturities of one year or less from the date of acquisition issued or fully guaranteed by any
state, commonwealth or territory of the United States, by any political subdivision or taxing
authority of any such state, commonwealth or territory or by any foreign government, the securities
of which state, commonwealth, territory, political subdivision, taxing authority or foreign
government (as the case may be) are rated at least A by S&P or A by Moody’s; (f) securities with
maturities of six months or less from the date of acquisition backed by standby letters of credit
issued by any commercial bank satisfying the requirements of clause (b) of this definition; or (g)
shares of money market mutual or similar funds which invest exclusively in assets satisfying the
requirements of clauses (a) through (f) of this definition or money market funds that (i) comply
with the criteria set forth in Securities and Exchange Commission Rule 2a-7 under the Investment
Company Act of 1940, as amended, (ii) are rated AAA by S&P and Aaa by Moody’s and (iii) have
portfolio assets of at least $5,000,000,000.




          “Closing Date” has the meaning set forth in the Purchase Agreement.




          “Common Stock” shall mean the Common Stock, par value $0.001 per share, of the Company
or any securities into which shares of Common Stock may be reclassified after the date hereof.




          “Company” has the meaning set forth in the first paragraph hereof.




          “Company Notes” has the meaning set forth in the third paragraph hereof.




          “Consolidated Net Income” means, for any period, the aggregate net income (or loss) of
the Company and its Subsidiaries for such period on a consolidated basis, determined in accordance
with GAAP, consistently applied for all relevant periods, less (i) gains and losses from any sale,
lease, conveyance, transfer or other disposition of any assets or property of the Company and its
Subsidiaries, other than in the ordinary course of business, including the tax effects thereof and
(ii) items classified under GAAP, consistently applied for all relevant periods, as extraordinary,
unusual or non-recurring gains and losses, and the related tax effects thereof.




          “Control” (including the terms “controlling”, “controlled by” or “under common control
with”) means the possession, direct or indirect, of the power to direct or cause the direction of
the management and policies of a Person, whether through the ownership of voting securities, by
contract or otherwise.




          “Conversion Price” shall mean initially $2.20 per share, subject to adjustment as
provided in Section 4.




          “Conversion Shares” means the shares of Common Stock issuable upon
conversion of this Note.




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          “Convertible Securities” has the meaning set forth in Section 4 hereof.




          “Deposit Account Control Agreement” means an agreement with a depository pursuant to
which the Agent will have the right, upon an Event of Default, to control accounts of the Company
and the Subsidiary Guarantors (as defined in the Security Agreement).




          “EBITDA” means, for any period, Consolidated Net Income for such period plus, without
duplication and to the extent reflected as a charge in the statement of such Consolidated Net
Income for such period, the sum of (a) income tax expense, (b) interest expense, amortization or
write-off of debt discount and debt issuance costs and commissions, discounts and other fees and
charges associated with Indebtedness, (c) depreciation and amortization expense, (d) amortization
of intangibles (including, but not limited to, goodwill) and organization costs and (e) other
non-cash items reducing Consolidated Net Income and minus, to the extent included in the statement
of such Consolidated Net Income for such period, (x) interest income and (y) all other non-cash
items increasing Consolidated Net Income, all as determined on a consolidated basis.




          “Event of Default” has the meaning set forth in Section 6 hereof.




          “Exchange Act” shall mean the Securities Exchange Act of 1934, as amended.




          “Excluded Issuances” has the meaning set forth in Section 4(j) hereof.




          “Fiscal Year” means the period commencing on August 1 of any year and ending on July
31 of the following year.




          “Free Cash” as of any date means the sum of the Company’s unrestricted cash and Cash
Equivalents, determined on a consolidated basis.




          “GAAP” means generally accepted accounting principles in the United States applied on
a consistent basis as in effect on the date hereof.




          “Hedging Agreement” means any interest rate swap, collar, cap, floor or forward rate
agreement or other agreement regarding the hedging of interest rate risk exposure executed in
connection with hedging the interest rate exposure of any Person and any confirming letter executed
pursuant to such agreement, all as amended, supplemented, restated or otherwise modified from time
to time.




          “Holder” has the meaning set forth in the first paragraph hereof.




          “Indebtedness” means any liability or obligation (i) for borrowed money, other than
trade payables incurred in the ordinary course of business, (ii) evidenced by bonds, debentures,
notes, or other similar instruments, (iii) in respect of letters of credit or other similar
instruments (or reimbursement obligations with respect thereto), except letters of credit or other
similar instruments issued to secure payment of trade payables or obligations in respect of
workers’ compensation, unemployment insurance and other social security laws or regulation, all




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arising in the ordinary course of business consistent with past practices, (iv) to pay the
deferred purchase price of property or services, except trade payables arising in the ordinary
course of business consistent with past practices, (v) as lessee under capitalized leases, (vi)
secured by a Lien on any asset of the Company or a Subsidiary, whether or not such obligation is
assumed by the Company or such Subsidiary.




          “Investment” means, for any Person: (a) the acquisition (whether for cash, property,
services or securities or otherwise) of capital stock, bonds, notes, debentures, partnership or
other ownership interests or other securities of any other Person or any agreement to make any such
acquisition (including, without limitation, any “short sale” or any sale of any securities at a
time when such securities are not owned by the Person entering into such sale); (b) the making of
any deposit with, or advance, loan or other extension of credit to, any other Person (including the
purchase of property from another Person subject to an understanding or agreement, contingent or
otherwise, to resell such property to such Person), but excluding any such advance, loan or
extension of credit having a term not exceeding 90 days arising in connection with the sale of
inventory or supplies by such Person in the ordinary course of business; (c) the entering into of
any guarantee of, or other contingent obligation with respect to, Indebtedness or other liability
of any other Person and (without duplication) any amount committed to be advanced, lent or extended
to such Person; or (d) the entering into of any Hedging Agreement.




          “Investors” has the meaning set forth in the Purchase Agreement.




          “Lien” means any lien, mortgage, deed of trust, pledge, security interest, charge or
encumbrance of any kind (including any conditional sale or other title retention agreement, any
lease in the nature thereof and any agreement to give any of the foregoing).




          “Majority Holders” has the meaning set forth in Section 8 hereof.




          “Market Price”, as of a particular date (the “Valuation Date”), shall mean the
following: (a) if the Common Stock is then listed on a national stock exchange, the closing sale
price of one share of Common Stock on such exchange on the last Trading Day prior to the Valuation
Date; (b) if the Common Stock is then quoted on the National Association of Securities Dealers,
Inc. OTC Bulletin Board (the “Bulletin Board”) or such similar quotation system or association, the
closing sale price of one share of Common Stock on the Bulletin Board or such other quotation
system or association on the last Trading Day prior to the Valuation Date or, if no such closing
sale price is available, the average of the high bid and the low asked price quoted thereon on the
last trading day prior to the Valuation Date; (c) if such security is then included in the “pink
sheets,” the closing sale price of one share of Common Stock on the “pink sheets” on the last
Trading Day prior to the Valuation Date or, if no such closing sale price is available, the average
of the high bid and the low ask price quoted on the “pink sheets” as of the end of the last Trading
Day prior to the Valuation Date; or (d) if the Common Stock is not then listed on a national stock
exchange or quoted on the Bulletin Board, the “pink sheets” or such other quotation system or
association, the fair market value of one share of Common Stock as of the Valuation Date, as
determined in good faith by the Board of Directors of the Company and the Holder. If the Common
Stock is not then listed on a national securities exchange or quoted on the Bulletin Board, the
“pink sheets” or other quotation system



5









 






or association, the Board of Directors of the Company shall respond promptly, in writing, to
an inquiry by the Holder as to the fair market value of a share of Common Stock as determined by
the Board of Directors of the Company. In the event that the Board of Directors of the Company and
the Holder are unable to agree upon the fair market value in respect of subpart (d) of this
paragraph, the Company and the Holder shall jointly select an appraiser, who is experienced in such
matters. The decision of such appraiser shall be final and conclusive, and the cost of such
appraiser shall be borne equally by the Company and the Holder.




          “Mortgage Financing” means the incurrence of up to $2,000,000 in aggregate principal
amount of Indebtedness secured only by the Owned Real Estate; provided that the Company retains fee
ownership of the Owned Real Estate.




          “Note” has the meaning set forth in the first paragraph hereof.




          “Optional Conversion Date” has the meaning set forth in Section 4(a) hereof.




          “Options” has the meaning set forth in Section 4 hereof.




          “Owned Real Estate” means the real property, improvements and related fixtures and
appurtenances thereto owned by the Company.




          “Permitted Indebtedness” means:




          (a) Unsecured Indebtedness existing on the Closing Date and refinancings, renewals and
extensions of any such Indebtedness if (i) the average life to maturity thereof is greater than or
equal to that of the Indebtedness being refinanced or extended (ii) the principal amount thereof or
interest payable thereon is not increased, and (iii) the terms thereof are not less favorable to
the Company or the Subsidiary incurring such Indebtedness than the Indebtedness being refinanced,
renewed or extended;




          (b) Working capital Indebtedness of the Company that is secured by the Company’s accounts and
inventory and otherwise containing terms and conditions approved by the Majority Holders, such
approval not to be unreasonably withheld;




          (c) Guaranties by any Subsidiary of any “Permitted Indebtedness” of the Company or another
Subsidiary;




          (d) Indebtedness representing the deferred purchase price of property and capital lease
obligations which collectively does not exceed $1,000,000 in aggregate principal amount;




          (e) the Mortgage Financing; and




          (f) Indebtedness of the Company to any wholly owned Subsidiary and Indebtedness of any wholly
owned Subsidiary to the Company or another wholly owned Subsidiary which constitutes “Permitted
Indebtedness.”




          “Permitted Investments” means:




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          (a) direct obligations of the United States of America, or of any agency thereof, or
obligations guaranteed as to principal and interest by the United States of America, or of any
agency thereof, in either case maturing not more than 90 days from the date of acquisition thereof;




          (b) certificates of deposit issued by any bank or trust company organized under the laws of
the United States of America or any State thereof and having capital, surplus and undivided profits
of at least $500,000,000, maturing not more than 90 days from the date of acquisition thereof; and




          (c) commercial paper rated A-1 or better or P-1 by Standard & Poor’s Ratings Services or
Moody’s Investors Services, Inc., respectively, maturing not more than 90 days from the date of
acquisition thereof; in each case so long as the same (x) provide for the payment of principal and
interest (and not principal alone or interest alone) and (y) are not subject to any contingency
regarding the payment of principal or interest.




          “Permitted Liens” means:




          (a) Liens imposed by law for taxes that are not yet due or are being contested in good faith
and for which adequate reserves have been established on the Company’s books and records in
accordance with U.S. generally accepted accounting principles, consistently applied;




          (b) carriers’, warehousemen’s, mechanics’, materialmen’s, repairmen’s and other like Liens
imposed by law, arising in the ordinary course of business and securing obligations that are not
overdue by more than 30 days or that are being contested in good faith and by appropriate
proceedings;




          (c) pledges and deposits made in the ordinary course of business in compliance with workers’
compensation, unemployment insurance and other social security laws or regulations;




          (d) deposits to secure the performance of bids, trade contracts, leases, statutory
obligations, surety and appeal bonds, performance bonds and other obligations of a like nature, in
each case in the ordinary course of business;




          (e) easements, zoning restrictions, rights-of-way and similar encumbrances on real property
imposed by law or arising in the ordinary course of business that do not secure any monetary
obligations and do not materially detract from the value of the affected property or interfere with
the ordinary conduct of business of the Company or any of its Subsidiaries; and




          (f) Liens granted to secure the obligations of the Company or any Subsidiary under any
Indebtedness permitted under clauses (b), (d) and (e) of the definition of “Permitted
Indebtedness”; provided, however, that any Liens securing Indebtedness permitted under (i) clause
(b) of such definition shall be limited to the Company’s accounts and inventory, (ii) clause (d) of
such definition shall be limited to the property acquired through such Indebtedness and (iii)
clause (e) of such definition shall be limited to the Owned Real Property. Upon the Company’s
request, the Investors shall subordinate or release their security interests in the



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Owned Real Property to permit the Mortgage Financing on terms approved by the Majority
Holders, such approval not to be unreasonably withheld.




          “Person” means an individual, corporation, partnership, limited liability company,
trust, business trust, association, joint stock company, joint venture, sole proprietorship,
unincorporated organization, governmental authority or any other form of entity not specifically
listed herein.




          “Purchase Agreement” shall mean the Purchase Agreement, dated as of November 13, 2006,
and as that agreement may be amended from time to time, by and among the Company and the Investors.




          “Qualifying Event of Default” means an Event of Default of the type specified in
Sections 6(b), 6(g) and 6(j).




          “Restricted Payment” has the meaning set forth in Section 5(b)(iv) hereof.




          “Second Amendment Agreement” means the Second Amendment Agreement, dated June 3, 2008,
among the Company, the Investors party thereto and Balyasny Asset Management, L.P.




          “Security Agreement” has the meaning set forth in the Purchase Agreement.




          “Security Documents” means the collective reference to the Security Agreement, the
Deposit Account Control Agreements and each other agreement or writing pursuant to which the
Company purports to pledge or grant a security interest in any property or assets securing the
Company’s obligations or any such Person purports to guaranty the payment and/or performance of the
Company’s obligations, in each case, as amended, restated, supplemented or otherwise modified from
time to time.




          “Stated Maturity Date” has the meaning set forth in the first paragraph hereof.




          “Subsidiary” of any Person means another Person, an amount of the voting securities,
other voting ownership or voting partnership interests of which is sufficient to elect at least a
majority of its Board of Directors or other governing body (or, if there are no such voting
interests, 50% or more of the equity interests of which) is owned directly or indirectly by such
first Person.




          “Trading Day” means (i) if the relevant stock or security is listed or admitted for
trading on The New York Stock Exchange, Inc., the Nasdaq Global Select Market, the Nasdaq Global
Market, the Nasdaq Capital Market or any other national securities exchange, a day on which such
exchange is open for business; (ii) if the relevant stock or security is quoted on a system of
automated dissemination of quotations of securities prices, a day on which trades may be effected
through such system; or (iii) if the relevant stock or security is not listed or admitted for
trading on any national securities exchange or quoted on any system of automated dissemination of
quotation of securities prices, a day on which the relevant stock or security is traded in a
regular way in the over-the-counter market and for which a closing bid and a closing asked price
for such stock or security are available, shall mean a day, other than a Saturday or
Sunday, on which The New York Stock Exchange, Inc. is open for trading.




8









 








          “Trigger Issuance” has the meaning set forth in Section 4(i) hereof.




     2. Purchase Agreement. This Note is one of the Senior Secured Convertible Notes of
the Company issued pursuant to the Purchase Agreement and amended and restated pursuant to the
Amendment Agreement and further amended and restated pursuant to the Second Amendment Agreement.
This Note is subject to the terms and conditions of, and entitled to the benefit of, the provisions
of the Purchase Agreement, the Amendment Agreement and the Second Amendment Agreement. This Note
is transferable and assignable to any Person to whom such transfer is permissible under the
Purchase Agreement and applicable law. The Company agrees to issue from time to time a replacement
Note in the form hereof to facilitate such transfers and assignments. In addition, after delivery
of an indemnity in form and substance reasonably satisfactory to the Company, the Company also
agrees to promptly issue a replacement Note if this Note is lost, stolen, mutilated or destroyed.



     3. Prepayment. This Note shall not be prepayable or redeemable by the Company prior
to the Stated Maturity Date.



     4. Conversion.



          (a) The Holder shall have the right, at its option, exercisable at any time, effective upon
delivery to the Company of a Conversion Notice, to convert all or a portion of the principal amount
of this Note and any accrued and unpaid interest due on the portion of the principal amount of this
Note being converted into fully paid and nonassessable shares of the Common Stock at the Conversion
Price then in effect. The date of any optional conversion is hereinafter referred to as the
“Optional Conversion Date.”




          (b) [reserved]




          (c) Promptly after any Optional Conversion Date, the Holder of this Note shall deliver this
Note to the Company (or, in lieu thereof, an appropriate lost security affidavit in the event this
Note shall have been lost or destroyed, together with a customary indemnity agreement) to the
Company at its principal office (or such other office or agency of the Company as the Company may
designate by notice in writing to the Holder), together with a statement of the name or names (with
address) in which the certificate or certificates for the Conversion Shares issuable upon such
conversion shall be issued. Promptly following the surrender of this Note (or, in lieu thereof,
delivery of an appropriate lost security affidavit in the event this Note shall have been lost or
destroyed, together with a customary indemnity agreement) as aforesaid, but in no event more than
three (3) Business Days thereafter, the Company shall issue and deliver, or cause to be issued and
delivered, to the Holder, registered in such name or names as the Holder may direct in writing, a
certificate or certificates for the number of whole Conversion Shares issuable upon the conversion
of this Note and, in the case of the conversion of less than the entire amount of this Note, a new
note of like tenor in the principal amount of this Note not being converted on the relevant
Optional Conversion Date. To the extent permitted by law, such conversion shall be deemed to have
been effected, and the Conversion Price shall be determined, as of the close of business on the
Optional Conversion Date and at such time, the rights of the




9









 




Holder shall cease with respect to the Note, or amount thereof, being converted, and the
Person or Persons in whose name or names any certificate or certificates for Conversion Shares
shall be issuable upon such conversion shall be deemed to have become the holder or holders of
record of the Conversion Shares represented thereby.




          (d) No fractional shares shall be issued upon any conversion of this Note into Common Stock.
If any fractional share of Common Stock would, except for the provisions of the first sentence of
this Section 4(d), be delivered upon such conversion, the Company, in lieu of delivering such
fractional share, shall pay to the Holder an amount in cash equal to the Market Price of such
fractional share of Common Stock.




          (e) If the Company shall, at any time or from time to time while this Note is outstanding, pay
a dividend or make a distribution on its Common Stock in shares of Common Stock, subdivide its
outstanding shares of Common Stock into a greater number of shares or combine its outstanding
shares of Common Stock into a smaller number of shares or issue by reclassification of its
outstanding shares of Common Stock any shares of its capital stock (including any such
reclassification in connection with a consolidation or merger in which the Company is the
continuing corporation), then (i) the Conversion Price in effect immediately prior to the date on
which such change shall become effective shall be adjusted by multiplying such Conversion Price by
a fraction, the numerator of which shall be the number of shares of Common Stock outstanding
immediately prior to such change and the denominator of which shall be the number of shares of
Common Stock outstanding immediately after giving effect to such change and (ii) the number of
Conversion Shares issuable upon conversion of this Note shall be adjusted by multiplying the number
of Conversion Shares issuable upon conversion of this Note immediately prior to the date on which
such change shall become effective by a fraction, the numerator of which is shall be the Conversion
Price in effect immediately prior to the date on which such change shall become effective and the
denominator of which shall be the Conversion Price in effect immediately after giving effect to
such change, calculated in accordance with clause (i) above. Such adjustments shall be made
successively whenever any event listed above shall occur.




          (f) If any capital reorganization, reclassification of the capital stock of the Company,
consolidation or merger of the Company with another corporation in which the Company is not the
survivor, or sale, transfer or other disposition of all or substantially all of the Company’s
assets to another Person shall be effected, then, as a condition of such reorganization,
reclassification, consolidation, merger, sale, transfer or other disposition, lawful and adequate
provision shall be made whereby the Holder shall thereafter have the right, at its option, either
(i) to purchase and receive upon the basis and upon the terms and conditions herein specified and
in lieu of the Conversion Shares immediately theretofore issuable upon conversion of this Note such
shares of stock, securities or assets as would have been issuable or payable with respect to or in
exchange for a number of Conversion Shares equal to the number of Conversion Shares immediately
theretofore issuable upon conversion of this Note, had such reorganization, reclassification,
consolidation, merger, sale, transfer or other disposition not taken place, and in any such case
appropriate provision shall be made with respect to the rights and interests of the Holder to the
end that the provisions hereof (including, without limitation, provision for adjustment of the
Conversion Price) shall thereafter be applicable, as nearly equivalent as may be practicable in
relation to any shares of stock, securities or assets thereafter deliverable upon the




10









 




conversion hereof or (ii) in the event or any such consolidation or merger of the Company or
such sale, transfer or other disposition of all or substantially all of the Company’s assets only,
to cause the Company to redeem this Note at a redemption price equal to 110% of the outstanding
principal amount of this Note, together with all accrued and unpaid interest hereon to the date of
redemption, which right must be exercised by the Holder within ten (10) Business Days after receipt
by it from the Company of written notice of the occurrence of any transaction giving rise to such
right. The Company shall not effect any such consolidation, merger, sale, transfer or other
disposition unless prior to or simultaneously with the consummation thereof the successor
corporation (if other than the Company) resulting from such consolidation or merger, or the
corporation purchasing or otherwise acquiring such assets or other appropriate corporation or
entity shall assume the obligation to deliver to the Holder, at the last address of the Holder
appearing on the books of the Company, such shares of stock, securities or assets as, in accordance
with the foregoing provisions, the Holder may be entitled to purchase, without regard to any
conversion limitation specified in Section 4, and the other obligations under this Note. The
provisions of this paragraph (f) shall similarly apply to successive reorganizations,
reclassifications, consolidations, mergers, sales, transfers or other dispositions.




          (g) In case the Company shall fix a payment date for the making of a distribution to all
holders of Common Stock (including any such distribution made in connection with a consolidation or
merger in which the Company is the continuing corporation) of evidences of indebtedness or assets
(other than cash dividends or cash distributions payable out of consolidated earnings or earned
surplus or dividends or distributions referred to in Section 4(e)), or subscription rights or
warrants, the Conversion Price to be in effect after such payment date shall be determined by
multiplying the Conversion Price in effect immediately prior to such payment date by a fraction,
the numerator of which shall be the total number of shares of Common Stock outstanding multiplied
by the Market Price of Common Stock immediately prior to such payment date, less the fair market
value (as determined by the Board in good faith) of said assets or evidences of indebtedness so
distributed, or of such subscription rights or warrants, and the denominator of which shall be the
total number of shares of Common Stock outstanding multiplied by such Market Price immediately
prior to such payment date. Such adjustment shall be made successively whenever such a payment
date is fixed.




          (h) An adjustment to the Conversion Price shall become effective immediately after the payment
date in the case of each dividend or distribution and immediately after the effective date of each
other event which requires an adjustment.




          (i) In the event that, as a result of an adjustment made pursuant to this Section 4, the
Holder shall become entitled to receive any shares of capital stock of the Company other than
shares of Common Stock, the number of such other shares so receivable upon conversion of this Note
shall be subject thereafter to adjustment from time to time in a manner and on terms as nearly
equivalent as practicable to the provisions contained in this Note.




          (j) Except as provided in Section 4(j) hereof, if and whenever the Company shall issue or
sell, or is, in accordance with any of Sections 4(j)(i) through 4(j)(vii) hereof, deemed to have
issued or sold, any Additional Shares of Common Stock (as defined below) for no consideration or
for a consideration per share less than the Conversion Price in effect immediately prior to the
time of such issuance or sale, then and in each such case (a “Trigger 




11









 







Issuance”) the then-existing Conversion Price, shall be reduced, as of the close of
business on the effective date of the Trigger Issuance, to a price determined as follows:




	 	 	 	 	 
	Adjusted Conversion Price =

	 	(A x B) + D	 	 
	 

	 	 

A+C
	 	 






               where



               “A” equals the number of shares of Common Stock outstanding, including Additional Shares of
Common Stock (as defined below) deemed to be issued hereunder, immediately preceding such Trigger
Issuance;



               “B” equals the Conversion Price in effect immediately preceding such Trigger Issuance;



               “C” equals the number of Additional Shares of Common Stock issued or deemed issued hereunder
as a result of the Trigger Issuance; and



               “D” equals the aggregate consideration, if any, received or deemed to be received by the
Company upon such Trigger Issuance;


provided, however, that in no event shall the Conversion Price after giving effect to such Trigger
Issuance be greater than the Conversion Price in effect prior to such Trigger Issuance.




          For purposes of this subsection (j), “Additional Shares of Common Stock” shall mean all shares
of Common Stock issued or sold by the Company or deemed to be issued or sold pursuant to this
subsection (j), other than Excluded Issuances (as defined in subsection (k) hereof).




          For purposes of this Section 4(j), the following subsections (j)(i) to (j)(viii) shall also be
applicable (subject, in each such case, to the provisions of Section 4(k) hereof):




          (i) In case at any time the Company shall in any manner grant (directly and not by assumption
in a merger or otherwise) any warrants or other rights to subscribe for or to purchase, or any
options for the purchase of, Common Stock or any stock or security convertible into or exchangeable
for Common Stock (such warrants, rights or options being called “Options” and such
convertible or exchangeable stock or securities being called “Convertible Securities”)
whether or not such Options or the right to convert or exchange any such Convertible Securities are
immediately exercisable, and the price per share for which Common Stock is issuable upon the
exercise of such Options or upon the conversion or exchange of such Convertible Securities
(determined by dividing (i) the sum (which sum shall constitute the applicable consideration) of
(x) the total amount, if any, received or receivable by the Company as consideration for the
granting of such Options, plus (y) the aggregate amount of additional consideration payable to the
Company upon the exercise of all such Options, plus (z), in the case of such Options which relate
to Convertible Securities, the aggregate amount of additional consideration, if any, payable upon
the issuance or sale of such Convertible Securities and upon the conversion or exchange thereof, by
(ii) the total maximum number of shares of Common Stock issuable upon the




12









 




exercise of such Options or upon the conversion or exchange of all such Convertible Securities
issuable upon the exercise of such Options) shall be less than the Conversion Price immediately
prior to the time of the granting of such Options, then the total number of shares of Common Stock
issuable upon the exercise of such Options or upon conversion or exchange of the total amount of
such Convertible Securities issuable upon the exercise of such Options shall be deemed to have been
issued for such price per share as of the date of granting of such Options or the issuance of such
Convertible Securities and thereafter shall be deemed to be outstanding for purposes of adjusting
the Conversion Price. Except as otherwise provided in subsection 4(i)(iii), no adjustment of the
Conversion Price shall be made upon the actual issuance of such Common Stock or of such Convertible
Securities upon exercise of such Options or upon the actual issuance of such Common Stock upon
conversion or exchange of such Convertible Securities.




          (ii) In case the Company shall in any manner issue (directly and not by assumption in a merger
or otherwise) or sell any Convertible Securities, whether or not the rights to exchange or convert
any such Convertible Securities are immediately exercisable, and the price per share for which
Common Stock is issuable upon such conversion or exchange (determined by dividing (i) the sum
(which sum shall constitute the applicable consideration) of (x) the total amount received or
receivable by the Company as consideration for the issuance or sale of such Convertible Securities,
plus (y) the aggregate amount of additional consideration, if any, payable to the Company upon the
conversion or exchange thereof, by (ii) the total number of shares of Common Stock issuable upon
the conversion or exchange of all such Convertible Securities) shall be less than the Conversion
Price immediately prior to the time of such issuance or sale, then the total maximum number of
shares of Common Stock issuable upon conversion or exchange of all such Convertible Securities
shall be deemed to have been issued for such price per share as of the date of the issuance or sale
of such Convertible Securities and thereafter shall be deemed to be outstanding for purposes of
adjusting the Conversion Price, provided that (a) except as otherwise provided in subsection
4(j)(iii), no adjustment of the Conversion Price shall be made upon the actual issuance of such
Common Stock upon conversion or exchange of such Convertible Securities and (b) no further
adjustment of the Conversion Price shall be made by reason of the issuance or sale of Convertible
Securities upon exercise of any Options to purchase any such Convertible Securities for which
adjustments of the Conversion Price have been made pursuant to the other provisions of Section
4(j).




          (iii) Upon the happening of any of the following events, namely, if the purchase price
provided for in any Option referred to in subsection 4(j)(i) hereof, the additional consideration,
if any, payable upon the conversion or exchange of any Convertible Securities referred to in
subsections 4(j)(i) or 4(j)(ii), or the rate at which Convertible Securities referred to in
subsections 4(j)(i) or 4(j)(ii) are convertible into or exchangeable for Common Stock shall change
at any time (including, but not limited to, changes under or by reason of provisions designed to
protect against dilution), the Conversion Price in effect at the time of such event shall forthwith
be readjusted to the Conversion Price which would have been in effect at such time had such Options
or Convertible Securities still outstanding provided for such changed purchase price, additional
consideration or conversion rate, as the case may be, at the time initially granted, issued or
sold. On the termination of any Option for which any adjustment was made pursuant to this
subsection 4(j) or any right to convert or exchange Convertible Securities for which any adjustment
was made pursuant to this subsection 4(j) (including without limitation upon the redemption or
purchase for consideration of such Convertible Securities by the




13









 




Company), the Conversion Price then in effect hereunder shall forthwith be changed to the
Conversion Price which would have been in effect at the time of such termination had such Option or
Convertible Securities, to the extent outstanding immediately prior to such termination, never been
issued.




          (iv) Subject to the provisions of this Section 4(j), in case the Company shall declare a
dividend or make any other distribution upon any stock of the Company (other than the Common Stock)
payable in Common Stock, Options or Convertible Securities, then any Common Stock, Options or
Convertible Securities, as the case may be, issuable in payment of such dividend or distribution
shall be deemed to have been issued or sold without consideration; provided, that if any adjustment
is made to the Conversion Price as a result of a declaration of a dividend and such dividend is
rescinded, the Conversion Price shall be appropriately readjusted to the Conversion Price in effect
had such dividend not been declared.




          (v) In case any shares of Common Stock, Options or Convertible Securities shall be issued or
sold for cash, the consideration received therefor shall be deemed to be the net amount received by
the Company therefor, after deduction therefrom of any expenses incurred or any underwriting
commissions or concessions paid or allowed by the Company in connection therewith. In case any
shares of Common Stock, Options or Convertible Securities shall be issued or sold for a
consideration other than cash, the amount of the consideration other than cash received by the
Company shall be deemed to be the fair value of such consideration as determined in good faith by
the Board, after deduction of any expenses incurred or any underwriting commissions or concessions
paid or allowed by the Company in connection therewith. In case any Options shall be issued in
connection with the issuance and sale of other securities of the Company, together comprising one
integral transaction in which no specific consideration is allocated to such Options by the parties
thereto, such Options shall be deemed to have been issued for such consideration as determined in
good faith by the Board of Directors of the Company. If Common Stock, Options or Convertible
Securities shall be issued or sold by the Company and, in connection therewith, other Options or
Convertible Securities (the “Additional Rights”) are issued, then the consideration
received or deemed to be received by the Company shall be reduced by the fair market value of the
Additional Rights (as determined using the Black-Scholes option pricing model or another method
mutually agreed to by the Company and the Holder). The Board shall respond promptly, in writing,
to an inquiry by the Holder as to the fair market value of the Additional Rights. In the event
that the Board and the Holder are unable to agree upon the fair market value of the Additional
Rights, the Company and the Holder shall jointly select an appraiser, who is experienced in such
matters. The decision of such appraiser shall be final and conclusive, and the cost of such
appraiser shall be borne evenly by the Company and the Holder.




          (vi) In case the Company shall take a record of the holders of its Common Stock for the
purpose of entitling them (i) to receive a dividend or other distribution payable in Common Stock,
Options or Convertible Securities or (ii) to subscribe for or purchase Common Stock, Options or
Convertible Securities, then such record date shall be deemed to be the date of the issuance or
sale of the shares of Common Stock deemed to have been issued or sold upon the declaration of such
dividend or the making of such other distribution or the date of the granting of such right of
subscription or purchase, as the case may be.




14









 








          (vii) The number of shares of Common Stock outstanding at any given time shall not include
shares owned or held by or for the account of the Company or any of its wholly-owned subsidiaries,
and the disposition of any such shares (other than the cancellation or retirement thereof) shall be
considered an issuance or sale of Common Stock for the purpose of this subsection (j).




          (viii) Notwithstanding any other provision in this subsection (j) to the contrary, if a
reduction in the Conversion Price pursuant to this subsection (j) (other than as set forth in this
clause (viii)) would require the Company to obtain stockholder approval of the transactions
contemplated by the Purchase Agreement to be consummated on the Closing Date pursuant to Nasdaq
Marketplace Rule 4350(i) and such stockholder approval has not been obtained, (i) the Conversion
Price shall be reduced to the maximum extent that would not require stockholder approval under such
Rule, and (ii) the Company shall use its commercially reasonable efforts to obtain such stockholder
approval as soon as reasonably practicable, including by calling a special meeting of stockholders
to vote on such Conversion Price adjustment. This provision shall not restrict the number of
shares of Common Stock which a Holder may receive or beneficially own in order to determine the
amount of securities or other consideration that such Holder may receive in the event of a
transaction contemplated by Section 4 of this Note.




          (k) Anything herein to the contrary notwithstanding, the Company shall not be required to make
any adjustment of the Conversion Price in the case of the issuance of (A) capital stock, Options or
Convertible Securities issued to directors, officers, employees or consultants of the Company in
connection with their service as directors of the Company, their employment by the Company or their
retention as consultants by the Company pursuant to an equity compensation program approved by the
Board of Directors of the Company or the compensation committee of the Board of Directors of the
Company, (B) shares of Common Stock issued upon the conversion or exercise of Options or
Convertible Securities issued prior to the date hereof, provided such securities are not amended
after the date hereof to increase the number of shares of Common Stock issuable thereunder or to
lower the exercise or conversion price thereof, (C) securities issued pursuant to the Purchase
Agreement and securities issued upon the exercise or conversion of those securities, (D) shares of
Common Stock issued or issuable by reason of a dividend, stock split or other distribution on
shares of Common Stock (but only to the extent that such a dividend, split or distribution results
in an adjustment in the Conversion Price pursuant to the other provisions of this Note) and (E) the
issuance of any PIK Shares (collectively, “Excluded Issuances”).




          (l) In case at any time:




          (i) the Company shall declare any dividend upon its Common Stock or any other class or series
of capital stock of the Company payable in cash or stock or make any other distribution to the
holders of its Common Stock or any such other class or series of capital stock;




          (ii) the Company shall offer for subscription pro rata to the holders of its
Common Stock or any other class or series of capital stock of the Company any additional shares of
stock of any class or other rights; or




15









 








          (iii) there shall be any capital reorganization or reclassification of the capital stock of
the Company, any acquisition or a liquidation, dissolution or winding up of the Company;



then, in any one or more of said cases, the Company shall give, by delivery in person or by
certified or registered mail, return receipt requested, addressed to the Holder at the address of
such Holder as shown on the books of the Company, (a) at least 20 Business Days’ prior written
notice of the date on which the books of the Company shall close or a record shall be taken for
such dividend, distribution or subscription rights or for determining rights to vote in respect of
any event set forth in clause (iii) of this Section 4(l) and (b) in the case of any event set forth
in clause (iii) of this Section 4(l), at least 20 Business Days’ prior written notice of the date
when the same shall take place. Such notice in accordance with the foregoing clause (a) shall also
specify, in the case of any such dividend, distribution or subscription rights, the date on which
the holders of Common Stock or such other class or series of capital stock shall be entitled
thereto and such notice in accordance with the foregoing clause (b) shall also specify the date on
which the holders of Common Stock and such other series or class of capital stock shall be entitled
to exchange their Common Stock and other stock for securities or other property deliverable upon
consummation of the applicable event set forth in clause (iii) of this Section 4(l).




          (m) Upon any adjustment of the Conversion Price, then and in each such case the Company shall
give prompt written notice thereof, by delivery in person or by certified or registered mail,
return receipt requested, addressed to the Holder at the address of such Holder as shown on the
books of the Company, which notice shall state the Conversion Price resulting from such adjustment
and setting forth in reasonable detail the method upon which such calculation is based.




          (n) The Company shall at all times reserve and keep available out of its authorized Common
Stock, solely for the purpose of issuance upon conversion of this Note as herein provided, such
number of shares of Common Stock as shall then be issuable upon the conversion of this Note. The
Company covenants that all shares of Common Stock which shall be so issued shall be duly and
validly issued and fully paid and nonassessable, and free from all taxes, liens and charges with
respect to the issue thereof, and, without limiting the generality of the foregoing, and that the
Company will from time to time take all such action as may be requisite to assure that the par
value per share of the Common Stock is at all times equal to or less than the Conversion Price in
effect at the time. The Company shall take all such action as may be necessary to assure that all
such shares of Common Stock may be so issued without violation of any applicable law or regulation,
or of any requirement of any national securities exchange or trading market upon which the Common
Stock may be listed. The Company shall not take any action which results in any adjustment of the
Conversion Price if the total number of shares of Common Stock issued and issuable after such
action upon conversion of this Note would exceed the total number of shares of Common Stock then
authorized by the Company’s Certificate of Incorporation.




          (o) The issuance of certificates for shares of Common Stock upon conversion of this Note shall
be made without charge to the holders thereof for any issuance tax in respect thereof, provided
that the Company shall not be required to pay any tax which may be payable in respect of any
transfer involved in the issuance and delivery of any certificate in a name other




16









 




than that of the Holder. When the Company is required to issue Conversion Shares hereunder,
if: (1) certificates representing such Conversion Shares are not delivered to the Holder within
three (3) Business Days of the Optional Conversion Date, and (2) prior to the time such
certificates are received, the Holder, or any third party on behalf of such Holder or for the
Holder’s account, purchases (in an open market transaction or otherwise) shares of Common Stock to
deliver in satisfaction of a sale by the Holder of such certificates (a “Buy-In”), then the Company
shall pay in cash to the Holder (for costs incurred either directly by such Holder or on behalf of
a third party) the amount by which the total purchase price paid for Common Stock as a result of
the Buy-In (including brokerage commissions, if any) exceeds the proceeds received by the Holder as
a result of the sale to which such Buy-In relates. The Holder shall provide the Company written
notice indicating the amounts payable to the Holder in respect of the Buy-In.




          (p) The Company will not at any time close its transfer books against the transfer, as
applicable, of this Note or of any shares of Common Stock issued or issuable upon the conversion of
this Note in any manner which interferes with the timely conversion of this Note, except as may
otherwise be required to comply with applicable securities laws.




          (q) Notwithstanding anything to the contrary contained herein, the number of Conversion Shares
that may be acquired by the Holder upon any conversion of this Note (or otherwise in respect
hereof) shall be limited to the extent necessary to insure that, following such conversion (or
other issuance), the total number of shares of Common Stock then beneficially owned by such Holder
and its Affiliates and any other Persons whose beneficial ownership of Common Stock would be
aggregated with the Holder’s for purposes of Section 13(d) of the Securities Exchange Act of 1934,
as amended (the “Exchange Act”), does not exceed 9.999% of the total number of issued and
outstanding shares of Common Stock (including for such purpose the shares of Common Stock issuable
upon such conversion). For such purposes, beneficial ownership shall be determined in accordance
with Section 13(d) of the Exchange Act and the rules and regulations promulgated thereunder. This
provision shall not restrict the number of shares of Common Stock which a Holder may receive or
beneficially own in order to determine the amount of securities or other consideration that such
Holder may receive in the event of a transaction contemplated by Section 4(f) of this Note. This
restriction may not be waived.




     5. Covenants.



          (a) So long as any amount due under this Note is outstanding and until the earlier of (i) the
indefeasible payment in full of all amounts payable by the Company hereunder and (ii) the
conversion of this Note:




          (i) The Company shall and shall cause each of its Subsidiaries to (A) carry on and conduct its
business in substantially the same manner and in substantially the same fields of enterprise as it
is presently conducting, (B) do all things necessary to remain duly organized, validly existing,
and in good standing as a domestic corporation under the laws of its state of incorporation and (C)
maintain all requisite authority to conduct its business in those jurisdictions in which its
business is conducted.




          (ii) The Company shall promptly notify the Holder in writing of (A) any change in the business
or the operations the Company or any Subsidiary which could reasonably




17









 




be expected to have a Material Adverse Effect, and (B) any information which indicates that
any financial statements which are the subject of any representation contained in the Deal
Documents, or which are furnished to the Holder pursuant to the Deal Documents, fail, in any
material respect, to present fairly, as of the date thereof and for the period covered thereby, the
financial condition and results of operations purported to be presented therein, disclosing the
nature thereof; provided, however, that this clause (B) shall not apply to any information provided
to the Holder pursuant to Section 6 of the Second Amendment Agreement.




          (iii) The Company shall promptly notify the Holder of the occurrence of any Event of Default
or any event which, with the giving of notice, the lapse of time or both would constitute an Event
of Default, which notice shall include a written statement as to such occurrence, specifying the
nature thereof and the action (if any) which is proposed to be taken with respect thereto.




          (iv) The Company shall promptly notify the Holder of any action, suit or proceeding at law or
in equity or by or before any governmental instrumentality or other agency against the Company or
any Subsidiary or to which the Company or any Subsidiary may be subject which alleges damages in
excess of Two Hundred Fifty Thousand United States Dollars ($250,000).




          (v) The Company shall promptly notify the Holder of any default in the performance, observance
or fulfillment of any of the obligations, covenants or conditions contained in any agreement or
instrument to which the Company or any Subsidiary is a party which default could reasonably be
expected to have a Material Adverse Effect.




          (vi) The Company shall and shall cause each Subsidiary to promptly take any and all actions
necessary to execute any definitive documentation (which documentation shall include customary
representations, warranties, covenants, conditions and agreements, and any UCC financing
statements) reasonably requested by the Holder, for obtaining the benefits of the Security
Agreement, subject to the terms and conditions stated therein.




          (vii) The Company shall and shall cause each Subsidiary to pay when due all taxes, assessments
and governmental charges and levies upon it or its income, profits or property, except those that
are being contested in good faith by appropriate proceedings and with respect to which adequate
reserves have been set aside.




          (viii) The Company shall and shall cause each Subsidiary to all times maintain with
financially sound and reputable insurance companies insurance covering its assets and its
businesses in such amounts and covering such risks (including, without limitation, hazard, business
interruption and public liability) as is consistent with sound business practice and as may be
obtained at commercially reasonable rates. The insurance policies will comply with the provisions
of Section 11 of the Security Agreement.




          (ix) The Company shall and shall cause each Subsidiary to comply with all laws, rules,
regulations, orders, writs, judgments, injunctions, decrees or awards to which they may be subject
except where the failure to so comply could not reasonably be expected to have a Material Adverse
Effect.




18









 








          (x) The Company shall and shall cause each Subsidiary to use commercially reasonable efforts
to do all things necessary to maintain, preserve, protect and keep its properties in good repair,
working order and condition and use commercially reasonable efforts to make all necessary and
proper repairs, renewals and replacements so that its business carried on in connection therewith
may be properly conducted.




          (xi) At its own expense, the Company shall and shall cause each Subsidiary to make, execute,
endorse, acknowledge, file and/or deliver any documents and take all commercially reasonable
actions necessary or required to maintain its ownership rights in its Intellectual Property,
including, without limitation, (i) any action reasonably required to protect the Intellectual
Property in connection with any infringement, suspected infringement, passing off, act of unfair
competition or other unlawful interference with the rights of the Company or any Subsidiary in and
to such Intellectual Property, and (ii) any registrations with the United States Patent & Trademark
Office and any corresponding foreign patent and/or trademark office required for the Company or any
Subsidiary to carry on its business as presently conducted and as presently proposed to be
conducted. Except for non-exclusive licenses granted in the ordinary course of business, the
Company shall not and shall cause each Subsidiary not to transfer, assign or otherwise convey the
Intellectual Property, any registrations or applications thereof and all goodwill associated
therewith, to any person or entity.




          (xii) Promptly after the occurrence thereof, the Company shall and shall cause each Subsidiary
to inform the Holder of the following material developments: (i) entering into material agreements
outside the ordinary course of business consistent with past practice, (ii) any issuance of debt
securities by the Company or any Subsidiary, (iii) the incurrence of any Indebtedness, other than
Permitted Indebtedness, by the Company or any Subsidiary, (iv) a change in the number of the Board
of Directors of the Company, (v) a sale, lease or transfer of any material portion of the assets of
the Company or any Subsidiary and (vi) any change in ownership of any Subsidiary (specifying the
details of any such change, including the identity and ownership amount of any new owner).




          (xiii) The Company shall maintain, as at the end of each fiscal quarter commencing with the
fiscal quarter ending July 31, 2007, Free Cash in an amount not less than $1,000,000.




          (xiv) The Company shall achieve EBITDA of at least $1 (the “EBITDA Target”) for at least one
fiscal quarter ending on or prior to July 31, 2009.




          (xv) Within 45 days after the end of each of the first three fiscal quarters and within 90
days after the end of each Fiscal Year, the Company shall deliver to the Holder an officer’s
certificate, in a form reasonably satisfactory to the Holder and signed by the Company’s Chief
Financial Officer, certifying as to the Company’s compliance with all of the terms, conditions and
covenants set forth in this Note (without regard to any period of grace or requirement of notice
provided hereunder) and, in the event any default or Event of Default exists, specifying the nature
of such default or Event of Default and the Company’s plans to cure such default or Event of
Default and demonstrating the Company’s compliance with each of the financial covenants set forth
in Sections 5(a)(xiii) and 5(a)(xiv). Each such officer’s certificate shall include a perfection
certificate update in a form reasonably satisfactory to the Holder.




19









 








          (xvi) Prior to the issuance of any PIK Shares, the Company shall file with Nasdaq a
Notification Form: Listing of Additional Shares for the inclusion of such PIK Shares on the Nasdaq
Capital Market, and shall provide a copy thereof to the Holder.




          (b) So long as any amount due under this Note is outstanding and until the earlier of (i) the
indefeasible payment in full of all amounts payable by the Company hereunder and (ii) the
conversion of this Note, without the prior written consent of the Majority Holders (for purposes of
this Section 5(b), any Company Notes held by any employee, director or officer of the Company or
any Subsidiary shall not be deemed to be outstanding):




          (i) The Company shall not and shall cause each Subsidiary not to create, incur, guarantee,
issue, assume or in any manner become liable in respect of any Indebtedness, other than Permitted
Indebtedness.




          (ii) The Company shall not and shall cause each Subsidiary not to create, incur, assume or
suffer to exist any Lien upon any of its property, whether now owned or hereafter acquired other
than (i) Liens created pursuant to the Security Agreement and (ii) Permitted Liens. The Company
shall not, and shall cause each Subsidiary not to, be bound by any agreement which limits the
ability of the Company or any Subsidiary to grant Liens.




          (iii) The Company shall not and shall cause each Subsidiary not to, directly or indirectly,
enter into or permit to exist any transaction or series of related transactions (including, without
limitation, the purchase, sale, lease or exchange of any property or the rendering of any service
(other than service as an employee)) with, or for the benefit of, any of its Affiliates other than
a wholly owned Subsidiary, except for consulting arrangements with directors approved by the Board.




20









 





          (iv) The Company shall not, and shall cause each of its Subsidiaries not to, directly or
indirectly, declare or pay any dividends on account of any shares of any class or series of its
capital stock now or hereafter outstanding, or set aside or otherwise deposit or invest any sums
for such purpose, or redeem, retire, defease, purchase or otherwise acquire any shares of any class
of its capital stock (or set aside or otherwise deposit or invest any sums for such purpose) for
any consideration or apply or set apart any sum, or make any other distribution (by reduction of
capital or otherwise) in respect of any such shares or pay any interest, premium if any, or
principal of any Indebtedness or redeem, retire, defease, repurchase or otherwise acquire any
Indebtedness (or set aside or otherwise deposit or invest any sums for such purpose) for any
consideration or apply or set apart any sum, or make any other payment in respect thereof or agree
to do any of the foregoing (each of the foregoing is herein called a “Restricted Payment”);
provided, that (i) the Company may make payments of interest, premium if any, and principal of the
Notes in accordance with the terms hereof, (ii) provided that no Event of Default or event which,
with the giving of notice, the lapse of time or both would constitute an Event of Default has
occurred and is continuing, the Company may declare and pay regular, recurring dividends on the
shares of its Series B Preferred Stock outstanding on the date hereof in accordance with the terms
of the Series B Preferred Stock as in effect on the date hereof, (iii) provided that no Event of
Default or event which, with the giving of notice, the lapse of time or both would constitute an
Event of Default has occurred and is continuing, the Company and its Subsidiaries may make
regularly scheduled payments of interest and principal of any Permitted Indebtedness, (iv) any
Subsidiary directly or indirectly wholly owned by the Company may pay dividends on its capital
stock and (v) the Company may repurchase capital stock from a former employee in connection with
the termination or other departure of such employee, strictly in accordance with the terms of any
agreement entered into with such employee and in effect on the Closing Date (as defined in the
Purchase Agreement), provided that (A) such repurchase is approved by a majority of the Board, (B)
payments permitted under this clause (v) shall not exceed $1,000,000 in the aggregate, and (C) no
such payment may be made if an Event of Default or an event which, with the giving of notice, the
lapse of time or both would constitute an Event of Default has occurred and is continuing or would
result from such payment.




          (v) The Company shall not and shall cause each Subsidiary not to, directly or indirectly,
engage in any business other than the business of developing, manufacturing and marketing
preventive healthcare technologies and products, focused on enhanced body defense and the detection
of pre-disease states.




          (vi) The Company shall not and shall cause each Subsidiary not to make or own any Investment
in any Person, including without limitation any joint venture, other than (A) Permitted
Investments, (B) operating deposit accounts with banks, (C) Hedging Agreements entered into in the
ordinary course of the Company’s financial planning and not for speculative purposes and (D)
investments by the Company in the capital stock of any wholly owned Subsidiary.




          (vii) The Company shall not and shall cause each Subsidiary not to, directly or indirectly,
become or remain liable as lessee or as a guarantor or other surety with respect to any lease of
any property (whether real, personal or mixed), whether now owned or hereafter acquired, which the
Company or any Subsidiary (a) has sold or transferred or is to sell or to transfer to any other
Person, or (b) intends to use for substantially the same purpose as any other




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property which has been or is to be sold or transferred by the Company or any Subsidiary to
any Person in connection with such lease.




          (viii) The Company shall not and shall cause each Subsidiary not to settle, or agree to
indemnify or defend third parties against, any material lawsuit, except as may be required by
judicial or regulatory order or by agreements entered into prior to the date hereof on a basis
consistent with past practice. A material lawsuit shall be any lawsuit in which the amount claimed
against the Company and its Subsidiaries exceeds One Million United States Dollars ($1,000,000).




          (ix) The Company shall not and shall cause each Subsidiary not to amend its bylaws,
certificate of incorporation or other charter document in a manner adverse to the Holder.




          (x) The Company shall not change its Fiscal Year.




     6. Event of Default. The occurrence of any of following events shall constitute an
“Event of Default” hereunder:



          (a) the failure of the Company to make any payment of principal on this Note when due, whether
at maturity, upon acceleration or otherwise;




          (b) the failure of the Company to make any payment of interest on this Note, or any other
amounts due under (i) the other Transaction Documents (as defined under the Purchase Agreement),
(ii) the Amendment Agreement and the documents entered into in connection therewith or (iii) the
Second Amendment Agreement and the documents entered into in connection therewith (collectively,
the “Deal Documents”), each when due, whether on an Interest Payment Date, at maturity, upon
acceleration or otherwise, and such failure continues for more than five (5) days;




          (c) the Company and/or its Subsidiaries fail to make a required payment or payments on
Indebtedness of $250,000 or more in aggregate principal amount and such failure continues for more
than ten (10) days;




          (d) there shall have occurred an acceleration of the stated maturity of any Indebtedness of
the Company or its Subsidiaries of $250,000 or more in aggregate principal amount (which
acceleration is not rescinded, annulled or otherwise cured within ten (10) days of receipt by the
Company or a Subsidiary of notice of such acceleration);




          (e) the Company makes an assignment for the benefit of creditors or admits in writing its
inability to pay its debts generally as they become due; or an order, judgment or decree is entered
adjudicating the Company as bankrupt or insolvent; or any order for relief with respect to the
Company is entered under title 11 of the United States Code or any other bankruptcy or insolvency
law; or the Company petitions or applies to any tribunal for the appointment of a custodian,
trustee, receiver or liquidator of the Company or of any substantial part of the assets of the
Company, or commences any proceeding relating to it under any bankruptcy, reorganization,
arrangement, insolvency, readjustment of debt, dissolution or liquidation law of any jurisdiction;
or any such petition or application is filed, or any such proceeding is commenced, against the
Company and either (i) the Company by any act indicates




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its approval thereof, consents thereto or acquiescence therein or (ii) such petition
application or proceeding is not dismissed within sixty (60) days;




          (f) a final, non-appealable judgment which, in the aggregate with other outstanding final
judgments against the Company and its Subsidiaries, exceeds $250,000 shall be rendered against the
Company or a Subsidiary and within sixty (60) days after entry thereof, such judgment is not
discharged or execution thereof stayed pending appeal, or within sixty (60) days after the
expiration of such stay, such judgment is not discharged; provided, however, that a judgment that
provides for the payment of royalties subsequent to the date of the judgment shall be deemed to be
discharged so long as the Company or the Subsidiary affected thereby is in compliance with the
terms of such judgment;




          (g) the Company is in breach of the requirements of Sections 5(a)(xiii) or 5(a)(xiv) or
Section 5(b) hereof;




          (h) if any representation or statement of fact made in the Deal Documents, any certificate or
other document furnished to the Holder at any time by or on behalf of the Company proves to have
been false in any material respect when made or furnished;




          (i) any Liens created by the Security Documents shall at any time not constitute a valid and
perfected first priority Lien on the collateral intended to be covered thereby (to the extent
perfection by filing, registration, recordation or possession is required herein or therein) in
favor of the Holders, free and clear of all other Liens (other than Permitted Liens), or any of the
security interests granted pursuant to the Security Documents shall be determined to be void,
voidable, invalid or unperfected, are subordinated or are ineffective to provide the Holder with a
perfected, first priority security interest in the collateral covered by the Security Documents,
free and clear of all other Liens (other than Permitted Liens) or, except for expiration or
termination in accordance with their terms, the Security Agreement shall for whatever reason be
terminated or cease to be in full force and effect, or the enforceability thereof or any other Deal
Documents shall be contested by the Company; or




          (j) if the Company fails to observe or perform in any material respect any of its covenants
contained in the Deal Documents (other than any failure covered by Section 6(a), (b) or (g)), and
such failure continues for thirty (30) days after receipt by the Company of notice thereof.




     Upon the occurrence of any such Event of Default, except as provided in the following
paragraph, all unpaid principal and accrued interest under this Note shall become immediately due
and payable (A) upon election of the Holder, with respect to (a) through (d) and (f) through (j),
and (B) automatically, with respect to (e). Except as provided in the following paragraph, upon
the occurrence of any Event of Default, the Holder may, in addition to declaring all amounts due
hereunder to be immediately due and payable, pursue any available remedy, whether at law or in
equity, including, without limitation, exercising its rights under the other Deal Documents. If an
Event of Default occurs, the Company shall pay to the Holder the reasonable attorneys’ fees and
disbursements and all other reasonable out-of-pocket costs incurred by the Holder in order to
collect amounts due and owing under this Note or otherwise to enforce the Holder’s rights and
remedies hereunder and under the other Deal Documents. Upon



23









 







the occurrence of any Event of Default, except as provided in the following paragraph, the
Agent (on behalf of the Holder) shall have all the rights of a secured party under Article IX of
the Uniform Commercial Code of the State or of any jurisdiction in which the Collateral is located.
In addition, except as provided in the following paragraph, the Agent shall have full power to
sell, lease, transfer, or otherwise deal with the Collateral or proceeds thereof in Agent’s own
name or that of the Company and, in particular, the Agent may sell the Collateral at public auction
or private sale. Unless the Collateral threatens to decline speedily in value or is of a type
customarily sold on a recognized market, the Agent will give the Company reasonable notice of the
time after which any private sale or any other intended disposition of the Collateral is to be
made. The requirements of reasonable notice shall be met if such notice is given at least ten (10)
Business Days before the time of the sale or disposition. All expenses relating to the disposition
of the Collateral, including without limitation, the expenses of retaking, holding, insuring,
preparing for sale and selling the Collateral (including legal fees and costs), shall become a part
of the Obligations secured by the Security Agreement and payable from the proceeds of the
disposition of the Collateral, and shall be payable on demand, with interest from date of
expenditure until repaid. Notwithstanding any other provision contained in this Agreement or the
Secured Notes, the Company, the Investors and the Agent agree that the following provisions will be
applicable if a case under Title 11 of the United States Code or any other bankruptcy, insolvency,
arrangement, reorganization, receivership, custodianship, or similar proceeding under any federal,
state, or foreign law is commenced by or against the Company or if the Company otherwise commences
any action to restrain, enjoin or otherwise impede Agent’s exercise of the remedies afforded to
Agent under this Agreement, the Secured Notes or the Security Agreement, at law or in equity (all
such proceedings and actions hereafter referred to as “Debtor Relief Proceedings”): (i) the Company
hereby stipulates that, at Agent’s option, the Agent and the Investors will be entitled to
immediate and absolute lifting of any automatic stay of the enforcement of the Agent’s remedies
under the Deal Documents, at law or in equity (including, without limitation, the provisions of 11
U.S.C. §362, as amended) which might be accorded to the Company in any Debtor Relief Proceeding;
(ii) the Company acknowledges that the Company, the Agent and the Investors have negotiated at
length and in good faith to reach the arrangements set forth in this Note; (iii) the Company
further acknowledges that the remedies available to the Company through Debtor Relief Proceedings
have been considered by the Company, the Agent, the Investors and their respective legal counsel;
and (iv) as a result of such negotiations and after being fully advised by independent legal
counsel, the Company has concluded that the institution of Debtor Relief Proceedings: (a) would
cause a material decline in the value of the Collateral; (b) would increase the potential loss to
the Company, the Agent, the Investors and the Company’s other creditors; (c) would only serve to
delay the exercise of the remedies afforded to the Agent and the Investors by this Agreement and
applicable law; and (d) would not be commenced in good faith. All capitalized terms not otherwise
defined in this paragraph have the meanings assigned to them in the Security Agreement.



     So long as the only Events of Default that have occurred and are continuing are Qualifying
Events of Default, upon the first occurrence of a Qualifying Event of Default which is not cured by
the Company or waived or rescinded by the Holder, the Holder’s right to accelerate the principal
and interest due under this Note shall be limited to one-third of the outstanding principal amount
and all accrued interest then due under this Note (the “First Default Amount”). The date on which
notice of the acceleration of the First Default Amount is given by the Holder is hereinafter
referred to as the “First Acceleration Date.” Upon the second occurrence of a



24









 







Qualifying Event of Default which is not cured or waived or rescinded by the Holder or upon
the continuation of an existing Qualifying Event of Default more than 90 days after the First
Acceleration Date and provided that the Holder shall have received the indefeasible payment in full
of the First Default Amount, the Holder’s right to accelerate the principal and interest due under
this Note shall be limited to one-half of the outstanding principal amount and all accrued interest
then due under this Note (the “Second Default Amount”); provided, however, that no such
acceleration shall be effective until 90 days after the First Acceleration Date. The date on which
notice of the acceleration of the Second Default Amount is given by the Holder is hereinafter
referred to as the “Second Acceleration Date.” Upon the third occurrence of a Qualifying Event of
Default which is not cured by the Company or waived or rescinded by the Holder or upon the
continuation of an existing Qualifying Event of Default more than 90 days after the Second
Acceleration Date and provided that the Holder shall have received the indefeasible payment in full
of the First Default Amount and the Second Default Amount, the Holder shall not have the right to
accelerate the remaining outstanding principal amount and all accrued interest then due under this
Note until 90 days after the Second Acceleration Date. The failure of the Company to indefeasibly
pay in full the First Default Amount or the Second Default Amount within three days of the First
Acceleration Date or the Second Acceleration Date, as applicable, shall constitute an additional
Event of Default hereunder and shall entitle the Holder, at its option, to declare the entire
principal amount of this Note and all accrued interest hereunder immediately due and payable. In
no event shall the Holder proceed against the collateral pursuant to the terms of the Security
Agreement in respect of one or more Qualifying Events of Default subject to the provisions of this
paragraph unless and until the Company shall have failed to pay the First Default Amount or the
Second Default Amount, as applicable, within three days of the First Acceleration Date or the
Second Acceleration Date, as applicable.



     7. No Waiver. To the extent permitted by applicable law, no delay or omission on the
part of the Holder in exercising any right under this Note shall operate as a waiver of such right
or of any other right of the Holder, nor shall any delay, omission or waiver on any one occasion be
deemed a bar to or waiver of the same or any other right on any future occasion.



     8. Amendments in Writing. Any term of this Note may be amended or waived upon the
written consent of the Company and the holders of Company Notes representing at least 50% of the
principal amount of Company Notes then outstanding (the “Majority Holders”);
provided, that (x) any such amendment or waiver must apply to all outstanding Company
Notes; and (y) without the consent of the Holder hereof, no amendment or waiver shall (i) change
the Stated Maturity Date of this Note, (ii) reduce the principal amount of this Note or the
interest rate due hereon, (iii) change the Conversion Price or (iv) change the place of payment of
this Note. No such waiver or consent on any one instance shall be construed to be a continuing
waiver or a waiver in any other instance unless it expressly so provides.



     9. Waivers. The Company hereby forever waives presentment, demand, presentment for
payment, protest, notice of protest, notice of dishonor of this Note and all other demands and
notices in connection with the delivery, acceptance, performance and enforcement of this Note.



     10. Waiver of Jury Trial. THE COMPANY HEREBY WAIVES ITS RIGHT TO A JURY TRIAL OF ANY
CLAIM OR CAUSE OF ACTION ARISING OUT OF OR BASED



25









 







UPON THIS NOTE OR ANY CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND
ALL OTHER CLAIMS. THE COMPANY HAS REVIEWED THIS WAIVER WITH ITS COUNSEL.



     11. Secured Obligation. This Note is one of the Notes referred to in the Security
Agreement and is secured by the collateral described therein. The Security Agreement grants the
Holder certain rights with respect to such collateral upon an Event of Default.



     12. Governing Law; Consent to Jurisdiction. This Note shall be governed by and
construed under the law of the State of New York, without giving effect to the conflicts of law
principles thereof. The Company and, by accepting this Note, the Holder, each irrevocably submits
to the exclusive jurisdiction of the courts of the State of New York located in New York County and
the United States District Court for the Southern District of New York for the purpose of any suit,
action, proceeding or judgment relating to or arising out of this Note and the transactions
contemplated hereby. Service of process in connection with any such suit, action or proceeding may
be served on each party hereto anywhere in the world by the same methods as are specified for the
giving of notices under this Note. The Company and, by accepting this Note, the Holder, each
irrevocably consents to the jurisdiction of any such court in any such suit, action or proceeding
and to the laying of venue in such court. The Company and, by accepting this Note, the Holder,
each irrevocably waives any objection to the laying of venue of any such suit, action or proceeding
brought in such courts and irrevocably waives any claim that any such suit, action or proceeding
brought in any such court has been brought in an inconvenient forum.



     13. Costs. If action is instituted to collect on this Note, the Company promises to
pay all reasonable costs and expenses, including reasonable attorney’s fees, incurred in connection
with such action.



     14. Notices. All notices hereunder shall be given in writing and shall be deemed
delivered when received by the other party hereto at the address set forth in the Purchase
Agreement or at such other address as may be specified by such party from time to time in
accordance with the Purchase Agreement.



     15. Successors and Assigns. This Note shall be binding upon the successors or assigns
of the Company and shall inure to the benefit of the successors and assigns of the Holder.



[Remainder of Page Intentionally Left Blank]




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     IN WITNESS WHEREOF, the Company has caused this Second Amended and Restated Senior Convertible
Note to be signed in its name, effective as of the date first above written.



	 	 	 	 	 
	 	ZILA, INC.

 	 
	 	By:  	 	 
	 	Name:	 Gary V. Klinefelter 	 
	 	Title:	 Vice President and Secretary 	 
	 




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