ex10_2.htm


    
      

    

    Exhibit
10.2

     

    
      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): $0.80

      


      $2,000,000

      


      BLUE
HOLDINGS, INC.

      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 5804 East Slauson Avenue, 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 $2,000,000 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.

      


      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).


      
        
           


        

        
          1

          
            

          

        

        
           


        

      


      “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 $0.50.


      
        
           


        

        
          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).

      


      “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.

      


      “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, 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 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.


      
        
           


        

        
          4

          
            

          

        

        
           


        

      


      “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.

      


      “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.


      
        
           


        

        
          5

          
            

          

        

        
           


        

      


      “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 Purchase Agreement.

      


      “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.

      


      “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.


      
        
           


        

        
          6

          
            

          

        

        
           


        

      


      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.

      


      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.


      
        
           


        

        
          7

          
            

          

        

        
           


        

      


      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.

      


      b)           Conversion
Price.  The conversion price shall be equal to $0.80, 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).


      
        
           


        

        
          8

          
            

          

        

        
           


        

      


      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.


      
        
           


        

        
          10

          
            

          

        

        
           


        

      


      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.  On or after the date which is six
months following the Original Issue Date on which this Note is issued, 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.

      


      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 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 $1000 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.


      
        
           


        

        
          11

          
            

          

        

        
           


        

      


      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.


      
        
           


        

        
          12

          
            

          

        

        
           


        

      


      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
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.

      


      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.

      

        
          
             


          

          
            13

            
              

            

          

          
             


          

        



      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.


      
        
           


        

        
          14

          
            

          

        

        
           


        

      


      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 Holders) 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.

      


      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)
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.


      
        
           


        

        
          15

          
            

          

        

        
           


        

      


      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.

      


      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.


      
        
           


        

        
          16

          
            

          

        

        
           


        

      


      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.

      


      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.


      
        
           


        

        
          17

          
            

          

        

        
           


        

      


      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.


      
        
           


        

        
          18

          
            

          

        

        
           


        

      


      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 $1.60 
(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.


      
        
           


        

        
          19

          
            

          

        

        
           


        

      


      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 as to (a) the
Conversion Shares or Warrant Shares as permitted or required under the
Transaction Documents and (b) 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;

      


      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); or

      


      h)          enter
into any agreement with respect to any of the foregoing.


      
        
           


        

        
          20

          
            

          

        

        
           


        

      


      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;

      


      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);

      


      iv.       any
representation or warranty made in this Note, any other Transaction Documents,
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;

      


      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;


      
        
           


        

        
          21

          
            

          

        

        
           


        

      


      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 three months following the initial Closing Date 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;

      


      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


      
        
           


        

        
          22

          
            

          

        

        
           


        

      


      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.

      


      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.


      
        
           


        

        
          23

          
            

          

        

        
           


        

      


      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.

      


      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.


      
        
           


        

        
          24

          
            

          

        

        
           


        

      


      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.

      


      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.


      
        
           


        

        
          25

          
            

          

        

        
           


        

      


      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.

      


      *********************


      
        
           


        

        
          26

          
            

          

        

        
           


        

      


      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:

              	 
      
	 
      	 
      	
                Title:

              	 
      


      

      
        	 
      	Facsimile
      No. for delivery of Notices:	
                 

              	 
      


      


      
        
           


        

        
          27

          
            

          

        

        
           


        

      


      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:

              	 
      	 


      

       

      
28