EXHIBIT 4.2
 
INTRUSION INC.
 
CERTIFICATE OF DESIGNATION OF PREFERENCES,
RIGHTS AND LIMITATIONS
OF
SERIES 3 5% CONVERTIBLE PREFERRED STOCK
 
PURSUANT TO SECTION 151 OF THE
DELAWARE GENERAL CORPORATION LAW
 
The undersigned, G. Ward Paxton and Michael Paxton, do hereby certify that:
 
1. They are the President and Secretary, respectively, of Intrusion Inc., a Delaware corporation (the “Corporation”).
 
2. The Corporation is authorized to issue 5,000,000 shares of preferred stock, 1,000,000 shares of designated 5% Convertible Preferred Stock which have been issued and 1,200,000 shares of designated 5% Series 2 Convertible Preferred Stock, 1,065,200 of which have been issued.
 
3. The following resolutions were duly adopted by the Board of Directors:
 
WHEREAS, the Certificate of Incorporation of the Corporation provides for a class of its authorized stock known as preferred stock, comprised of 5,000,000 shares, $0.01 par value, issuable from time to time in one or more series;
 
WHEREAS, the Board of Directors of the Corporation is authorized to fix the dividend rights, dividend rate, voting rights, conversion rights, rights and terms of redemption and liquidation preferences of any wholly unissued series of preferred stock and the number of shares constituting any Series and the designation thereof, of any of them; and
 
WHEREAS, it is the desire of the Board of Directors of the Corporation, pursuant to its authority as aforesaid, to fix the rights, preferences, restrictions and other matters relating to a series of the preferred stock, which shall consist of, except as otherwise set forth in the Purchase Agreement, up to 565,000 shares of the preferred stock which the corporation has the authority to issue, as follows:
 
NOW, THEREFORE, BE IT RESOLVED, that the Board of Directors does hereby provide for the issuance of a series of preferred stock for cash or exchange of other securities, rights or property and does hereby fix and determine the rights, preferences, restrictions and other matters relating to such series of preferred stock as follows:


 


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TERMS OF PREFERRED STOCK
 
Section 1.               Definitions. Capitalized terms used and not otherwise defined herein that are defined in the Purchase Agreement shall have the meanings given such terms in the Purchase Agreement. For the purposes hereof, the following terms shall have the following meanings:
 
“Alternate Consideration” shall have the meaning set forth in Section 7(e).
 
“Bankruptcy Event” means any of the following events: (a) the Corporation or any Significant Subsidiary (as such term is defined in Rule 1.02(s) 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 Corporation or any Significant Subsidiary thereof; (b) there is commenced against the Corporation or any Significant Subsidiary thereof any such case or proceeding that is not dismissed within 60 days after commencement; (c) the Corporation 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 Corporation 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 days; (e) the Corporation or any Significant Subsidiary thereof makes a general assignment for the benefit of creditors; (f) the Corporation 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 Corporation 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 6(b).
 
“Buy-In” shall have the meaning set forth in Section 6(e)(iii).
 
“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), other than a purchaser of Preferred Stock under the Purchase Agreement or a director, officer or other affiliate (as defined in Rule 144 of the Securities Act) of the Corporation of effective control (whether through legal or beneficial ownership of capital stock of the Corporation, by contract or otherwise) of in excess of 33% of the voting securities of the Corporation, or (ii) the Corporation merges into or consolidates with any other Person, or any Person merges into or consolidates with the Corporation and, after giving effect to such transaction, the stockholders of the Corporation immediately prior to such transaction own less than 66% of the aggregate voting power of the Corporation or the successor entity of such transaction, or (iii) the Corporation sells or transfers its assets, as


 


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an entirety or substantially as an entirety, to another Person and the stockholders of the Corporation immediately prior to such transaction own less than 66% of the aggregate voting power of the acquiring entity immediately after the transaction, (iv) a replacement at one time or within a one year period of more than one-half of the members of the Corporation’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 Corporation of an agreement to which the Corporation is a party or by which it is bound, providing for any of the events set forth above in (i) or (iv).
 
“Closing Date” means the Trading Day when all of the Transaction Documents have been executed and delivered by the applicable parties thereto, and all conditions precedent to (i) the Holders’ obligations to pay the Subscription Amount and (ii) the Corporation’s obligations to deliver the Securities have been satisfied or waived.
 
“Commission” means the Securities and Exchange Commission.
 
“Common Stock” means the Corporation’s common stock, par value $0.01 per share, and stock of any other class of securities into which such securities may hereafter have been reclassified or changed into.
 
“Common Stock Equivalents” means any securities of the Corporation or the Subsidiaries which would entitle the holder thereof to acquire at any time Common Stock, including without limitation, any debt, preferred stock, rights, options, warrants or other instrument that is at any time convertible into or exchangeable for, or otherwise entitles the holder thereof to receive, Common Stock.
 
“Conversion Amount” means the sum of the Stated Value at issue.
 
“Conversion Date” shall have the meaning set forth in Section 6(a).
 
“Conversion Price” shall have the meaning set forth in Section 6(b).
 
“Conversion Shares” means, collectively, the shares of Common Stock into which the shares of Preferred Stock are convertible in accordance with the terms hereof.
 
“Conversion Shares Registration Statement” means a registration statement that meets the requirements of the Registration Rights Agreement and registers the resale of all Conversion Shares by the Holder, who shall be named as a “selling stockholder” thereunder, all as provided in the Registration Rights Agreement.
 
“Dividend Payment Date” shall have the meaning set forth in Section 3(a).


 


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“Effective Date” means the date that the Conversion Shares Registration Statement is declared effective by the Commission.
 
“Equity Conditions” shall mean, during the period in question, (i) the Corporation shall have duly honored all conversions scheduled to occur or occurring by virtue of one or more Notices of Conversion, if any, (ii) all liquidated damages and other amounts owing in respect of the Preferred Stock shall have been paid; (iii) there is an effective Conversion Shares Registration Statement pursuant to which the Holder is permitted to utilize the prospectus thereunder to resell all of the shares issuable pursuant to the Transaction Documents (and the Corporation believes, in good faith, that such effectiveness will continue uninterrupted for the foreseeable future), (iv) the Common Stock is trading on the Trading Market and all of the shares issuable pursuant to the Transaction Documents are listed for trading on a Trading Market (and the Corporation 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 then existing no Triggering Event or event which, with the passage of time or the giving of notice, would constitute a Triggering Event, (vii) the issuance of all of the shares issued or issuable pursuant to the Transaction Documents would not violate the limitations set forth in Sections 6(c) and (d) and (viii) no public announcement of a pending or proposed Fundamental Transaction, Change of Control Transaction or acquisition transaction has occurred that has not been consummated.
 


“Exchange
Act” means the Securities Exchange Act of 1934, as amended, and the rules and
regulations promulgated thereunder.


 


“Exempt
Issuance” means the issuance of (a) shares of Common Stock or options
to employees, officers or directors of, or consultants to, the Corporation
pursuant to any stock or option plan duly adopted by a majority of the
non-employee members of the Board of Directors of the Corporation or a majority
of the members of a committee of non-employee directors established for such
purpose, (b) securities upon the exercise of or conversion of (i) the
Warrants or the Preferred Stock or (ii), convertible securities, options or
warrants issued and outstanding on the date of the Purchase Agreement, provided
that in the case of this clause (ii) such securities have not been amended
since the date of the Purchase Agreement to increase the number of such
securities or to decrease the exercise or conversion price of any such
securities other than as a result of the operation of the anti-dilution
provisions thereof, (c) securities issued pursuant to acquisitions or
strategic transactions, provided any such issuance shall only be to a Person
which is, itself or through its subsidiaries, an operating company in a
business synergistic with the business of the Corporation and in which the
Corporation receives benefits in addition to the investment of funds, but shall
not include a transaction in which the Corporation is issuing securities
primarily for the purpose of raising capital or to an entity whose primary
business is investing in securities, (d) shares of capital stock,
convertible securities, options or warrants issued in connection with any pro rata
stock


 


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split or stock dividend in respect of any
series or class of capital stock of the Corporation or recapitalization by the
Corporation, (e) warrants issued pursuant to a commercial borrowing, secured
lending or lease financing transaction approved by the Corporation’s Board of
Directors, (f) securities issued to a registered broker-dealer engaged by
the Company to seek financing on the Company’s behalf, paid as compensation for
actually obtaining any such financing, (g) shares of capital stock issued
in a firm-commitment underwritten public offering of securities pursuant to a
registration statement filed under the Securities Act with gross proceeds of at
least $30,000,000 and (h) securities issued upon the conversion or
exercise of any of the capital stock, convertible securities, options or
warrants described in clauses (a) through (g), provided that in the case
of this clause (h) such securities have not been amended since the date of
the Purchase Agreement to increase the number of such securities or to decrease
the exercise or conversion price of any such securities other than as a result
of the operation of the anti-dilution provisions thereof.


 


“Existing
Preferred Stock” means the Corporation’s 1,000,000 shares of 5% Convertible
Preferred Stock, par value $0.01 per share, designated pursuant the Certificate
of Designation filed with the Delaware Secretary of State on March 25,
2004 and the Company’s 1,200,000 shares of 5% Series 2 Convertible Preferred
Stock, par value $0.01 per share, designated pursuant the Certificate of
Designation filed with the Delaware Secretary of State on March 24, 2005.


 


“Forced
Conversion Notice” shall have the meaning set forth in Section 8(a).


 


“Forced
Conversion Notice Date” shall have the meaning set forth in Section 8(a).


 


“Fundamental
Transaction” shall have the meaning set forth in Section 7(e).


 


“Holder”
shall have the meaning given such term in Section 2.


 


“Junior Securities” means the Common Stock, the Existing Preferred Stock and all other equity or equity equivalent securities of the Corporation other than those securities that are (a) outstanding on the Original Issue Date and (b) which are explicitly senior or pari passu in rights or liquidation preference to the Preferred Stock.
 
“Liquidation” shall have the meaning given such term in Section 5.
 
“New York Courts” shall have the meaning given such term in Section 10(d).
 
“Notice of Conversion” shall have the meaning given such term in Section 6(a).
 
“Original Issue Date” shall mean the date of the first issuance of any shares of the Preferred Stock regardless of the number of transfers of any particular shares of Preferred Stock and regardless of the number of certificates which may be issued to evidence such Preferred Stock.


 


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“Person” means a corporation, an association, a partnership, an organization, a business, an individual, a government or political subdivision thereof or a governmental agency.
 
“Preferred Stock” shall have meaning given such term in Section 2.
 
“Purchase Agreement” means the Securities Purchase Agreement, dated as of the Original Issue Date, to which the Corporation and the original Holders are parties, as amended, modified or supplemented from time to time in accordance with its terms.
 
“Registration Rights Agreement” means the Registration Rights Agreement, dated as of the date of the Purchase Agreement, to which the Corporation and the original Holder are parties, as amended, modified or supplemented from time to time in accordance with its terms.
 
“Securities Act” means the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder.
 
“Share Delivery Date” shall have the meaning given such term in Section 6(e).
 
“Stated Value” shall have the meaning given such term in Section 2.
 
“Subscription Amount” shall mean, as to each Purchaser, the amount to be paid for the Preferred Stock purchased pursuant to the Purchase Agreement as specified below such Purchaser’s name on the signature page of the Purchase Agreement and next to the heading “Subscription Amount”, in United States Dollars and in immediately available funds.
 
“Subsidiary” shall have the meaning given to such term in the Purchase Agreement.
 
“Trading Day” means a day on which the Common Stock is traded on a Trading Market.
 
“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 Nasdaq SmallCap Market, the American Stock Exchange, the New York Stock Exchange, the Nasdaq National Market or the OTC Bulletin Board.
 
“Transaction Documents” shall have the meaning set forth in the Purchase Agreement.
 
“Triggering Event” shall have the meaning set forth in Section 9(a).


 


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“Triggering Redemption Amount” for each share of Preferred Stock means the sum of (i) the greater of (A) 130% of the Stated Value and (B) the product of (a) the VWAP on the Trading Day immediately preceding the date of the Triggering Event and (b) the Stated Value divided by the then Conversion Price, (ii) all accrued but unpaid dividends thereon and (iii) all liquidated damages and other amounts due in respect of the Preferred Stock.
 
“Triggering Redemption Payment Date” shall have the meaning set forth in Section 9(b).
 
“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 as reported by Bloomberg Financial L.P. (based on a Trading Day from 9:30 a.m. Eastern Time to 4:02 p.m. Eastern Time); (b)  if the Common Stock is not then listed or quoted on a Trading Market and if prices for the Common Stock are then quoted on the OTC Bulletin Board, 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 listed or quoted on the OTC Bulletin Board and if prices for the Common Stock are then reported in the “Pink Sheets” published by the 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 Purchasers and reasonably acceptable to the Corporation.
 
“Warrants” means the warrants to purchase up to approximately 283,000 shares of Common Stock issued pursuant to the Purchase Agreement.
 
Section 2.               Designation, Amount and Par Value. The series of preferred stock shall be designated as its Series 3 5% Convertible Preferred Stock (the “Preferred Stock”) and the number of shares so designated shall be 565,000 (which shall not be subject to increase without the consent of 75% in interest of the holders of the Preferred Stock (each, a “Holder” and collectively, the “Holders”)). Each share of Preferred Stock shall have a par value of $0.01 per share and a stated value equal to $2.18 (the “Stated Value”).  Capitalized terms not otherwise defined herein shall have the meaning given such terms in Section 1 hereof.  For avoidance of doubt, the Preferred Stock shall rank senior in priority to any Junior Securities with respect to the payment of dividends and to liquidation rights.
 
Section 3.               Dividends.
 


a)             The
Holders shall be entitled to receive and the Corporation shall pay, cumulative
dividends at the rate per share (as a percentage of the Stated Value per share)


 


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of 5% per annum (subject to increase pursuant
to Section 9(b)), payable
quarterly on March 1, June 1, September 1 and December 2,
beginning with the first such date after the Original Issue Date and on any
Conversion Date (except that, if such date is not a Trading Day, the payment
date shall be the next succeeding Trading Day) (“Dividend Payment Date”).    Any dividends that are not paid within five
Trading Days following a Dividend Payment Date shall continue to accrue and
shall entail a late fee, which must be paid in cash, at the rate of 18% per
annum or the lesser rate permitted by applicable law (such fees to accrue
daily, from the Dividend Payment Date through and including the date of
payment).


 


b)            So
long as any Preferred Stock shall remain outstanding, neither the Corporation
nor any Subsidiary thereof shall redeem, purchase or otherwise acquire directly
or indirectly any Junior Securities (unless all of the shares of the Preferred
Stock are concurrently redeemed), other than as a result of the conversion into
or exchange for Junior Securities or in connection with repurchases of shares of Common Stock from
employees, officers, directors, consultants or other persons performing
services for the Corporation or any Subsidiary pursuant to agreements under
which the Corporation has the option to repurchase such shares upon the
happening of certain events, such as termination in an aggregate amount not to
exceed $100,000 per calendar year. So long as any Preferred Stock shall
remain outstanding, neither the Corporation nor any Subsidiary thereof shall
directly or indirectly pay or declare any dividend or make any distribution
(other than a dividend or distribution described in Section 6 or dividends
due and paid in the ordinary course on preferred stock, including the Existing
Preferred Stock, of the Corporation at such times when the Corporation is in
compliance with its payment and other obligations hereunder) upon, nor shall
any distribution be made in respect of, any Junior Securities other than
dividends or distributions otherwise permitted by this paragraph (b) so
long as any dividends due on the Preferred Stock remain unpaid, nor shall any
monies be set aside for or applied to the purchase or redemption (through a
sinking fund or otherwise) of any Junior Securities or shares pari passu with
the Preferred Stock.


 


c)             The
Corporation acknowledges and agrees that the capital of the Corporation (as
such term is used in Section 154 of the Delaware General Corporation Law)
in respect of the Preferred Stock and any future issuances of the Corporation’s
capital stock shall be equal to the aggregate par value of such Preferred Stock
or capital stock, as the case may be, and that, on or after the date of the
Purchase Agreement, it shall not increase the capital of the Corporation with
respect to any shares of the Corporation’s capital stock issued and outstanding
on such date
if such increase could adversely affect the Corporation’s ability to pay cash
dividends on the Preferred Stock under Section 170 of the Delaware General
Corporation Law.  The Corporation
also acknowledges and agrees that it shall not create any special reserves
under Section 171 of the Delaware General Corporation Law without the
prior written consent of Holders of at least 75% of the outstanding shares of
Preferred Stock.


 


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d)            Any
reference to “distribution” contained in this Section 3 shall not be
deemed to include any distribution made in connection with any liquidation,
dissolution or winding-up of the Corporation, whether voluntary or involuntary,
including any Liquidation under Section 5.


 


Section 4.               Voting Rights. Except as otherwise provided herein and as otherwise required by law, the Preferred Stock shall have no voting rights. However, so long as any shares of Preferred Stock are outstanding, the Corporation shall not, without the affirmative vote of 75% in interest of the Holders of the shares of the Preferred Stock then outstanding, (a) alter or change adversely the powers, preferences or rights given to the Preferred Stock or alter or amend this Certificate of Designation, (b) authorize or create any class of stock ranking as to dividends, redemption or distribution of assets upon a Liquidation (as defined in Section 5) senior to or otherwise pari passu with the Preferred Stock, (c) amend its certificate of incorporation or other charter documents so as to affect adversely any rights of the Holders, (d) increase the authorized number of shares of Preferred Stock, or (e) enter into any agreement with respect to the foregoing. Notwithstanding any provision of the Company’s Certificate of Incorporation or bylaws (each as amended to date) to the contrary, any matter requiring the vote or consent of the Holders of Preferred Stock may be taken without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action to be taken, shall be signed by the Holders of outstanding Preferred Stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares of Preferred Stock entitled to vote thereon were present and voted.
 
Section 5.               Liquidation. Upon any liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary (a “Liquidation”), the Holders shall be entitled to receive out of the assets of the Corporation, whether such assets are capital or surplus, for each share of Preferred Stock an amount equal to the Stated Value per share plus any accrued and unpaid dividends thereon and any other fees or liquidated damages owing thereon before any distribution or payment shall be made to the holders of any Junior Securities, and if the assets of the Corporation shall be insufficient to pay in full such amounts, then the entire assets to be distributed to the Holders shall be distributed among the Holders ratably in accordance with the respective amounts that would be payable on such shares if all amounts payable thereon were paid in full.  A Fundamental Transaction shall not be treated as a Liquidation, but a Change of Control Transaction shall be deemed to be a Liquidation. The Corporation shall mail written notice of any such Liquidation, not less than 30 days prior to the payment date stated therein, to each record Holder.
 
Section 6.               Conversion.
 


a)             Conversions at Option of Holder.
Each share of Preferred Stock shall be convertible into that number of shares
of Common Stock (subject to the limitations set forth in Sections 6(c) and
(d)) determined by dividing the Stated Value of such share of Preferred Stock
by the Conversion Price, at the option of the Holder, at any time and from time
to time from and after the Original Issue Date. Holders shall effect
conversions by providing the Corporation with the form of conversion notice
attached hereto as


 


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Annex A (a “Notice
of Conversion”). Each Notice of Conversion shall specify the number of
shares of Preferred Stock to be converted, the number of shares of Preferred
Stock owned prior to the conversion at issue, the number of shares of Preferred
Stock owned subsequent to the conversion at issue and the date on which such
conversion is to be effected, which date may not be prior to the date the
Holder delivers such Notice of Conversion to the Corporation by facsimile (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 to the
Corporation is deemed delivered hereunder. The calculations and entries set
forth in the Notice of Conversion shall control in the absence of manifest or
mathematical error.  To effect
conversions, as the case may be, of shares of Preferred Stock, a Holder shall
not be required to surrender the certificate(s) representing such shares of
Preferred Stock to the Corporation unless all of the shares of Preferred Stock
represented thereby are so converted, in which case the Holder shall deliver
the certificate representing such share of Preferred Stock promptly following
the Conversion Date at issue.  Shares of
Preferred Stock converted into Common Stock or redeemed in accordance with the
terms hereof shall be canceled and may not be reissued.


 


b)            Conversion
Price.  The conversion price for the
Preferred Stock shall equal $2.18 (the
“Conversion Price”), subject to adjustment herein.


 


c)             Beneficial Ownership Limitation.  The Corporation shall not
effect any conversion of the Preferred Stock, and the Holder shall not have the
right to convert any portion of the Preferred Stock to the extent that after
giving effect to such conversion, the Holder (together with the Holder’s
affiliates), as set forth on the applicable Notice of Conversion, would
beneficially own in excess of 4.99% of the number of shares of the Common Stock
outstanding immediately after giving effect to such conversion.  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 the Preferred Stock with
respect to which the determination of such sentence is being made, but shall
exclude the number of shares of Common Stock which would be issuable upon (A) conversion
of the remaining, nonconverted Stated Value of Preferred Stock beneficially
owned by the Holder or any of its affiliates and (B) exercise or
conversion of the unexercised or nonconverted portion of any other securities
of the Corporation (including the Warrants) subject to a limitation on
conversion or exercise analogous to the limitation contained herein
beneficially owned by the Holder or any of its affiliates.  Except as set
forth in the preceding sentence, for purposes of this Section 6(c),
beneficial ownership shall be calculated in accordance with Section 13(d) of
the Exchange Act.  To the extent that the
limitation contained in this Section 6(c) applies, the determination
of whether the Preferred Stock is convertible (in relation to other securities
owned by the Holder together with any affiliates) and of which shares of
Preferred Stock is convertible shall be in the sole discretion of such Holder,
and the submission of a Notice of Conversion shall be deemed to be such Holder’s
determination of whether the shares of Preferred Stock may be converted (in
relation to other securities owned by such Holder) and which shares of the
Preferred Stock is convertible, in each case subject to such aggregate
percentage limitations. To ensure


 


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compliance with this restriction, the Holder
will be deemed to represent to the Corporation 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 Corporation shall have no obligation to
verify or confirm the accuracy of such determination.  For purposes of this Section 6(c), in
determining the number of outstanding shares of Common Stock, the Holder may
rely on the number of outstanding shares of Common Stock as reflected in the most
recent of the following: (A) the Corporation’s most recent Form 10-Q
or Form 10-K, as the case may be, (B) a more recent public
announcement by the Corporation or (C) any other notice by the Corporation
or the Corporation’s transfer agent setting forth the number of shares of
Common Stock outstanding.  Upon the written or oral request of the Holder,
the Corporation shall within two 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
Corporation, including the Preferred Stock, by the Holder or its affiliates
since the date as of which such number of outstanding shares of Common Stock
was reported.  The provisions of this Section 6(c) may
be waived by the Holder, at the election of the Holder, upon not less than 61
days’ prior notice to the Corporation, and the provisions of this Section 6(c) shall
continue to apply until such 61st day (or such later date, as
determined by the Holder, as may be specified in such notice of waiver);
provided, that upon any such waiver, the beneficial ownership limitation shall
be 9.99%, which may not be waived by the Holder.  Notwithstanding any of the foregoing, the
foregoing provisions of this Section 6(c) shall not apply to any
Holder who is an officer or director of the Corporation as of the Closing Date
or as of the date of conversion. In addition, if the Holder is an officer or
director of the Company as of the Original Issue Date, such Holder may not
convert any of his shares of Preferred Stock into shares of Common Stock or
receive any shares of Common Stock in connection with a Triggering Event unless
and until the issuance of such shares is approved by the Company’s
stockholders, to the extent required by the rules and regulations of the
Nasdaq Stock Market.


 


d)            Limitation on
Number of Shares Issuable. 
Notwithstanding anything herein to the contrary, the Corporation shall
not issue to any Holder any shares of Common Stock, including pursuant to any
rights herein, including, without limitation, any conversion rights, to the
extent such shares, when added to the number of shares of Common Stock issued
upon conversion of any shares of Preferred Stock pursuant to Section 6(a) or
upon exercise of any Warrants would exceed 1,381,900, or such greater number of
shares of Common Stock permitted pursuant to the corporate governance rules of
the Nasdaq Stock Market that is at the time the principal trading exchange or
market for the Common Stock, based upon share volume, as confirmed in writing
by counsel to the Corporation (the “Maximum Aggregate Share Amount”),
unless the Corporation first obtains shareholder approval permitting such
issuances in accordance with the Nasdaq Market Place Rule 4350 (“Shareholder
Approval”).  Each Holder shall be
entitled to a portion of the Maximum Aggregate Share Amount equal to the
quotient obtained by dividing (x) such the number of shares of Preferred Stock
initially purchased by such Holder by (y) the aggregate number of shares purchased by all Holders.  Such portions


 


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shall be adjusted upward ratably in the event
all of the shares of Preferred Stock of any Holder are no longer outstanding.


 


e)             Mechanics
of Conversion


 


i.              Delivery
of Certificate Upon Conversion. Not later than three Trading Days after
each Conversion Date (the “Share Delivery Date”), the Corporation shall
deliver or cause to be delivered to the Holder (A) a certificate or
certificates which, after the Effective Date, shall be free of restrictive
legends and trading restrictions (other than those required by the Purchase
Agreement) representing the number of shares of Common Stock being acquired
upon the conversion of shares of Preferred Stock, and (B) a bank check in
the amount of accrued and unpaid dividends. After the Effective Date, the
Corporation shall, upon request of the Holder, deliver any certificate or
certificates representing Common Stock required to be delivered by the
Corporation under this Section electronically through the Depository Trust
Corporation or another established clearing corporation performing similar
functions. If in the case of any Notice of Conversion such certificate or
certificates 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 Corporation at any time on or before its
receipt of such certificate or certificates thereafter, to rescind such
conversion, in which event the Corporation shall immediately return the
certificates representing the shares of Preferred Stock tendered for
conversion.


 


ii.             Obligation
Absolute; Partial Liquidated Damages. 
The Corporation’s obligations to issue and deliver the Conversion Shares
upon conversion of Preferred Stock 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 Corporation 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 Corporation to
the Holder in connection with the issuance of such Conversion Shares.  In the event a Holder shall elect to convert
any or all of the Stated Value of its Preferred Stock, the Corporation may not
refuse conversion based on any claim that such Holder or any one associated or
affiliated with the Holder of has been engaged in any violation of law,
agreement or for any other reason, unless, an injunction from a court, on
notice, restraining and or enjoining conversion of all or part of this Preferred
Stock shall have been sought and obtained and the Corporation posts a surety
bond for the benefit of the Holder in the amount of 150% of the Stated Value of
Preferred Stock outstanding, which is subject to the injunction, which bond
shall remain in effect until the completion of arbitration/litigation of the
dispute and the proceeds of which shall


 


12





















 


be payable to such Holder to the extent it
obtains judgment.  In the absence of an
injunction precluding the same, the Corporation shall issue Conversion Shares
or, if applicable, cash, upon a properly noticed conversion. If the Corporation
fails to deliver to the Holder such certificate or certificates pursuant to Section 6(e)(i) within
two Trading Days of the Share Delivery Date applicable to such conversion, the
Corporation shall pay to such Holder, in cash, as liquidated damages and not as
a penalty, for each $5,000 of Stated Value of Preferred Stock being converted,
$50 per Trading Day (increasing to $100 per Trading Day after three Trading
Days and increasing to $200 per Trading Day six Trading Days after such damages
begin to accrue) for each Trading Day after the Share Delivery Date until such
certificates are delivered. Nothing herein shall limit a Holder’s right to
pursue actual damages for the Corporation’s failure to deliver certificates
representing shares of Common Stock upon conversion within the period specified
herein and such Holder shall have the right to pursue all remedies available to
it hereunder, at law or in equity including, without limitation, a decree of
specific performance and/or injunctive relief.


 


iii.            Compensation
for Buy-In on Failure to Timely Deliver Certificates Upon Conversion. If
the Corporation fails to deliver to the Holder such certificate or certificates
pursuant to Section 6(e)(i) by a Share Delivery Date, and if after
such Share Delivery Date the Holder purchases (in an open market transaction or
otherwise) Common Stock to deliver in satisfaction of a sale by such 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
Corporation shall pay in cash to the Holder the amount by which (x) the Holder’s
total purchase price (including brokerage commissions, if any) for the Common
Stock so purchased exceeds (y) the product of (1) the aggregate number of
shares of Common Stock that such Holder was entitled to receive from the
conversion at issue multiplied by (2) the price at which the sell order
giving rise to such purchase obligation was executed. For example, if the
Holder purchases Common Stock having a total purchase price of $11,000 to cover
a Buy-In with respect to an attempted conversion of shares of Preferred Stock
with respect to which the aggregate sale price giving rise to such purchase
obligation is $10,000, under clause (A) of the immediately preceding
sentence the Corporation shall be required to pay the Holder $1,000. The Holder
shall provide the Corporation written notice indicating the amounts payable to
the Holder in respect of the Buy-In, together with applicable confirmations and
other evidence reasonably requested by the Corporation. 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 Corporation’s failure
to timely deliver certificates representing shares of Common Stock upon
conversion of the shares of Preferred Stock as required pursuant to the terms
hereof.


 


13





















 


iv.            Reservation
of Shares Issuable Upon Conversion. The Corporation covenants that it will
at all times reserve and keep available out of its authorized and unissued
shares of Common Stock solely for the purpose of issuance upon conversion of
the Preferred Stock, free from preemptive rights or any other actual contingent
purchase rights of persons other than the Holder (and the other Holders of the
Preferred Stock), not less than such number of shares of the Common Stock as
shall (subject to any additional requirements of the Corporation as to
reservation of such shares set forth in the Purchase Agreement) be issuable
(taking into account the adjustments and restrictions of Section 7) upon
the conversion of all outstanding shares of Preferred Stock.  The Corporation covenants that all shares of
Common Stock that shall be so issuable shall, upon issue, be duly and validly
authorized, issued and fully paid, nonassessable and, if the Conversion Shares
Registration Statement is then effective under the Securities Act, registered
for public sale in accordance with such Conversion Shares Registration
Statement.


 


v.             Fractional
Shares. Upon a conversion hereunder, the Corporation shall not be required
to issue stock certificates representing fractions of shares of the Common
Stock, but may if otherwise permitted, make a cash payment in respect of any
final fraction of a share based on the VWAP at such time.  If the Corporation elects not, or is unable,
to make such a cash payment, the Holder shall be entitled to receive, in lieu
of the final fraction of a share, one whole share of Common Stock.


 


vi.            Transfer
Taxes.  The issuance of certificates
for shares of the Common Stock on conversion of this Preferred Stock 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
certificate, provided that the Corporation 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 such shares of Preferred Stock so converted and the Corporation
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
Corporation the amount of such tax or shall have established to the
satisfaction of the Corporation that such tax has been paid.


 


Section 7.               Certain Adjustments.
 


a)             Stock
Dividends and Stock Splits.  If the
Corporation, at any time while this Preferred Stock is outstanding: (A) pays
a stock dividend or otherwise make a distribution or distributions on shares of
its Common Stock or any other equity or equity equivalent securities payable in
shares of Common Stock (which, for avoidance of doubt, shall not include any
shares of Common Stock issued by the Corporation pursuant to this Preferred
Stock) or any distribution made in connection with any liquidation, dissolution
or winding-up of the Corporation, whether voluntary or involuntary, including
any


 


14





















 


Liquidation under Section 5, (B) subdivides
outstanding shares of Common Stock into a larger number of shares, (C) combines
(including by way of reverse stock split) outstanding shares of Common Stock
into a smaller number of shares, or (D) issues by reclassification of
shares of the Common Stock any shares of capital stock of the Corporation, then
the Conversion Price shall be multiplied by a fraction of which the numerator
shall be the number of shares of Common Stock (excluding treasury shares, if
any) 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 7(a) 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)            [RESERVED].


 


c)             Subsequent
Rights Offerings.  If the Corporation,
at any time while the Preferred Stock 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 less than the VWAP at the record date mentioned 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 so offered (assuming
receipt by the Corporation 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 Corporation, at any time while Preferred Stock
is outstanding, shall distribute to all holders of Common Stock (and not to
Holders) evidences of its indebtedness or assets (including cash and cash
dividends) or rights or warrants to subscribe for or purchase any security,
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 one
outstanding share of the Common Stock as determined by the Board of Directors
in good faith.  In either case the
adjustments shall be described in a statement provided to the Holder of the
portion of assets or evidences of indebtedness so distributed or such
subscription rights applicable to one share of Common Stock.  Such adjustment shall be made whenever any
such 


 


15





















 


distribution is made and shall become
effective immediately after the record date mentioned above.


 


e)             Fundamental
Transaction. If, at any time while this Preferred Stock is outstanding, (A) the
Corporation effects any merger or consolidation of the Corporation with or into
another Person (other than a merger or consolidation that does not result in
any reclassification, conversion, exchange or cancellation of outstanding
shares of Common Stock of the Corporation), (B) the Corporation effects
any sale of all or substantially all of its assets in one or a series of
related transactions, (C) any tender offer or exchange offer (whether by
the Corporation 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 Corporation 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 each case which does not otherwise constitute
a Liquidation (in any such case, a “Fundamental Transaction”), then upon
any subsequent conversion of this Preferred Stock, 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 one 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 one share of Common Stock in such Fundamental
Transaction, and the Corporation 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 Preferred Stock following
such Fundamental Transaction.  To the
extent necessary to effectuate the foregoing provisions, any successor to the
Corporation or surviving entity in such Fundamental Transaction, as the case
may be, shall make provisions in its certificate or articles of incorporation
or other constituent document to provide the Holder with new preferred stock or
other equity security consistent with the foregoing provisions and evidencing
the Holder’s right to convert such preferred stock 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 7(e) and
insuring that this Preferred Stock (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 7 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 7,
the number of shares of Common Stock deemed to be issued and outstanding


 


16





















 


as of a given date shall be the sum of the
number of shares of Common Stock (excluding treasury shares, if any) issued and
outstanding.


 


g)            Notice
to Holders.


 


i.              Adjustment
to Conversion Price.  Whenever the
Conversion Price is adjusted pursuant to any of this Section 7, the
Corporation shall promptly mail to each Holder a notice setting forth the
Conversion Price after such adjustment and setting forth a brief statement of
the facts requiring such adjustment.


 


ii.             Notice
to Allow Conversion by Holder.  If (A) the
Corporation shall declare a dividend (or any other distribution) on the Common
Stock; (B) the Corporation shall declare a special nonrecurring cash
dividend on or a redemption of the Common Stock (other than repurchases of
shares of Common Stock from employees, officers, directors, consultants or
other persons performing services for the Corporation or any subsidiary
pursuant to agreements under which the Corporation has the option to repurchase
such shares upon the happening of certain events, such as termination in an
aggregate amount not to exceed $100,000); (C) the Corporation shall
authorize the granting to all holders of the Common Stock 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 Corporation shall be
required in connection with any reclassification of the Common Stock, any
consolidation or merger to which the Corporation is a party, any sale or
transfer of all or substantially all of the assets of the Corporation, of any
compulsory share exchange whereby the Common Stock is converted into other
securities, cash or property; (E) the Corporation shall authorize the
voluntary or involuntary dissolution, liquidation or winding up of the affairs
of the Corporation; then, in each case, the Corporation shall cause to be filed
at each office or agency maintained for the purpose of conversion of this
Preferred Stock, and shall cause to be mailed to the Holder at its last address
as its shall appear upon the stock books of the Corporation, 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 mail such notice or any defect
therein or in the mailing thereof shall not affect the validity of the
corporate action required to be specified in such notice.  The Holder is entitled to convert the
Conversion Amount of this Preferred Stock (or any part hereof) during the 20-day


 


17





















 


period commencing the date of such notice to
the effective date of the event triggering such notice.


 


Section 8.               Forced Conversion


 


a)             Forced
Conversion.  Notwithstanding anything
herein to the contrary, if after the 12 month anniversary of the Original Issue
Date and after the Effective Date the VWAP for each of any 20 consecutive
Trading Days (“Threshold Period”), which 20 consecutive Trading Day
period shall have commenced only after the Effective Date, exceeds 200% of the
then effective Conversion Price, the Corporation may, within 1 Trading Day
after any such Threshold Period, deliver a notice to all Holders (a “Forced
Conversion Notice” and the date such notice is received by the Holders, the
“Forced Conversion Notice Date”) to cause each Holder to immediately
convert up to such Holder’s entire remaining number of shares of Preferred
Stock.  The Corporation may only effect a
Forced Conversion Notice if all of the Equity Conditions have been met during
the Threshold Period through the Forced Conversion Notice Date.   Any Forced Conversion Notices shall be
applied ratably to all of the Holders in proportion to each Holder’s initial
purchases of Preferred Stock hereunder, provided that any voluntary conversions
by a Holder shall be applied against such Holder’s pro-rata allocation thereby
decreasing the aggregate amount forcibly converted hereunder.  Immediately upon the Forced Conversion Notice
Date, each outstanding share of Preferred Stock shall be converted
automatically without any further action by the Holders of such shares and
whether or not the certificates representing such shares are surrendered to the
Corporation or its transfer agent; provided, however, that the Corporation
shall not be obligated to issue certificates evidencing the shares of Common
Stock issuable upon such conversion unless the certificates evidencing such
shares of Preferred Stock are delivered to the Corporation in accordance with
the following sentence.  Upon the Forced
Conversion Notice Date, the Holders of Preferred Stock shall surrender the certificates
representing such shares at the office of the Corporation in accordance with Section 6(a);
provided that the Holders shall have no obligation to deliver a Notice of
Conversion.  Thereupon, there shall be
issued and delivered to each Holder within three (3) Trading Days and in
its name as shown on such surrendered certificate or certificates, a
certificate or certificates for the number of shares of Common Stock into which
the shares of Preferred Stock surrendered were convertible upon the Forced
Conversion Notice Date.


 


Section 9.               Redemption Upon Triggering Events.
 


a)             “Triggering
Event” means any one or more of the following events (whatever the reason
and whether it 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.                  the
failure of a Conversion Shares Registration Statement to be declared effective
by the Commission on or prior to the 230th day after the Original
Issue Date;


 


18





















 


ii.                 if,
during the Effectiveness Period, the effectiveness of the Conversion Shares
Registration Statement lapses for any reason for more than an aggregate of 90
calendar days (which need not be consecutive days) during any 12 month period,
or the Holder shall not be permitted to resell Registrable Securities under the
Conversion Shares Registration Statement for more than an aggregate of 90
calendar days (which need not be consecutive days) during any 12 month period;


 


iii.                the
Corporation shall fail to deliver certificates representing Conversion Shares
issuable upon a conversion hereunder that comply with the provisions hereof
prior to the 10th Trading Day after such shares are required to be
delivered hereunder, or the Corporation shall provide written notice to any
Holder, including by way of public announcement, at any time, of its intention
not to comply with requests for conversion of any shares of Preferred Stock in
accordance with the terms hereof;


 


iv.                one
of the Events (as defined in the Registration Rights Agreement) described in
subsections (i), (ii) or (iii) of Section 2(b) of the
Registration Rights Agreement shall not have been cured to the satisfaction of
the Holders prior to the expiration of 60 days from the Event Date (as defined
in the Registration Rights Agreement) relating thereto (other than an Event
resulting from a failure of a Conversion Shares Registration Statement to be
declared effective by the Commission on or prior to the 230th day
after the Original Issue Date, which shall be covered by Section 9(a)(i));


 


v.                 the
Corporation shall fail for any reason to pay in full the amount of cash due
pursuant to a Buy-In within 10 days after notice therefor is delivered
hereunder or shall fail to pay all amounts owed on account of an Event within
five days of the date due;


 


vi.                the
Corporation shall fail to have available a sufficient number of authorized and
unreserved shares of Common Stock to issue to such Holder upon a conversion
hereunder;


 


vii.               the
Corporation shall fail to observe or perform any other covenant, agreement or
warranty contained in, or otherwise commit any breach of the Transaction
Documents, and such failure or breach shall not, if subject to the possibility
of a cure by the Corporation, have been remedied within 45 calendar days after
the date on which written notice of such failure or breach shall have been
given;


 


viii.              the
Corporation shall redeem more than a de minimis number of Junior Securities
other than as a result of the conversion into or exchange for Junior Securities
or in connection with repurchases of shares of Common Stock


 


19





















 


from employees, officers, directors,
consultants or other persons performing services for the Corporation or any
subsidiary pursuant to agreements under which the Corporation has the option to
repurchase such shares upon the happening of certain events, such as
termination, in an aggregate amount not to exceed $100,000 per calendar year;


 


ix.                the
Corporation shall be party to a Change of Control Transaction;


 


x.                 there
shall have occurred a Bankruptcy Event;


 


xi.                the
Common Stock shall fail to be listed or quoted for trading on a Trading Market
for more than 10 Trading Days, which need not be consecutive Trading Days; or


 


xii.               any
breach of the agreements delivered to the initial Holders at the Closing
pursuant to Section 2.2(a)(vii) of the Purchase Agreement.


 


b)            Upon
the occurrence of a Triggering Event, each Holder shall (in addition to all
other rights it may have hereunder or under applicable law) have the right,
exercisable at the sole option of such Holder, to require the Corporation to, (i) with
respect to the Triggering Events set forth in Sections 9(a) (iii), (v),
(vii), (ix) and (x)(as to voluntary filings only)), redeem all of the
Preferred Stock then held by such Holder for a redemption price, in cash, equal
to the Triggering Redemption Amount; or, (ii) at the option of the Holder
and with respect to the Triggering Events set forth in Sections 9(a)(i), (ii),
(iv), (vi), (viii), (x)(as to involuntary filings only), (xi) and (xii), either
(A) redeem all of the Preferred Stock then held by such Holder for a
redemption price, in shares of Common Stock, equal to a number of shares of
Common Stock equal to the Triggering Redemption Amount divided by 75% of the
average of the 10 VWAPs immediately prior to the date of election hereunder,
but in no event less than $0.87 (adjusted for any stock splits and like capital
adjustments after the Original Issue Date) or (B) increase the dividend on
all of the outstanding Preferred Stock held by such Holder to equal 18% per
annum thereafter; provided, however, the aggregate number of
shares issuable upon a Triggering Event, when added to all actual or potential
Conversion Shares, shall not exceed the Maximum Aggregate Share Amount.  The Triggering Redemption Amount, if in cash
or in shares, shall be due and payable or issuable, as the case may be, within
five Trading Days of the date on which the notice for the payment therefor is
provided by a Holder (the “Triggering Redemption Payment Date”).  If the Corporation fails to pay the
Triggering Redemption Amount hereunder in full pursuant to this Section on
the date such amount is due in accordance with this Section (whether in
cash or shares of Common Stock), the Corporation will pay interest thereon at a
rate of 18% per annum (or such lesser amount permitted by applicable law),
accruing daily from such date until the Triggering Redemption Amount, plus all
such interest thereon, is paid in full. 
For purposes of this Section, a share of Preferred Stock is outstanding
until such date as the Holder shall have received Conversion Shares upon a
conversion (or attempted conversion) thereof that meets the requirements hereof
or has been paid the


 


20





















 


Triggering Redemption Amount plus all accrued
but unpaid dividends and all accrued but unpaid liquidated damages in cash.


 


Section 10.             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, sent by a nationally recognized overnight courier
service, addressed to the Corporation, at 1101 E. Arapaho Road, Richardson, Texas 75081, facsimile
number  972.301.3892, Attn: Corporate Secretary or such
other address or facsimile number as the Corporation may specify for such
purposes by notice to the Holders delivered in accordance with this
Section.  Any and all notices or other
communications or deliveries to be provided by the Corporation hereunder shall
be in writing and delivered personally, by facsimile, sent by a nationally
recognized overnight courier service addressed to each Holder at the facsimile
telephone number or address of such Holder appearing on the books of the
Corporation, or if no such facsimile telephone 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 telephone number specified in this Section prior to 5:30 p.m.
(New York City time), (ii) the date after the date of transmission, if
such notice or communication is delivered via facsimile at the facsimile
telephone number specified in this Section later than 5:30 p.m. (New
York City time) on any date and earlier than 11:59 p.m. (New York City
time) on such date, (iii) the second Business Day following the date of
mailing, if sent by nationally recognized overnight courier service, or (iv) upon
actual receipt by the party to whom such notice is required to be given.


 


b)            Absolute
Obligation. Except as expressly provided herein, no provision of this
Certificate of Designation shall alter or impair the obligation of the
Corporation, which is absolute and unconditional, to pay the liquidated damages
(if any) on, the shares of Preferred Stock at the time, place, and rate, and in
the coin or currency, herein prescribed.


 


c)             Lost
or Mutilated Preferred Stock Certificate. 
If a Holder’s Preferred Stock certificate shall be mutilated, lost,
stolen or destroyed, the Corporation shall execute and deliver, in exchange and
substitution for and upon cancellation of a mutilated certificate, or in lieu
of or in substitution for a lost, stolen or destroyed certificate, a new
certificate for the shares of Preferred Stock so mutilated, lost, stolen or
destroyed but only upon receipt of evidence of such loss, theft or destruction
of such certificate, and of the ownership hereof, and indemnity, if requested,
all reasonably satisfactory to the Corporation.


 


d)            Governing
Law.  All questions concerning the
construction, validity, enforcement and interpretation of this Certificate of
Designation shall be governed by and


 


21





















 


construed and enforced in accordance with the
internal laws of the State of Delaware, without regard to the principles of
conflicts of law thereof.  Each party
agrees that all legal proceedings concerning the interpretations, 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 any such court, 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 Certificate of Designation 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 manner permitted by 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 Certificate of Designation or the
transactions contemplated hereby. If either party shall commence an action or
proceeding to enforce any provisions of this Certificate of Designation, then
the prevailing party in such action or proceeding shall be reimbursed by the
other party for its attorneys fees and other costs and expenses incurred with
the investigation, preparation and prosecution of such action or proceeding.


 


e)             Waiver.  Any waiver by the Corporation or the Holder
of a breach of any provision of this Certificate of Designation 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 Certificate of
Designation.  The failure of the
Corporation or the Holder to insist upon strict adherence to any term of this
Certificate of Designation 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 Certificate of
Designation.  Any waiver must be in
writing.


 


f)             Severability.  If any provision of this Certificate of
Designation is invalid, illegal or unenforceable, the balance of this
Certificate of Designation 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 applicable laws governing
usury, the applicable rate of interest due hereunder shall automatically be
lowered to equal the maximum permitted rate of interest.


 


22





















 


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


 


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


 


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


 


23





















 


RESOLVED, FURTHER, that the Chairman, the president or any vice-president, and the secretary or any assistant secretary, of the Corporation be and they hereby are authorized and directed to prepare and file a Certificate of Designation of Preferences, Rights and Limitations in accordance with the foregoing resolution and the provisions of the Delaware General Corporation Law.
 
IN WITNESS WHEREOF, the undersigned have executed this Certificate this 2nd day of December , 2005.
 
 


	
    /s/ G. Ward
  Paxton

  	
   

  	
    /s/ Michael
  Paxton

  
	
  Name:  G. Ward Paxton

  	
  Name:  Michael Paxton

  
	
  Title:  President

  	
  Title:  Secretary

  



 


24





















 


ANNEX A
 
NOTICE OF CONVERSION
 
(TO BE EXECUTED BY THE REGISTERED HOLDER IN ORDER TO CONVERT SHARES OF PREFERRED STOCK)
 
The undersigned hereby elects to convert the number of shares of Series 3 5% Convertible Preferred Stock indicated below, into shares of common stock, par value $0.01 per share (the “Common Stock”), of Intrusion Inc., a Delaware corporation (the “Corporation”), according to the conditions hereof, as of the date written below. If shares are to be issued in the name of a person other than 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 Corporation in accordance therewith. No fee will be charged to the Holder for any conversion, except for such transfer taxes, if any.
 
Conversion calculations:
 


	Date to Effect Conversion: 

	 

	Number of shares of Preferred Stock owned prior to Conversion: 

	 

	Number of shares of Preferred Stock to be Converted: 

	 

	Stated Value of shares of Preferred Stock to be Converted: 

	 

	Number of shares of Common Stock to be Issued: 

	 

	Applicable Conversion Price:

	 

	Number of shares of Preferred Stock subsequent to Conversion: 

	 

	Name(s) in which shares of Common Stock will be registered (if different than the undersigned): 

	 

	 

	If the Holder wants the shares of Common Stock to be issued via DWAC, please provide:
(a)    Broker DTC: 
(b)   Investor Account Number: 




 


	 
	[HOLDER]

	 
	 

	 
	By:
	 

	 
	 
	Name:

	 
	 
	Title:




 


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