Document:

exv10w1

 

Exhibit 10.1

PURCHASE AGREEMENT

          THIS PURCHASE AGREEMENT (“Agreement”) is made as of the 5th day of August, 2005 by
and among Visual Networks, Inc., a Delaware corporation (the “Company”), and the Investors set
forth on the signature pages affixed hereto (each an “Investor” and collectively the “Investors”).

Recitals

          A. The Company and the Investors are executing and delivering this Agreement in reliance upon
the exemption from securities registration afforded by the provisions of Regulation D (“Regulation
D”), as promulgated by the U.S. Securities and Exchange Commission (the “SEC”) under the Securities
Act of 1933, as amended; and

          B. The Investors wish to purchase from the Company, and the Company wishes to sell and issue
to the Investors, upon the terms and conditions stated in this Agreement, an aggregate principal
amount of $10,000,000 of the Company’s 5% Senior Secured Convertible Notes with a stated maturity
date of December 31, 2007 in the form attached hereto as Exhibit A (the “Notes”), which
Notes are convertible into shares of the Company’s Common Stock, par value $0.01 per share
(together with any securities into which such shares may be reclassified the “Common Stock”), at a
conversion price of $1.45 per share; and

          C. Contemporaneous with the sale of the Notes, the parties hereto will execute and deliver a
Registration Rights Agreement, in the form attached hereto as Exhibit B (the “Registration
Rights Agreement”), pursuant to which the Company will agree to provide certain registration rights
under the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder,
and applicable state securities laws.

          In consideration of the mutual promises made herein and for other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto
agree as follows:

     1. Definitions. In addition to those terms defined above and elsewhere in this
Agreement, for the purposes of this Agreement, the following terms shall have the meanings set
forth below:

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

          “Bank” means Silicon Valley Bank, its successors and assigns.

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

 

 

          “Cash Purchase Price” means Eight Million Dollars ($8,000,000).

          “Company’s Knowledge” means the actual knowledge of the executive officers (as defined
in Rule 405 under the 1933 Act) of the Company, after due inquiry.

          “Confidential Information” means trade secrets, confidential information and know-how
(including but not limited to ideas, formulae, compositions, processes, procedures and techniques,
research and development information, computer program code, performance specifications, support
documentation, drawings, specifications, designs, business and marketing plans, and customer and
supplier lists and related information).

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

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

          “Effective Date” means the date on which the initial Registration Statement is
declared effective by the SEC.

          “Effectiveness Deadline” means the date on which the initial Registration Statement is
required to be declared effective by the SEC under the terms of the Registration Rights Agreement.

          “Existing Debt” means the Company’s outstanding obligations under the Line of Credit.

          “Existing Notes” means the 5% Senior Secured Convertible Debentures issued on March
25, 2002 by the Company to: (a) Special Situations Private Equity Fund, L.P. with a principal
amount of One Million Five Hundred and Fifty Thousand Dollars ($1,550,000) and (b) Special
Situations Technology Fund, L.P. with a principal amount of Four Hundred and Fifty Thousand Dollars
($450,000).

          “Intellectual Property” means all of the following: (i) patents, patent applications,
patent disclosures and inventions (whether or not patentable and whether or not reduced to
practice); (ii) trademarks, service marks, trade dress, trade names, corporate names, logos,
slogans and Internet domain names, together with all goodwill associated with each of the
foregoing; (iii) copyrights and copyrightable works; (iv) registrations, applications and renewals
for any of the foregoing; and (v) proprietary computer software (including but not limited to data,
data bases and documentation).

          “Line of Credit” means the revolving line of credit agreement, dated as of June 21,
2005, with the Bank, and all ancillary agreements entered into in connection therewith,

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including, without limitation, any agreements creating a security interest in the property of the
Company or any Subsidiary.

          “Material Adverse Effect” means a material adverse effect on (i) the assets,
liabilities, results of operations, condition (financial or otherwise), business, or prospects of
the Company and its Subsidiaries taken as a whole, or (ii) the ability of the Company to perform
its obligations under the Transaction Documents.

          “Nasdaq” means The Nasdaq Stock Market, Inc., including the Nasdaq SmallCap Market.

          “Payoff Letter” means the payoff letter, dated August 2, 2005, from the Bank to the
Company, a true and complete copy of which has been provided to the Investors.

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

          “Registration Statement” has the meaning set forth in the Registration Rights
Agreement.

          “SEC Filings” has the meaning set forth in Section 4.6.

          “Securities” means the Notes and the Conversion Shares.

          “Security Agreement” means the Pledge and Security Agreement in the form attached
hereto as Exhibit C.

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

          “Transaction Documents” means this Agreement, the Notes, the Security Agreement and
the Registration Rights Agreement.

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

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

     2. Purchase and Sale of the Notes. Subject to the terms and conditions of this
Agreement, on the Closing Date, each of the Investors shall severally, and not jointly, purchase,

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and the Company shall sell and issue to the Investors, the Notes in the respective principal
amounts set forth opposite the Investors’ names on the signature pages hereto in exchange for (i)
the Cash Purchase Price, payable as specified in Section 3 below, and (ii) the surrender and
cancellation of $2,000,000 in aggregate principal amount of the Existing Notes by the Investors as
specified on the signature pages hereto.

     3. Closing. Upon confirmation that the other conditions to closing specified herein
have been satisfied or duly waived by the Investors, the Company shall deliver to Lowenstein
Sandler PC, in trust, the Notes, registered in such name or names as the Investors may designate,
with instructions that such Notes are to be held for release to the Investors only upon (i) payment
to the Bank of the amount owed to the Bank calculated pursuant to the terms of the Payoff Letter
(the “Payoff Amount”), (ii) payment in full of the remaining Cash Purchase Price to the Company and
(iii) the surrender of $2,000,000 in aggregate principal amount of the Existing Notes. Upon such
receipt by Lowenstein Sandler PC of the Notes, each Investor shall promptly, but no more than one
Business Day thereafter, (i) cause a wire transfer in same day funds to be sent to the account of
the Bank as instructed in the Payoff Letter, in an amount representing such Investor’s pro rata
portion of the Payoff Amount, (ii) cause a wire transfer in same day funds to be sent to the
account of the Company as instructed in writing by the Company, in an amount representing the
remainder of such Investor’s pro rata portion of the Cash Purchase Price as set forth on the
signature pages to this Agreement and (iii) deliver to Lowenstein Sandler PC the Existing Notes to
be surrendered. On the date (the “Closing Date”) the Bank receives the Payoff Amount, the Company
receives the remaining Cash Purchase Price and Lowenstein Sandler PC receives the Existing Notes to
be surrendered, the Notes shall be released to the Investors (the “Closing”). The Closing shall
take place at the offices of Lowenstein Sandler PC, 1251 Avenue of the Americas, 18th Floor, New
York, New York 10020, or at such other location and on such other date as the Company and the
Investors shall mutually agree.

     4. Representations and Warranties of the Company. The Company hereby represents and
warrants to the Investors that, except as set forth in the schedules delivered herewith
(collectively, the “Disclosure Schedules”):

          4. 1 Organization, Good Standing and Qualification. Each of the Company and its
Subsidiaries is a corporation duly organized, validly existing and in good standing under the laws
of the jurisdiction of its incorporation and has all requisite corporate power and authority to
carry on its business as now conducted and to own its properties. Each of the Company and its
Subsidiaries is duly qualified to do business as a foreign corporation and is in good standing in
each jurisdiction in which the conduct of its business or its ownership or leasing of property
makes such qualification or leasing necessary unless the failure to so qualify has not had and
could not reasonably be expected to have a Material Adverse Effect. The Company’s Subsidiaries are
listed on Schedule 4.1 hereto.

          4.2 Authorization. The Company has full power and authority and, except for approval
of the Proposal by its stockholders as contemplated in Section 7.9, has taken all requisite action
on the part of the Company, its officers, directors and stockholders necessary for (i) the
authorization, execution and delivery of the Transaction Documents, (ii) the authorization of the
performance of all obligations of the Company hereunder or thereunder, and (iii) the

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authorization, issuance (or reservation for issuance) and delivery of the Securities. The
Transaction Documents constitute the legal, valid and binding obligations of the Company,
enforceable against the Company in accordance with their terms, subject to bankruptcy, insolvency,
fraudulent transfer, reorganization, moratorium and similar laws of general applicability, relating
to or affecting creditors’ rights generally.

          4.3 Capitalization. Schedule 4.3 sets forth (a) the authorized capital stock
of the Company as of the date hereof; (b) the number of shares of capital stock issued and
outstanding; (c) the number of shares of capital stock issuable pursuant to the Company’s stock
plans; and (d) the number of shares of capital stock issuable and reserved for issuance pursuant to
securities (other than the Notes) exercisable for, or convertible into or exchangeable for any
shares of capital stock of the Company. All of the issued and outstanding shares of the Company’s
capital stock have been duly authorized and validly issued and are fully paid, nonassessable and
free of pre-emptive rights and were issued in full compliance with applicable state and federal
securities law and any rights of third parties. Except as described on Schedule 4.3, all
of the issued and outstanding shares of capital stock of each Subsidiary have been duly authorized
and validly issued and are fully paid, nonassessable and free of pre-emptive rights, were issued in
full compliance with applicable state and federal securities law and any rights of third parties
and are owned by the Company, beneficially and of record, subject to no lien, encumbrance or other
adverse claim. Except as described on Schedule 4.3, no Person is entitled to pre-emptive
or similar statutory or contractual rights with respect to any securities of the Company. Except
as described on Schedule 4.3, there are no outstanding warrants, options, convertible
securities or other rights, agreements or arrangements of any character under which the Company or
any of its Subsidiaries is or may be obligated to issue any equity securities of any kind and
except as contemplated by this Agreement, neither the Company nor any of its Subsidiaries is
currently in negotiations for the issuance of any equity securities of any kind. Except as
described on Schedule 4.3 and except for the Registration Rights Agreement, there are no
voting agreements, buy-sell agreements, option or right of first purchase agreements or other
agreements of any kind among the Company and any of the securityholders of the Company relating to
the securities of the Company held by them. Except as described on Schedule 4.3 and except
as provided in the Registration Rights Agreement, no Person has the right to require the Company to
register any securities of the Company under the 1933 Act, whether on a demand basis or in
connection with the registration of securities of the Company for its own account or for the
account of any other Person.

          Except as described on Schedule 4.3, the issuance and sale of the Securities hereunder
will not obligate the Company to issue shares of Common Stock or other securities to any other
Person (other than the Investors) and will not result in the adjustment of the exercise,
conversion, exchange or reset price of any outstanding security.

          Except as described on Schedule 4.3, the Company does not have outstanding stockholder
purchase rights or “poison pill” or any similar arrangement in effect giving any Person the right
to purchase any equity interest in the Company upon the occurrence of certain events.

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          4.4 Valid Issuance. The Conversion Shares have been duly and validly authorized.
Upon the due conversion of the Notes, the Conversion Shares will be validly issued, fully paid and
nonassessable, and shall be free and clear of all encumbrances and restrictions (other than those
created by the Investors), except for restrictions on transfer set forth in the Transaction
Documents or imposed by applicable securities laws. The Company has reserved a sufficient number
of shares of Common Stock for issuance upon the conversion of the Notes, free and clear of all
encumbrances and restrictions, except for restrictions on transfer set forth in the Transaction
Documents or imposed by applicable securities laws and except for those created by the Investors.

          4.5 Consents. Except for approval of the Proposal by its stockholders as contemplated
in Section 7.9, the execution, delivery and performance by the Company of the Transaction Documents
and the offer, issuance and sale of the Securities require no consent of, action by or in respect
of, or filing with, any Person, governmental body, agency, or official other than filings that have
been made pursuant to applicable state securities laws and post-sale filings pursuant to applicable
state and federal securities laws which the Company undertakes to file within the applicable time
periods. Subject to the accuracy of the representations and warranties of each Investor set forth
in Section 5 hereof, the Company has taken all action necessary to exempt (i) the issuance and sale
of the Notes, (ii) the issuance of the Conversion Shares upon due conversion of the Notes, and
(iii) the other transactions contemplated by the Transaction Documents from the provisions of any
stockholder rights plan or other “poison pill” arrangement, any anti-takeover, business combination
or control share law or statute binding on the Company or to which the Company or any of its assets
and properties may be subject and any provision of the Company’s Certificate of Incorporation or
Bylaws that is or could reasonably be expected to become applicable to the Investors as a result of
the transactions contemplated hereby, including without limitation, the issuance of the Securities
and the ownership, disposition or voting of the Securities by the Investors or the exercise of any
right granted to the Investors pursuant to this Agreement or the other Transaction Documents. A
true and complete copy of the Payoff Letter has been delivered to the Investors and is in full
force and effect. The Payoff Amount, as calculated in accordance with the terms of the Payoff
Letter, will be sufficient to repay in full all amounts due and owing to the Bank and from and
after the payment of the Payoff Amount as contemplated hereby, the Bank will have no further right,
title or interest in any of the assets or properties of the Company or its Subsidiaries.

          4.6 Delivery of SEC Filings; Business. The Company has made available to the
Investors through the EDGAR system, true and complete copies of the Company’s most recent Annual
Report on Form 10-K for the fiscal year ended December 31, 2004 (the “10-K”), and all other reports
filed by the Company pursuant to the 1934 Act since the filing of the 10-K and prior to the date
hereof (collectively, the “SEC Filings”). The SEC Filings are the only filings required of the
Company pursuant to the 1934 Act for such period. The Company and its Subsidiaries are engaged in
all material respects only in the business described in the SEC Filings and the SEC Filings contain
a complete and accurate description in all material respects of the business of the Company and its
Subsidiaries, taken as a whole.

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          4.7 Use of Proceeds. The net proceeds of the sale of the Notes hereunder shall be
used by the Company to repay the Existing Debt and for working capital and general corporate
purposes.

          4.8 No Material Adverse Change. Since December 31, 2004, except as identified and
described in the SEC Filings or as described on Schedule 4.8, there has not been:

               (i) any change in the consolidated assets, liabilities, financial condition or operating
results of the Company from that reflected in the financial statements included in the Company’s
Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, except for changes in the
ordinary course of business which have not had and could not reasonably be expected to have a
Material Adverse Effect, individually or in the aggregate;

               (ii) any declaration or payment of any dividend, or any authorization or payment of any
distribution, on any of the capital stock of the Company, or any redemption or repurchase of any
securities of the Company;

               (iii) any material damage, destruction or loss, whether or not covered by insurance to any
assets or properties of the Company or its Subsidiaries;

               (iv) any waiver, not in the ordinary course of business, by the Company or any Subsidiary of a
material right or of a material debt owed to it;

               (v) any satisfaction or discharge of any lien, claim or encumbrance or payment of any
obligation by the Company or a Subsidiary, except in the ordinary course of business and which is
not material to the assets, properties, financial condition, operating results or business of the
Company and its Subsidiaries taken as a whole (as such business is presently conducted and as it is
proposed to be conducted);

               (vi) any change or amendment to the Company’s Certificate of Incorporation or Bylaws, or
material change to any material contract or arrangement by which the Company or any Subsidiary is
bound or to which any of their respective assets or properties is subject;

               (vii) any material labor difficulties or labor union organizing activities with respect to
employees of the Company or any Subsidiary;

               (viii) any material transaction entered into by the Company or a Subsidiary other than in the
ordinary course of business;

               (ix) the loss of the services of any key employee, or material change in the composition or
duties of the senior management of the Company or any Subsidiary;

               (x) the loss or threatened loss of any customer which has had or could reasonably be expected
to have a Material Adverse Effect; or

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               (xi) any other event or condition of any character that has had or could reasonably be
expected to have a Material Adverse Effect.

          4.9 SEC Filings; S-3 Eligibility.

               (a) At the time of filing thereof, the SEC Filings complied as to form in all material
respects with the requirements of the 1934 Act and did not contain any untrue statement of a
material fact or omit to state any material fact necessary in order to make the statements made
therein, in the light of the circumstances under which they were made, not misleading.

               (b) Each registration statement and any amendment thereto filed by the Company since January
1, 2002 pursuant to the 1933 Act and the rules and regulations thereunder, as of the date such
statement or amendment became effective, complied as to form in all material respects with the 1933
Act and did not contain any untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary in order to make the statements made therein not
misleading; and each prospectus filed pursuant to Rule 424(b) under the 1933 Act, as of its issue
date and as of the closing of any sale of securities pursuant thereto did not contain any untrue
statement of a material fact or omit to state any material fact required to be stated therein or
necessary in order to make the statements made therein, in the light of the circumstances under
which they were made, not misleading.

               (c) The Company is eligible to use Form S-3 to register the Registrable Securities (as such
term is defined in the Registration Rights Agreement) for sale by the Investors as contemplated by
the Registration Rights Agreement.

          4.10 No Conflict, Breach, Violation or Default. Subject to the approval of the
Proposal by its stockholders as contemplated in Section 7.9, the execution, delivery and
performance of the Transaction Documents by the Company and the issuance and sale of the Securities
will not conflict with or result in a breach or violation of any of the terms and provisions of, or
constitute a default under (i) the Company’s Certificate of Incorporation or the Company’s Bylaws,
both as in effect on the date hereof (true and complete copies of which have been made available to
the Investors through the EDGAR system), or (ii)(a) any statute, rule, regulation or order of any
governmental agency or body or any court, domestic or foreign, having jurisdiction over the
Company, any Subsidiary or any of their respective assets or properties, or (b) any agreement or
instrument to which the Company or any Subsidiary is a party or by which the Company or a
Subsidiary is bound or to which any of their respective assets or properties is subject.

          4.11 Tax Matters. The Company and each Subsidiary has timely prepared and filed all
tax returns required to have been filed by the Company or such Subsidiary with all appropriate
governmental agencies and timely paid all taxes shown thereon or otherwise owed by it. The
charges, accruals and reserves on the books of the Company in respect of taxes for all fiscal
periods are adequate in all material respects, and there are no material unpaid assessments against
the Company or any Subsidiary nor, to the Company’s Knowledge, any basis for the assessment of any
additional taxes, penalties or interest for any fiscal period or audits by any

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federal, state or local taxing authority except for any assessment which is not material to the
Company and its Subsidiaries, taken as a whole. All taxes and other assessments and levies that
the Company or any Subsidiary is required to withhold or to collect for payment have been duly
withheld and collected and paid to the proper governmental entity or third party when due. There
are no tax liens or claims pending or, to the Company’s Knowledge, threatened against the Company
or any Subsidiary or any of their respective assets or property. Except as described on
Schedule 4.11, there are no outstanding tax sharing agreements or other such arrangements
between the Company and any Subsidiary or other corporation or entity.

          4.12 Title to Properties. Except as disclosed in the SEC Filings, the Company and
each Subsidiary has good and marketable title to all real properties and all other properties and
assets owned by it, in each case free from liens, encumbrances and defects that would materially
affect the value thereof or materially interfere with the use made or currently planned to be made
thereof by them; and except as disclosed in the SEC Filings, the Company and each Subsidiary holds
any leased real or personal property under valid and enforceable leases with no exceptions that
would materially interfere with the use made or currently planned to be made thereof by them.

          4.13 Certificates, Authorities and Permits. The Company and each Subsidiary possess
adequate certificates, authorities or permits issued by appropriate governmental agencies or bodies
necessary to conduct the business now operated by it, and neither the Company nor any Subsidiary
has received any notice of proceedings relating to the revocation or modification of any such
certificate, authority or permit that, if determined adversely to the Company or such Subsidiary,
could reasonably be expected to have a Material Adverse Effect, individually or in the aggregate.

          4.14 Labor Matters.

          (a) Except as set forth on Schedule 4.14, the Company is not a party to or bound by
any collective bargaining agreements or other agreements with labor organizations. The Company has
not violated in any material respect any laws, regulations, orders or contract terms, affecting the
collective bargaining rights of employees, labor organizations or any laws, regulations or orders
affecting employment discrimination, equal opportunity employment, or employees’ health, safety,
welfare, wages and hours.

          (b) (i) There are no labor disputes existing, or to the Company’s Knowledge, threatened,
involving strikes, slow-downs, work stoppages, job actions, lockouts or any other disruptions of or
by the Company’s employees, (ii) there are no unfair labor practices or petitions for election
pending or, to the Company’s Knowledge, threatened before the National Labor Relations Board or any
other federal, state or local labor commission relating to the Company’s employees, (iii) no demand
for recognition or certification heretofore made by any labor organization or group of employees is
pending with respect to the Company and (iv) to the Company’s Knowledge, the Company enjoys good
labor and employee relations with its employees and labor organizations.

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          (c) The Company is, and at all times has been, in compliance in all material respects with all
applicable laws respecting employment (including laws relating to classification of employees and
independent contractors) and employment practices, terms and conditions of employment, wages and
hours, and immigration and naturalization. There are no claims pending against the Company before
the Equal Employment Opportunity Commission or any other administrative body or in any court
asserting any violation of Title VII of the Civil Rights Act of 1964, the Age Discrimination Act of
1967, 42 U.S.C. §§ 1981 or 1983 or any other federal, state or local Law, statute or ordinance
barring discrimination in employment.

          (d) Except as disclosed in the SEC Filings or as described on Schedule 4.14, the
Company is not a party to, or bound by, any employment or other contract or agreement that contains
any severance, termination pay or change of control liability or obligation, including, without
limitation, any “excess parachute payment,” as defined in Section 2806(b) of the Internal Revenue
Code.

          (e) Except as specified in Schedule 4.14, each of the Company’s employees is a Person
who is either a United States citizen or a permanent resident entitled to work in the United
States. To the Company’s Knowledge, the Company has no liability for the improper classification
by the Company of such employees as independent contractors or leased employees prior to the
Closing.

          4.15 Intellectual Property.

               (a) All Intellectual Property of the Company and its Subsidiaries is currently in compliance
with all legal requirements (including timely filings, proofs and payments of fees) and is valid
and enforceable. Except as described on Schedule 4.15, no Intellectual Property of the
Company or its Subsidiaries which is necessary for the conduct of Company’s and each of its
Subsidiaries’ respective businesses as currently conducted or as currently proposed to be conducted
has been or is now involved in any cancellation, dispute or litigation, and, to the Company’s
Knowledge, no such action is threatened. No patent of the Company or its Subsidiaries has been or
is now involved in any interference, reissue, re-examination or opposition proceeding.

               (b) All of the licenses and sublicenses and consent, royalty or other agreements concerning
Intellectual Property which are necessary for the conduct of the Company’s and each of its
Subsidiaries’ respective businesses as currently conducted or as currently proposed to be conducted
to which the Company or any Subsidiary is a party or by which any of their assets are bound (other
than generally commercially available, non-custom, off-the-shelf software application programs
having a retail acquisition price of less than $10,000 per license) (collectively, “License
Agreements”) are valid and binding obligations of the Company or its Subsidiaries that are parties
thereto and, to the Company’s Knowledge, the other parties thereto, enforceable in accordance with
their terms, except to the extent that enforcement thereof may be limited by bankruptcy,
insolvency, reorganization, moratorium, fraudulent conveyance or other similar laws affecting the
enforcement of creditors’ rights generally, and, to the Company’s Knowledge, there exists no event
or condition which will result in a material

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violation or breach of or constitute (with or without due notice or lapse of time or both) a
default by the Company or any of its Subsidiaries under any such License Agreement.

               (c) The Company and its Subsidiaries own or have the valid right to use all of the
Intellectual Property that is necessary for the conduct of the Company’s and each of its
Subsidiaries’ respective businesses as currently conducted or as currently proposed to be conducted
and for the ownership, maintenance and operation of the Company’s and its Subsidiaries’ properties
and assets, free and clear of all liens, encumbrances, adverse claims or obligations to license all
such owned Intellectual Property and Confidential Information, other than licenses entered into in
the ordinary course of the Company’s and its Subsidiaries’ businesses. The Company and its
Subsidiaries have a valid and enforceable right to use all third party Intellectual Property and
Confidential Information used or held for use in the respective businesses of the Company and its
Subsidiaries.

               (d) Except as described in the SEC Filings, the conduct of the Company’s and its Subsidiaries’
businesses as currently conducted does not infringe or otherwise impair or conflict with
(collectively, “Infringe”) any Intellectual Property rights of any third party or any
confidentiality obligation owed to a third party, and, to the Company’s Knowledge, the Intellectual
Property and Confidential Information of the Company and its Subsidiaries which are necessary for
the conduct of Company’s and each of its Subsidiaries’ respective businesses as currently conducted
or as currently proposed to be conducted are not being Infringed by any third party. There is no
litigation or order pending or outstanding or, to the Company’s Knowledge, threatened or imminent,
that seeks to limit or challenge or that concerns the ownership, use, validity or enforceability of
any Intellectual Property or Confidential Information of the Company and its Subsidiaries and the
Company’s and its Subsidiaries’ use of any Intellectual Property or Confidential Information owned
by a third party, and, to the Company’s Knowledge, there is no valid basis for the same.

               (e) The consummation of the transactions contemplated hereby and by the other Transaction
Documents will not result in the alteration, loss, impairment of or restriction on the Company’s or
any of its Subsidiaries’ ownership or right to use any of the Intellectual Property or Confidential
Information which is necessary for the conduct of Company’s and each of its Subsidiaries’
respective businesses as currently conducted or as currently proposed to be conducted.

               (f) The Company and its Subsidiaries have taken reasonable steps to protect the Company’s and
its Subsidiaries’ rights in their Intellectual Property and Confidential Information. Each
employee, consultant and contractor who has had access to Confidential Information which is
necessary for the conduct of the Company’s and each of its Subsidiaries’ respective businesses as
currently conducted or as currently proposed to be conducted has executed an agreement to maintain
the confidentiality of such Confidential Information and has executed appropriate agreements that
are substantially consistent with the Company’s standard forms thereof. To the Company’s
Knowledge, except under confidentiality obligations, there has been no material disclosure of any
of the Company’s or its Subsidiaries’ Confidential Information to any third party.

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          4.16 Environmental Matters. Neither the Company nor any Subsidiary is in violation of
any statute, rule, regulation, decision or order of any governmental agency or body or any court,
domestic or foreign, relating to the use, disposal or release of hazardous or toxic substances or
relating to the protection or restoration of the environment or human exposure to hazardous or
toxic substances (collectively, “Environmental Laws”), owns or operates any real property
contaminated with any substance that is subject to any Environmental Laws, is liable for any
off-site disposal or contamination pursuant to any Environmental Laws, or is subject to any claim
relating to any Environmental Laws, which violation, contamination, liability or claim has had or
could reasonably be expected to have a Material Adverse Effect, individually or in the aggregate;
and there is no pending or, to the Company’s Knowledge, threatened investigation that might lead to
such a claim.

          4.17 Litigation. Except as described in the SEC Filings or on Schedule 4.17,
there are no pending actions, suits or proceedings against or affecting the Company, its
Subsidiaries or any of its or their properties; and to the Company’s Knowledge, no such actions,
suits or proceedings are threatened or contemplated.

          4.18 Financial Statements. The financial statements included in each SEC Filing
present fairly, in all material respects, the consolidated financial position of the Company as of
the dates shown and its consolidated results of operations and cash flows for the periods shown,
and such financial statements have been prepared in conformity with United States generally
accepted accounting principles applied on a consistent basis (“GAAP”) (except as may be disclosed
therein or in the notes thereto, and, in the case of quarterly financial statements, as permitted
by Form 10-Q under the 1934 Act). Except as set forth in the financial statements of the Company
included in the SEC Filings filed prior to the date hereof or as described on Schedule
4.18, neither the Company nor any of its Subsidiaries has incurred any liabilities, contingent
or otherwise, except those incurred in the ordinary course of business, consistent (as to amount
and nature) with past practices since the date of such financial statements, none of which,
individually or in the aggregate, have had or could reasonably be expected to have a Material
Adverse Effect.

          4.19 Insurance Coverage. The Company and each Subsidiary maintains in full force and
effect insurance coverage that is customary for comparably situated companies for the business
being conducted and properties owned or leased by the Company and each Subsidiary, and the Company
reasonably believes such insurance coverage to be adequate against all liabilities, claims and
risks against which it is customary for comparably situated companies to insure.

          4.20 Compliance with Nasdaq Continued Listing Requirements. The Company is in
compliance with applicable Nasdaq continued listing requirements. There are no proceedings pending
or, to the Company’s Knowledge, threatened against the Company relating to the continued listing of
the Common Stock on Nasdaq and the Company has not received any notice of, nor to the Company’s
Knowledge is there any basis for, the delisting of the Common Stock from Nasdaq.

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          4.21 Brokers and Finders. No Person will have, as a result of the transactions
contemplated by the Transaction Documents, any valid right, interest or claim against or upon the
Company, any Subsidiary or an Investor for any commission, fee or other compensation pursuant to
any agreement, arrangement or understanding entered into by or on behalf of the Company, other than
as described in Schedule 4.21.

          4.22 No Directed Selling Efforts or General Solicitation. Neither the Company nor any
Person acting on its behalf has conducted any general solicitation or general advertising (as those
terms are used in Regulation D) in connection with the offer or sale of any of the Securities.

          4.23 No Integrated Offering. Neither the Company nor any of its Affiliates, nor any
Person acting on its or their behalf has, directly or indirectly, made any offers or sales of any
Company security or solicited any offers to buy any security, under circumstances that would
adversely affect reliance by the Company on Section 4(2) for the exemption from registration for
the transactions contemplated hereby or would require registration of the Securities under the 1933
Act.

          4.24 Private Placement. Assuming that the representations and warranties of the
Investors in Section 5 hereof are true and accurate, the offer and sale of the Securities to the
Investors as contemplated hereby is exempt from the registration requirements of the 1933 Act.

          4.25 Questionable Payments. Neither the Company nor any of its Subsidiaries nor, to
the Company’s Knowledge, any of their respective current or former stockholders, directors,
officers, employees, agents or other Persons acting on behalf of the Company or any Subsidiary,
has, since January 1, 2002, on behalf of the Company or any Subsidiary or in connection with their
respective businesses: (a) used any corporate funds for unlawful contributions, gifts,
entertainment or other unlawful expenses relating to political activity; (b) made any direct or
indirect unlawful payments to any governmental officials or employees from corporate funds; (c)
established or maintained any unlawful or unrecorded fund of corporate monies or other assets; (d)
made any false or fictitious entries on the books and records of the Company or any Subsidiary; or
(e) made any unlawful bribe, rebate, payoff, influence payment, kickback or other unlawful payment
of any nature.

          4.26 Transactions with Affiliates. Except as disclosed in the SEC Filings or as
disclosed on Schedule 4.26, none of the officers or directors of the Company and, to the
Company’s Knowledge, none of the employees of the Company is presently a party to any transaction
with the Company or any Subsidiary (other than as holders of stock options and/or warrants, and for
services as employees, officers and directors), including any contract, agreement or other
arrangement providing for the furnishing of services to or by, providing for rental of real or
personal property to or from, or otherwise requiring payments to or from any officer, director or
such employee or, to the Company’s Knowledge, any entity in which any officer, director, or any
such employee has a substantial interest or is an officer, director, trustee or partner.

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          4.27 Internal Controls. The Company is in material compliance with the provisions of
the Sarbanes-Oxley Act of 2002 currently applicable to the Company. The Company and the
Subsidiaries maintain a system of internal accounting controls sufficient to provide reasonable
assurance that (i) transactions are executed in accordance with management’s general or specific
authorizations, (ii) transactions are recorded as necessary to permit preparation of financial
statements in conformity with GAAP and to maintain asset accountability, (iii) access to assets is
permitted only in accordance with management’s general or specific authorization, and (iv) the
recorded accountability for assets is compared with the existing assets at reasonable intervals and
appropriate action is taken with respect to any differences. The Company has established disclosure
controls and procedures (as defined in 1934 Act Rules 13a-14 and 15d-14) for the Company and
designed such disclosure controls and procedures to ensure that material information relating to
the Company, including the Subsidiaries, is made known to the certifying officers by others within
those entities, particularly during the period in which the Company’s most recently filed period
report under the 1934 Act, as the case may be, is being prepared. The Company’s certifying
officers have evaluated the effectiveness of the Company’s controls and procedures as of the end of
the period covered by the most recently filed periodic report under the 1934 Act (such date, the
“Evaluation Date”). The Company presented in its most recently filed periodic report under the
1934 Act the conclusions of the certifying officers about the effectiveness of the disclosure
controls and procedures based on their evaluations as of the Evaluation Date. Since the Evaluation
Date, there have been no significant changes in the Company’s internal controls (as such term is
defined in Item 308 of Regulation S-K) or, to the Company’s Knowledge, in other factors that could
significantly affect the Company’s internal controls. The Company maintains and will continue to
maintain a standard system of accounting established and administered in accordance with GAAP and
the applicable requirements of the 1934 Act.

          4.28 Disclosures. Neither the Company nor any Person acting on its behalf has
provided the Investors or their agents or counsel with any information that constitutes or might
constitute material, non-public information. The written materials delivered to the Investors in
connection with the transactions contemplated by the Transaction Documents do not contain any
untrue statement of a material fact or omit to state a material fact necessary in order to make the
statements contained therein, in light of the circumstances under which they were made, not
misleading.

     5. Representations and Warranties of the Investors. Each of the Investors hereby
severally, and not jointly, represents and warrants to the Company that:

          5.1 Organization and Existence. Such Investor is a validly existing corporation,
limited partnership or limited liability company and has all requisite corporate, partnership or
limited liability company power and authority to invest in the Securities pursuant to this
Agreement.

          5.2 Authorization. The execution, delivery and performance by such Investor of the
Transaction Documents to which such Investor is a party have been duly authorized and will each
constitute the valid and legally binding obligation of such Investor, enforceable against such
Investor in accordance with their respective terms, subject to bankruptcy, insolvency,

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fraudulent transfer, reorganization, moratorium and similar laws of general applicability, relating
to or affecting creditors’ rights generally.

          5.3 Purchase Entirely for Own Account. The Securities to be received by such Investor
hereunder will be acquired for such Investor’s own account, not as nominee or agent, and not with a
view to the resale or distribution of any part thereof in violation of the 1933 Act, and such
Investor has no present intention of selling, granting any participation in, or otherwise
distributing the same in violation of the 1933 Act without prejudice, however, to such Investor’s
right at all times to sell or otherwise dispose of all or any part of such Securities in compliance
with applicable federal and state securities laws. Nothing contained herein shall be deemed a
representation or warranty by such Investor to hold the Securities for any period of time. Such
Investor is not a broker-dealer registered with the SEC under the 1934 Act or an entity engaged in
a business that would require it to be so registered.

          5.4 Investment Experience. Such Investor acknowledges that it can bear the economic
risk and complete loss of its investment in the Securities and has such knowledge and experience in
financial or business matters that it is capable of evaluating the merits and risks of the
investment contemplated hereby.

          5.5 Disclosure of Information. Such Investor has had an opportunity to receive all
information related to the Company requested by it and to ask questions of and receive answers from
the Company regarding the Company, its business and the terms and conditions of the offering of the
Securities. Such Investor acknowledges receipt of copies of the SEC Filings. Neither such
inquiries nor any other due diligence investigation conducted by such Investor shall modify, amend
or affect such Investor’s right to rely on the Company’s representations and warranties contained
in this Agreement.

          5.6 Restricted Securities. Such Investor understands that the Securities are
characterized as “restricted securities” under the U.S. federal securities laws inasmuch as they
are being acquired from the Company in a transaction not involving a public offering and that under
such laws and applicable regulations such securities may be resold without registration under the
1933 Act only in certain limited circumstances.

          5.7 Legends. It is understood that, except as provided below, certificates evidencing
the Securities may bear the following or any similar legend:

               (a) “The securities represented hereby may not be transferred unless (i) such securities have
been registered for sale pursuant to the Securities Act of 1933, as amended, (ii) such securities
may be sold pursuant to Rule 144(k), or (iii) the Company has received an opinion of counsel
reasonably satisfactory to it that such transfer may lawfully be made without registration under
the Securities Act of 1933 or qualification under applicable state securities laws.”

               (b) If required by the authorities of any state in connection with the issuance of sale of the
Securities, the legend required by such state authority.

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          5.8 Qualified Institutional Buyer. Such Investor is a qualified institutional buyer
as defined in Rule 144A(a) under the 1933 Act.

          5.9 No General Solicitation. Such Investor did not learn of the investment in the
Securities as a result of any public advertising or general solicitation.

          5.10 Brokers and Finders. No Person will have, as a result of the transactions
contemplated by the Transaction Documents, any valid right, interest or claim against or upon the
Company, any Subsidiary or an Investor for any commission, fee or other compensation pursuant to
any agreement, arrangement or understanding entered into by or on behalf of such Investor.

          5.11 Prohibited Transactions. During the last thirty (30) days prior to the date
hereof, neither such Investor nor any Affiliate of such Investor which (x) had knowledge of the
transactions contemplated hereby, (y) has or shares discretion relating to such Investor’s
investments or trading or information concerning such Investor’s investments, including in respect
of the Securities, or (z) is subject to such Investor’s review or input concerning such Affiliate’s
investments or trading (collectively, “Trading Affiliates”) has, directly or indirectly, effected
or agreed to effect any short sale, whether or not against the box, established any “put equivalent
position” (as defined in Rule 16a-1(h) under the 1934 Act) with respect to the Common Stock,
granted any other right (including, without limitation, any put or call option) with respect to the
Common Stock or with respect to any security that includes, relates to or derived any significant
part of its value from the Common Stock or otherwise sought to hedge its position in the Securities
(each, a “Prohibited Transaction”). Prior to the earliest to occur of (i) the termination of this
Agreement, (ii) the Effective Date or (iii) the Effectiveness Deadline, such Investor shall not,
and shall cause its Trading Affiliates not to, engage, directly or indirectly, in a Prohibited
Transaction. Such Investor acknowledges that the representations, warranties and covenants
contained in this Section 5.11 are being made for the benefit of the Investors as well as the
Company and that each of the other Investors shall have an independent right to assert any claims
against such Investor arising out of any breach or violation of the provisions of this Section
5.11.

     6. Conditions to Closing.

          6.1 Conditions to the Investors’ Obligations. The obligation of each Investor to
purchase the Notes at the Closing is subject to the fulfillment to such Investor’s satisfaction, on
or prior to the Closing Date, of the following conditions, any of which may be waived by such
Investor (as to itself only):

               (a) The representations and warranties made by the Company in Section 4 hereof qualified as to
materiality shall be true and correct at all times prior to and on the Closing Date, except to the
extent any such representation or warranty expressly speaks as of an earlier date, in which case
such representation or warranty shall be true and correct as of such earlier date, and, the
representations and warranties made by the Company in Section 4 hereof not qualified as to
materiality shall be true and correct in all material respects at all times prior to and on the
Closing Date, except to the extent any such representation or warranty expressly

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speaks as of an earlier date, in which case such representation or warranty shall be true and
correct in all material respects as of such earlier date. The Company shall have performed in all
material respects all obligations and covenants herein required to be performed by it on or prior
to the Closing Date.

               (b) The Company shall have obtained any and all consents, permits, approvals, registrations
and waivers necessary or appropriate for consummation of the purchase and sale of the Securities
and the consummation of the other transactions contemplated by the Transaction Documents, all of
which shall be in full force and effect.

               (c) The Company shall have executed and delivered the Registration Rights Agreement.

               (d) No judgment, writ, order, injunction, award or decree of or by any court, or judge,
justice or magistrate, including any bankruptcy court or judge, or any order of or by any
governmental authority, shall have been issued, and no action or proceeding shall have been
instituted by any governmental authority, enjoining or preventing the consummation of the
transactions contemplated hereby or in the other Transaction Documents.

               (e) The Company shall have delivered a Certificate, executed on behalf of the Company by its
Chief Executive Officer or its Chief Financial Officer, dated as of the Closing Date, certifying to
the fulfillment of the conditions specified in subsections (a), (b), (d) and (h) of this Section
6.1.

               (f) The Company shall have delivered a Certificate, executed on behalf of the Company by its
Secretary, dated as of the Closing Date, certifying the resolutions adopted by the Board of
Directors of the Company approving the transactions contemplated by this Agreement and the other
Transaction Documents and the issuance of the Securities, certifying the current versions of the
Certificate of Incorporation and Bylaws of the Company and certifying as to the signatures and
authority of persons signing the Transaction Documents and related documents on behalf of the
Company.

               (g) The Investors shall have received an opinion from DLA Piper Rudnick Gray Cary US LLP, the
Company’s counsel, dated as of the Closing Date, in form and substance reasonably acceptable to the
Investors and addressing such legal matters as the Investors may reasonably request.

               (h) No stop order or suspension of trading shall have been imposed by Nasdaq, the SEC or any
other governmental or regulatory body with respect to public trading in the Common Stock.

          6.2 Conditions to Obligations of the Company. The Company’s obligation to sell and
issue the Notes at the Closing is subject to the fulfillment to the satisfaction of the Company on
or prior to the Closing Date of the following conditions, any of which may be waived by the
Company:

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               (a) The representations and warranties made by the Investors in Section 5 hereof, other than
the representations and warranties contained in Sections 5.3, 5.4, 5.5, 5.6, 5.7, 5.8 and 5.9 (the
“Investment Representations”), shall be true and correct in all material respects when made, and
shall be true and correct in all material respects on the Closing Date with the same force and
effect as if they had been made on and as of said date. The Investment Representations shall be
true and correct in all respects when made, and shall be true and correct in all respects on the
Closing Date with the same force and effect as if they had been made on and as of said date. The
Investors shall have performed in all material respects all obligations and covenants herein
required to be performed by them on or prior to the Closing Date.

               (b) The Investors shall have executed and delivered the Registration Rights Agreement.

               (c) The Investors shall have (i) delivered the Cash Purchase Price to the Company and (ii)
surrendered $2,000,000 in aggregate principal amount of the Existing Notes to Lowenstein Sandler PC
as provided in Section 3.

          6.3 Termination of Obligations to Effect Closing; Effects.

               (a) The obligations of the Company, on the one hand, and the Investors, on the other hand, to
effect the Closing shall terminate as follows:

                    (i) Upon the mutual written consent of the Company and the Investors;

                    (ii) By the Company if any of the conditions set forth in Section 6.2 shall have become
incapable of fulfillment, and shall not have been waived by the Company;

                    (iii) By an Investor (with respect to itself only) if any of the conditions set forth in
Section 6.1 shall have become incapable of fulfillment, and shall not have been waived by the
Investor; or

                    (iv) By either the Company or any Investor (with respect to itself only) if the Closing has
not occurred on or prior to August 15, 2005;

provided, however, that, except in the case of clause (i) above, the party seeking to terminate its
obligation to effect the Closing shall not then be in breach of any of its representations,
warranties, covenants or agreements contained in this Agreement or the other Transaction Documents
if such breach has resulted in the circumstances giving rise to such party’s seeking to terminate
its obligation to effect the Closing.

          (b) In the event of termination by the Company or any Investor of its obligations to effect
the Closing pursuant to this Section 6.3, written notice thereof shall forthwith be given to the
other Investors and the other Investors shall have the right to terminate

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their obligations to effect the Closing upon written notice to the Company and the other Investors.
Nothing in this Section 6.3 shall be deemed to release any party from any liability for any breach
by such party of the terms and provisions of this Agreement or the other Transaction Documents or
to impair the right of any party to compel specific performance by any other party of its
obligations under this Agreement or the other Transaction Documents.

     7. Covenants and Agreements of the Company.

          7.1 Reservation of Common Stock. The Company shall at all times reserve and keep
available out of its authorized but unissued shares of Common Stock, solely for the purpose of
providing for the conversion of the Notes, such number of shares of Common Stock as shall from time
to time equal the number of Conversion Shares in accordance with their terms.

          7.2 Reports. The Company will furnish to the Investors and/or their assignees such
information relating to the Company and its Subsidiaries as from time to time may reasonably be
requested by the Investors and/or their assignees; provided, however, that the Company shall not
disclose material nonpublic information to the Investors, or to advisors to or representatives of
the Investors, unless prior to disclosure of such information the Company identifies such
information as being material nonpublic information and provides the Investors, such advisors and
representatives with the opportunity to accept or refuse to accept such material nonpublic
information for review and any Investor wishing to obtain such information enters into an
appropriate confidentiality agreement with the Company with respect thereto.

          7.3 No Conflicting Agreements. The Company will not take any action, enter into any
agreement or make any commitment that would conflict or interfere in any material respect with the
Company’s obligations to the Investors under the Transaction Documents.

          7.4 Insurance. The Company shall not materially reduce the insurance coverages
described in Section 4.19.

          7.5 Compliance with Laws. The Company will comply in all material respects with all
applicable laws, rules, regulations, orders and decrees of all governmental authorities.

          7.6 Listing of Underlying Shares and Related Matters. The Company shall take all
necessary action to cause the Conversion Shares to be listed on The Nasdaq SmallCap Market promptly
following the approval, if any, of the Proposal at the Stockholders Meeting (as defined below).
Further, if the Company applies to have its Common Stock or other securities traded on any other
principal stock exchange or market, it shall include in such application the Conversion Shares and
will take such other action as is necessary to cause such Common Stock to be so listed. The
Company will use commercially reasonable efforts to continue the listing and trading of its Common
Stock on Nasdaq and, in accordance, therewith, will use commercially reasonable efforts to comply
in all respects with the Company’s reporting, filing and other obligations under the bylaws or
rules of such market or exchange, as applicable.

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          7.7 Termination of Covenants. The provisions of Sections 7.2 through 7.5 shall
terminate and be of no further force and effect on the date on which the Company’s obligations
under the Registration Rights Agreement to register or maintain the effectiveness of any
registration covering the Registrable Securities (as such term is defined in the Registration
Rights Agreement) shall terminate.

          7.8 Removal of Legends. Upon the earlier of (i) registration for resale pursuant to
the Registration Rights Agreement and receipt by the Company of the Investor’s written confirmation
that such Securities will not be disposed of except in compliance with the prospectus delivery
requirements of the 1933 Act or (ii) Rule 144(k) becoming available the Company shall, upon an
Investor’s written request, promptly cause certificates evidencing the Investor’s Securities to be
replaced with certificates which do not bear such restrictive legends, and Conversion Shares
subsequently issued upon due conversion of the Notes shall not bear such restrictive legends
provided the provisions of either clause (i) or clause (ii) above, as applicable, are satisfied
with respect to such Conversion Shares. When the Company is required to cause unlegended
certificates to replace previously issued legended certificates, if unlegended certificates are not
delivered to an Investor within three (3) Business Days of submission by that Investor of legended
certificate(s) to the Company’s transfer agent together with a representation letter in customary
form, the Company shall be liable to the Investor for liquidated damages in an amount equal to 1.5%
of the aggregate purchase price of the Securities evidenced by such certificate(s) for each thirty
(30) day period (or portion thereof) beyond such three (3) Business Day that the unlegended
certificates have not been so delivered.

          7.9 Proxy Statement; Stockholders Meeting. (a) Promptly following the execution and
delivery of this Agreement the Company shall take all action necessary to call a meeting of its
stockholders (the “Stockholders Meeting”), which shall occur not later than the 100th
day after the date hereof (the “Stockholders Meeting Deadline”), for the purpose of seeking
approval of the Company’s stockholders for (i) the issuance and sale to the Investors of the
Securities pursuant to Nasdaq Marketplace Rule 4350(i)(1)(B) (the “Proposal”). In connection
therewith, the Company will promptly prepare and file with the SEC proxy materials (including a
proxy statement and form of proxy) for use at the Stockholders Meeting and, after receiving and
promptly responding to any comments of the SEC thereon, shall promptly mail such proxy materials to
the stockholders of the Company. Each Investor shall promptly furnish in writing to the Company
such information relating to such Investor and its investment in the Company as the Company may
reasonably request for inclusion in the Proxy Statement. The Company will comply with Section
14(a) of the 1934 Act and the rules promulgated thereunder in relation to any proxy statement (as
amended or supplemented, the “Proxy Statement”) and any form of proxy to be sent to the
stockholders of the Company in connection with the Stockholders Meeting, and the Proxy Statement
shall not, on the date that the Proxy Statement (or any amendment thereof or supplement thereto) is
first mailed to stockholders or at the time of the Stockholders Meeting, contain any untrue
statement of a material fact or omit to state any material fact necessary in order to make the
statements made therein not false or misleading, or omit to state any material fact necessary to
correct any statement in any earlier communication with respect to the solicitation of proxies or
the Stockholders Meeting which has become false or misleading. If the Company should discover at
any time prior to the Stockholders Meeting, any event relating to the Company or any of its
Subsidiaries or any of their respective affiliates,

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officers or directors that is required to be set forth in a supplement or amendment to the Proxy
Statement, in addition to the Company’s obligations under the 1934 Act, the Company will promptly
inform the Investors thereof.

            (b) Subject to their fiduciary obligations under applicable law (as determined in good faith
by the Company’s Board of Directors after consultation with the Company’s outside counsel), the
Company’s Board of Directors shall recommend to the Company’s stockholders that the stockholders
vote in favor of the Proposal (the “Company Board Recommendation”) and take all commercially
reasonable action (including, without limitation, the hiring of a proxy solicitation firm of
nationally recognized standing) to solicit the approval of the stockholders for the Proposal unless
the Board of Directors shall have modified, amended or withdrawn the Company Board Recommendation
pursuant to the provisions of the immediately succeeding sentence. The Company covenants that the
Board of Directors of the Company shall not modify, amend or withdraw the Company Board
Recommendation unless the Board of Directors (after consultation with the Company’s outside
counsel) shall determine in the good faith exercise of its business judgment that maintaining the
Company Board Recommendation would violate its fiduciary duty to the Company’s stockholders.
Whether or not the Company’s Board of Directors modifies, amends or withdraws the Company Board
Recommendation pursuant to the immediately preceding sentence, the Company shall in accordance with
Section 146 of the Delaware General Corporation Law and the provisions of its Certificate of
Incorporation and Bylaws, (i) take all action necessary to convene the Stockholders Meeting as
promptly as practicable, but no later than the Stockholders Meeting Deadline, to consider and vote
upon the approval of the Proposal and (ii) submit the Proposal at the Stockholders Meeting to the
stockholders of the Company for their approval.

          7.10 Director Designee.

               (a) So long as Special Situations Fund III, L.P. (“SSF”) and/or one or more of its Affiliates
collectively own Notes, SSF shall have the right to designate one person for election to the board
of directors of the Company (the “SSF Designee”). The Company shall use its commercially
reasonable efforts to cause the SSF Designee to be elected to the Company’s board of directors.
SSF shall have the right to remove or replace any SSF Designee by giving notice to such SSF
Designee and the Company. The Company shall use its commercially reasonable efforts to effect the
removal or replacement of any such SSF Designee.

               (b) Subject to any limitations imposed by applicable law, the SSF Designee shall be entitled
to the same perquisites, including stock options, reimbursement of expenses and other similar
rights in connection with such person’s membership on the Board of Directors of the Company, as
every other non-employee member of the Board of Directors of the Company.

          7.11 Release of Bank Liens. Promptly following the Closing Date, the Company shall,
at its own expense, take or assist the Investors in taking all actions necessary or desirable in
the reasonable judgment of the Investors to effect the termination and release of any lien, claim,
security interest or encumbrance in favor of the Bank on the assets and properties of the Company
or any Subsidiary, including, but not limited to, causing the Bank to execute and

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deliver to the order of the Investors one or more UCC-3 termination statements or other appropriate
documents or instruments terminating any security interest the Bank may have in the assets and
properties of the Company or any Subsidiary.

     8. Survival and Indemnification.

          8.1 Survival. The representations, warranties, covenants and agreements contained in
this Agreement shall survive the Closing of the transactions contemplated by this Agreement.

          8.2 Indemnification. The Company agrees to indemnify and hold harmless each Investor
and its Affiliates and their respective directors, officers, employees and agents from and against
any and all losses, claims, damages, liabilities and expenses (including without limitation
reasonable attorney fees and disbursements and other expenses incurred in connection with
investigating, preparing or defending any action, claim or proceeding, pending or threatened and
the costs of enforcement thereof) (collectively, “Losses”) to which such Person may become subject
as a result of any breach of representation, warranty, covenant or agreement made by or to be
performed on the part of the Company under the Transaction Documents, and will reimburse any such
Person for all such amounts as they are incurred by such Person.

          8.3 Conduct of Indemnification Proceedings. Promptly after receipt by any Person
(the “Indemnified Person”) of notice of any demand, claim or circumstances which would or might
give rise to a claim or the commencement of any action, proceeding or investigation in respect of
which indemnity may be sought pursuant to Section 8.2, such Indemnified Person shall promptly
notify the Company in writing and the Company shall assume the defense thereof, including the
employment of counsel reasonably satisfactory to such Indemnified Person, and shall assume the
payment of all fees and expenses; provided, however, that the failure of any
Indemnified Person so to notify the Company shall not relieve the Company of its obligations
hereunder except to the extent that the Company is materially prejudiced by such failure to notify.
In any such proceeding, any Indemnified Person shall have the right to retain its own counsel, but
the fees and expenses of such counsel shall be at the expense of such Indemnified Person unless:
(i) the Company and the Indemnified Person shall have mutually agreed to the retention of such
counsel; or (ii) in the reasonable judgment of counsel to such Indemnified Person representation of
both parties by the same counsel would be inappropriate due to actual or potential differing
interests between them. The Company shall not be liable for any settlement of any proceeding
effected without its written consent, which consent shall not be unreasonably withheld, but if
settled with such consent, or if there be a final judgment for the plaintiff, the Company shall
indemnify and hold harmless such Indemnified Person from and against any loss or liability (to the
extent stated above) by reason of such settlement or judgment. Without the prior written consent
of the Indemnified Person, which consent shall not be unreasonably withheld, the Company shall not
effect any settlement of any pending or threatened proceeding in respect of which any Indemnified
Person is or could have been a party and indemnity could have been sought hereunder by such
Indemnified Party, unless such settlement includes an unconditional release of such Indemnified
Person from all liability arising out of such proceeding.

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     9. Miscellaneous.

          9.1 Successors and Assigns. This Agreement may not be assigned by a party hereto
without the prior written consent of the Company or the Investors, as applicable, provided,
however, that an Investor may assign its rights and delegate its duties hereunder in whole or in
part to an Affiliate or to a third party acquiring some or all of its Securities in a private
transaction without the prior written consent of the Company or the other Investors, after notice
duly given by such Investor to the Company provided, that no such assignment or obligation shall
affect the obligations of such Investor hereunder. The provisions of this Agreement shall inure to
the benefit of and be binding upon the respective permitted successors and assigns of the parties.
Nothing in this Agreement, express or implied, is intended to confer upon any party other than the
parties hereto or their respective successors and assigns any rights, remedies, obligations, or
liabilities under or by reason of this Agreement, except as expressly provided in this Agreement.

          9.2 Counterparts; Faxes. This Agreement may be executed in two or more counterparts,
each of which shall be deemed an original, but all of which together shall constitute one and the
same instrument. This Agreement may also be executed via facsimile, which shall be deemed an
original.

          9.3 Titles and Subtitles. The titles and subtitles used in this Agreement are used
for convenience only and are not to be considered in construing or interpreting this Agreement.

          9.4 Notices. Unless otherwise provided, any notice required or permitted under this
Agreement shall be given in writing and shall be deemed effectively given as hereinafter described
(i) if given by personal delivery, then such notice shall be deemed given upon such delivery, (ii)
if given by telex or telecopier, then such notice shall be deemed given upon receipt of
confirmation of complete transmittal, (iii) if given by mail, then such notice shall be deemed
given upon the earlier of (A) receipt of such notice by the recipient or (B) three days after such
notice is deposited in first class mail, postage prepaid, and (iv) if given by an internationally
recognized overnight air courier, then such notice shall be deemed given one Business Day after
delivery to such carrier. All notices shall be addressed to the party to be notified at the
address as follows, or at such other address as such party may designate by ten days’ advance
written notice to the other party:

If to the Company:

Visual Networks, Inc.

2092 Gaither Road

Rockville Center, Maryland 20850

Attention: Donald E. Clarke, Chief Financial Officer

Fax: (301) 296-2742

-23-

 

With a copy to:

DLA Piper Rudnick Gray Cary US LLP

1775 Wiehle Avenue, Suite 400

Reston, Virginia 20190

Attention: Nancy A. Spangler

Fax: (703) 773-5021

If to the Investors:

to the addresses set forth on the signature pages hereto.

          9.5 Expenses. The parties hereto shall pay their own costs and expenses in connection
herewith, except that the Company shall pay the reasonable fees and expenses of Lowenstein Sandler
PC not to exceed $35,000. Such expenses shall be paid not later than the Closing. The Company
shall reimburse the Investors upon demand for all reasonable out-of-pocket expenses incurred by the
Investors, including without limitation reimbursement of attorneys’ fees and disbursements, in
connection with any amendment, modification or waiver of this Agreement or the other Transaction
Documents. In the event that legal proceedings are commenced by any party to this Agreement
against another party to this Agreement in connection with this Agreement or the other Transaction
Documents, the party or parties which do not prevail in such proceedings shall severally, but not
jointly, pay their pro rata share of the reasonable attorneys’ fees and other reasonable
out-of-pocket costs and expenses incurred by the prevailing party in such proceedings.

          9.6 Amendments and Waivers. Any term of this Agreement may be amended and the
observance of any term of this Agreement may be waived (either generally or in a particular
instance and either retroactively or prospectively), only with the written consent of the Company
and the Investors holding Notes representing at least 50% of the principal amount of Notes then
outstanding. Any amendment or waiver effected in accordance with this paragraph shall be binding
upon each holder of any Securities purchased under this Agreement at the time outstanding, each
future holder of all such Securities, and the Company.

          9.7 Publicity. Except as set forth below, no public release or announcement
concerning the transactions contemplated hereby shall be issued by the Company or the Investors
without the prior consent of the Company (in the case of a release or announcement by the
Investors) or the Investors (in the case of a release or announcement by the Company) (which
consents shall not be unreasonably withheld), except as such release or announcement may be
required by law or the applicable rules or regulations of any securities exchange or securities
market, in which case the Company or the Investors, as the case may be, shall allow the Investors
or the Company, as applicable, to the extent reasonably practicable in the circumstances,
reasonable time to comment on such release or announcement in advance of such issuance. By 8:30
a.m. (New York City time) on the trading day immediately following both (i) the full execution of
this Agreement by the Company and the Investors and (ii) the Closing Date, the Company shall issue
a press release disclosing the execution of definitive agreements relating to, or the consummation
of, the transactions contemplated by this Agreement, as applicable. No

-24-

 

later than the third trading day following the Closing Date, the Company will file a Current Report
on Form 8-K attaching the press release described in the foregoing sentence as well as copies of
the Transaction Documents. In addition, the Company will make such other filings and notices in
the manner and time required by the SEC or Nasdaq. Notwithstanding the foregoing, the Company
shall not publicly disclose the name of any Investor, or include the name of any Investor in any
filing with the SEC (other than the Registration Statement and any exhibits to filings made in
respect of this transaction in accordance with periodic filing requirements under the 1934 Act) or
any regulatory agency or Nasdaq, without the prior written consent of such Investor, except to the
extent such disclosure is required by law or trading market regulations, in which case the Company
shall provide the Investors with prior notice of such disclosure.

          9.8 Severability. Any provision of this Agreement that is prohibited or unenforceable
in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such
prohibition or unenforceability without invalidating the remaining provisions hereof but shall be
interpreted as if it were written so as to be enforceable to the maximum extent permitted by
applicable law, and any such prohibition or unenforceability in any jurisdiction shall not
invalidate or render unenforceable such provision in any other jurisdiction. To the extent
permitted by applicable law, the parties hereby waive any provision of law which renders any
provision hereof prohibited or unenforceable in any respect.

          9.9 Entire Agreement. This Agreement, including the Exhibits and the Disclosure
Schedules, and the other Transaction Documents constitute the entire agreement among the parties
hereof with respect to the subject matter hereof and thereof and supersede all prior agreements and
understandings, both oral and written, between the parties with respect to the subject matter
hereof and thereof.

          9.10 Further Assurances. The parties shall execute and deliver all such further
instruments and documents and take all such other actions as may reasonably be required to carry
out the transactions contemplated hereby and to evidence the fulfillment of the agreements herein
contained.

          9.11 Governing Law; Consent to Jurisdiction; Waiver of Jury Trial. This Agreement
shall be governed by, and construed in accordance with, the internal laws of the State of New York
without regard to the choice of law principles thereof. Each of the parties hereto irrevocably
submits to the exclusive jurisdiction of the courts of the State of New York located in New York
County and the United States District Court for the Southern District of New York for the purpose
of any suit, action, proceeding or judgment relating to or arising out of this Agreement and the
transactions contemplated hereby. Service of process in connection with any such suit, action or
proceeding may be served on each party hereto anywhere in the world by the same methods as are
specified for the giving of notices under this Agreement. Each of the parties hereto irrevocably
consents to the jurisdiction of any such court in any such suit, action or proceeding and to the
laying of venue in such court. Each party hereto irrevocably waives any objection to the laying of
venue of any such suit, action or proceeding brought in such courts and irrevocably waives any
claim that any such suit, action or proceeding brought in any such court has been brought in an
inconvenient forum. EACH OF THE PARTIES HERETO WAIVES ANY RIGHT TO REQUEST A TRIAL BY JURY IN ANY
LITIGATION WITH

-25-

 

RESPECT TO THIS AGREEMENT AND REPRESENTS THAT COUNSEL HAS BEEN CONSULTED SPECIFICALLY AS TO THIS
WAIVER.

          9.12 Independent Nature of Investors’ Obligations and Rights. The obligations of each
Investor under any Transaction Document are several and not joint with the obligations of any other
Investor, and no Investor shall be responsible in any way for the performance of the obligations of
any other Investor under any Transaction Document. The decision of each Investor to purchase
Securities pursuant to the Transaction Documents has been made by such Investor independently of
any other Investor. Nothing contained herein or in any Transaction Document, and no action taken
by any Investor pursuant thereto, shall be deemed to constitute the Investors as a partnership, an
association, a joint venture or any other kind of entity, or create a presumption that the
Investors are in any way acting in concert or as a group with respect to such obligations or the
transactions contemplated by the Transaction Documents. Each Investor acknowledges that no other
Investor has acted as agent for such Investor in connection with making its investment hereunder
and that no Investor will be acting as agent of such Investor in connection with monitoring its
investment in the Securities or enforcing its rights under the Transaction Documents. Each
Investor shall be entitled to independently protect and enforce its rights, including, without
limitation, the rights arising out of this Agreement or out of the other Transaction Documents, and
it shall not be necessary for any other Investor to be joined as an additional party in any
proceeding for such purpose. The Company acknowledges that each of the Investors has been provided
with the same Transaction Documents for the purpose of closing a transaction with multiple
Investors and not because it was required or requested to do so by any Investor.

[signature page follows]

-26-

 

          IN WITNESS WHEREOF, the parties have executed this Agreement or caused their duly authorized
officers to execute this Agreement as of the date first above written.

	 	 	 	 	 
	The Company:	 	VISUAL NETWORKS, INC.
	 
	 	 	 	 
	 

	 	By:	 	/s/ Lawrence S. Barker
	 

	 	 	 	 
	 	 	Name: LAWRENCE S. BARKER

Title: CEO

-27-

 

	 	 	 	 	 
	The Investors:	 	SPECIAL SITUATIONS FUND III, L.P.
	 
	 	 	 	 
	 

	 	By:
	 	/s/ David M. Greenhouse
	 

	 	 	 	 
	 	 	Name: David M. Greenhouse

Title: General Partner

	 	 	 
	Principal Amount of Notes: $4,195,151
	 	 
	Cash Purchase Price: $4,195,151
	 	 
	 
	 	 
	Address for Notice:
	 	 
	 
	 	 
	 

	 	153 E. 53rd Street
	 

	 	55th Floor
	 

	 	New York, NY 10022
	 
	 

	 	with a copy to:
	 
	 

	 	Lowenstein Sandler PC
	 

	 	65 Livingston Avenue
	 

	 	Roseland, NJ 07068
	 

	 	Attn: John D. Hogoboom, Esq.
	 

	 	Telephone:     973.597.2500
	 

	 	Facsimile:       973.597.2400

	 	 	 	 	 
	 	 	SPECIAL SITUATIONS CAYMAN FUND, L.P.
	 
	 	 	 	 
	 

	 	By:
	 	/s/ David M. Greenhouse
	 

	 	 	 	 
	 	 	Name: David M. Greenhouse

Title: General Partner

	 	 	 
	Principal Amount of Notes: $1,277,401

Cash Purchase Price: $1,277,401
	 	 
	 
	 	 
	Address for Notice:
	 	 
	 
	 	 
	 

	 	153 E. 53rd Street
	 

	 	55th Floor
	 

	 	New York, NY 10022

-28-

 

	 	 	 
	 

	 	with a copy to:
	 
	 	 
	 

	 	Lowenstein Sandler PC
	 

	 	65 Livingston Avenue
	 

	 	Roseland, NJ 07068
	 

	 	Attn: John D. Hogoboom, Esq.
	 

	 	Telephone:     973.597.2500
	 

	 	Facsimile:       973.597.2400

	 	 	 	 	 
	 	 	SPECIAL SITUATIONS PRIVATE EQUITY FUND, L.P.
	 
	 	 	 	 
	 

	 	By:
	 	/s/ David M. Greenhouse
	 

	 	 	 	 
	 	 	Name: David M. Greenhouse

Title: General Partner

Principal Amount of Notes: $3,685,340

Cash Purchase Price: $2,135,340

Principal Amount of Existing Notes Surrendered: $1,550,000

	 	 	 
	 

	 	153 E. 53rd Street
	 

	 	55th Floor
	 

	 	New York, NY 10022
	 
	 	 
	 

	 	with a copy to:
	 
	 	 
	 

	 	Lowenstein Sandler PC
	 

	 	65 Livingston Avenue
	 

	 	Roseland, NJ 07068
	 

	 	Attn: John D. Hogoboom, Esq.
	 

	 	Telephone:     973.597.2500
	 

	 	Facsimile:       973.597.2400

	 	 	 	 	 
	 	 	SPECIAL SITUATIONS TECHNOLOGY FUND, L.P.
	 
	 	 	 	 
	 

	 	By:
	 	/s/ David M. Greenhouse
	 

	 	 	 	 
	 	 	Name: David M. Greenhouse

Title: General Partner

Principal Amount of Notes: $130,291

Cash Purchase Price: $130,291

-29-

 

Address for Notice:

	 	 	 
	 

	 	153 E. 53rd Street
	 

	 	55th Floor
	 

	 	New York, NY 10022
	 
	 	 
	 

	 	with a copy to:
	 
	 	 
	 

	 	Lowenstein Sandler PC
	 

	 	65 Livingston Avenue
	 

	 	Roseland, NJ 07068
	 

	 	Attn: John D. Hogoboom, Esq.
	 

	 	Telephone:     973.597.2500
	 

	 	Facsimile:       973.597.2400

	 	 	 	 	 
	 	 	SPECIAL SITUATIONS TECHNOLOGY FUND II, L.P.
	 
	 	 	 	 
	 

	 	By:
	 	/s/ David M. Greenhouse
	 

	 	 	 	 
	 	 	Name: David M. Greenhouse

Title: General Partner

Principal Amount of Notes: $711,818

Cash Purchase Price: $261,818

Principal Amount of Existing Notes Surrendered: $450,000

Address for Notice:

	 	 	 
	 

	 	153 E. 53rd Street
	 

	 	55th Floor
	 

	 	New York, NY 10022
	 
	 	 
	 

	 	with a copy to:
	 
	 	 
	 

	 	Lowenstein Sandler PC
	 

	 	65 Livingston Avenue
	 

	 	Roseland, NJ 07068
	 

	 	Attn: John D. Hogoboom, Esq.
	 

	 	Telephone:     973.597.2500
	 

	 	Facsimile:       973.597.2400

-30-exv10w2

 

Exhibit 10.2

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

5% SENIOR SECURED CONVERTIBLE NOTE

			
	 	 	 
	US$_______________
	 	August 8, 2005     

          FOR VALUE RECEIVED, Visual Networks, Inc., a Delaware corporation (the “Company”),
hereby unconditionally promises to pay to the order of _________ (the “Holder”), having
an address at _________ , at such address or at such other place as may be designated in
writing by the Holder, or its assigns, the aggregate principal sum of One _________
United States Dollars ($_________), together with interest from the date set forth above on the
unpaid principal balance of this Note outstanding at a rate equal to five percent (5.0%) (computed
on the basis of the actual number of days elapsed in a 360-day year) per annum and continuing on
the outstanding principal until this 5% Senior Secured Convertible Note (the “Note”) is
converted into Common Stock as provided herein or indefeasibly and irrevocably paid in full by the
Company. Simple interest on this Note shall accrue semi-annually and shall be payable
semi-annually on the last day of June and December of each year (each, an “Interest Payment
Date”), commencing on December 31, 2005, to the Holder of record on the immediately preceding
June 15 or December 15, as applicable (each, an “Interest Record Date”). Subject to the
other provisions of this Note, the principal of this Note and all accrued and unpaid interest
hereon shall mature and become due and payable on December 31, 2007 (the “Stated Maturity
Date”). Except as provided herein, all payments of principal and interest by the Company under
this Note shall be made in United States dollars in immediately available funds to an account
specified by the Holder.

          In the event that any amount due hereunder is not paid when due, such overdue amount shall
bear interest at an annual rate of twelve percent (12%) until paid in full. In no event shall any
interest charged, collected or reserved under this Note exceed the maximum rate then permitted by
applicable law and if any such payment is paid by the Company, then such excess sum shall be
credited by the Holder as a payment of principal.

          This Note is one of a series of Notes (the “Company Notes”) of like tenor in an
aggregate principal amount of Ten Million United States Dollars ($10,000,000) issued by the Company
pursuant to the terms of the Purchase Agreement (as defined below).

 

 

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

          “Additional Rights” has the meaning set forth in Section 5 hereof.

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

          “Approval Date” means the date, if any, on which the Company’s stockholders approve
the Proposal at the Stockholders Meeting as contemplated by the Purchase Agreement.

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

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

          “Change of Control” means, at any time (i) any Person or any Persons acting together
that would constitute a “group” for purposes of Section 13(d) under the Exchange Act, or any
successor provision thereto, shall acquire beneficial ownership (within the meaning of Rule 13d-3
under the Exchange Act, or any successor provision thereto) in a single transaction or a series of
related transactions, of more than 50% of the aggregate voting power of the Company; 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 50% of the aggregate voting power of
the Company or the successor entity of such transaction; or (iii) the Company sells or transfers
its assets, as an entirety or substantially as an entirety, to another Person; or (iv) any “change
of control” or similar event under any loan agreement, mortgage, indenture or other agreement
relating to any indebtedness for borrowed money of the Company shall occur; or (v) during any
period of two consecutive years, individuals who at the beginning of such period constituted the
Board (together with any new directors whose election by the stockholders of the Company was
proposed by a vote of the majority of directors of the Company then still in office who were either
directors at the beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority of the Board then in office.

          “Common Stock” shall mean the Common Stock, par value $0.01 per share, of the Company
or any securities into which shares of Common Stock may be reclassified after the date hereof.

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

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

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

          “Conversion Option” has the meaning set forth in Section 6(a) hereof.

-2-

 

          “Conversion Price” shall mean initially $1.45 per share, subject to adjustment as
provided in Section 6.

          “Convertible Securities” has the meaning set forth in Section 5 hereof.

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

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

          “Excluded Issuances” has the meaning set forth in Section 5(j) hereof.

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

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

          “Indebtedness” means any liability or obligation (i) for borrowed money, other than
trade payables incurred in the ordinary course of business, (ii) evidenced by bonds, debentures,
notes, or other similar instruments, (iii) in respect of letters of credit or other similar
instruments (or reimbursement obligations with respect thereto), except letters of credit or other
similar instruments issued to secure payment of trade payables arising in the ordinary course of
business consistent with past practices, (iv) to pay the deferred purchase price of property or
services, except trade payables arising in the ordinary course of business consistent with past
practices, (v) as lessee under capitalized leases, (vi) secured by a Lien on any asset of the
Company or a Subsidiary, whether or not such obligation is assumed by the Company or such
Subsidiary.

          “Interest Payment Date” has the meaning set forth in the first paragraph hereof.

          “Interest Record Date” has the meaning set forth in the first paragraph hereof.

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

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

-3-

 

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

          “Majority Holders” has the meaning set forth in Section 10 hereof.

          “Mandatory Termination Date” has the meaning set forth in Section 6(a) hereof.

          “Market Price”, as of a particular date (the “Valuation Date”), shall mean the
following with respect to any class of securities: (A) if such security is then listed on a
national stock exchange, the Market Price shall be the closing bid price of one share of such
security on such exchange on the last Trading Day prior to the Valuation Date, provided that if
such security has not traded in the prior ten (10) trading sessions, the Market Price shall be the
average closing bid price of such security in the most recent ten (10) trading sessions during
which such security has traded; (B) if such security is then included in The Nasdaq Stock Market,
Inc., including the Nasdaq SmallCap Market (“Nasdaq”), the Market Price shall be the
closing bid price of one share of such security on Nasdaq on the last Trading Day prior to the
Valuation Date or, if no such closing sale price is available, the average of the high bid and the
low ask price quoted on Nasdaq as of the end of the last Trading Day prior to the Valuation Date,
provided that if such security has not traded in the prior ten (10) trading sessions, the Market
Price shall be the average closing price of one share of such security in the most recent ten (10)
trading sessions during which such security has traded; (C) if such security is then included in
the Over-the-Counter Bulletin Board, the Market Price shall be the closing sale price of one share
of such security on the Over-the-Counter Bulletin Board on the last Trading Day prior to the
Valuation Date or, if no such closing sale price is available, the average of the high bid and the
low ask price quoted on the Over-the-Counter Bulletin Board as of the end of the last Trading Day
prior to the Valuation Date, provided that if such stock has not traded in the prior ten (10)
trading sessions, the Market Price shall be the average closing price of one share of such security
in the most recent ten (10) trading sessions during which such security has traded; or (D) if such
security is then included in the “pink sheets,” the Market Price shall be the closing sale price of
one share of such security on the “pink sheets” on the last Trading Day prior to the Valuation Date
or, if no such closing sale price is available, the average of the high bid and the low ask price
quoted on the “pink sheets” as of the end of the last Trading Day prior to the Valuation Date,
provided that if such stock has not traded in the prior ten (10) trading sessions, the Market Price
shall be the average closing price of one share of such security in the most recent ten (10)
trading sessions during which such security has traded.

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

          “Notice Period” has the meaning set forth in Section 6(a) hereof.

          “Options” has the meaning set forth in Section 5 hereof.

          “Permitted Indebtedness” means:

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

-4-

 

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

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

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

          “Permitted Investments” means:

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

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

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

          “Permitted Liens” means:

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

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

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

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

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

-5-

 

affected property or interfere with the ordinary conduct of business of the Company or any of
its Subsidiaries; and

               (f) Liens granted to secure the obligations of the Company or any Subsidiary under any
Indebtedness permitted under clause (c) of the definition of “Permitted Indebtedness” provided the
Lien is limited to the property acquired or so financed.

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

          “Prepayment Date” has the meaning set forth in Section 3(b) hereof.

          “Purchase Agreement” shall mean the Purchase Agreement, dated as of August 5, 2005,
and as that agreement may be amended from time to time, by and among the Company and the Investors.

          “Registration Rights Agreement” shall mean the Registration Rights Agreement, dated as
of August 8, 2005, and as that agreement may be amended from time to time, by and among the
Company and the Investors.

          “Redemption Option” has the meaning set forth in Section 6(a) hereof.

          “Registration Condition” has the meaning set forth in Section 6(d) hereof.

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

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

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

          “Restricted Payment” has the meaning set forth in Section 7 hereof.

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

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

          “Trading Condition” has the meaning set forth in Section 6(c) hereof.

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

-6-

 

          “Trigger Issuance” has the meaning set forth in Section 5(i) hereof.

     2. Purchase Agreement. This Note is one of the several 5% Senior Secured Convertible
Notes of the Company issued pursuant to the Purchase Agreement. This Note is subject to the terms
and conditions of, and entitled to the benefit of, the provisions of the Purchase Agreement. This
Note is transferable and assignable to any Person to whom such transfer is permissible under the
Purchase Agreement and applicable law. The Company agrees to issue from time to time a replacement
Note in the form hereof to facilitate such transfers and assignments. In addition, after delivery
of an indemnity in form and substance reasonably satisfactory to the Company, the Company also
agrees to promptly issue a replacement Note if this Note is lost, stolen, mutilated or destroyed.

     3. No Right of Prepayment or Redemption.

          (a) Except as provided in Section 3(b) or in Section 6 hereof, this Note shall not be
prepayable or redeemable by the Company prior to the Stated Maturity Date.

          (b) In the event that the aggregate principal amount of outstanding Company Notes held by the
Holder or its Affiliates is less than $1,000,000, the Company may prepay this Note and all other
Company Notes held by the Holder and its Affiliates, in whole but not in part, without the prior
written consent of the Holder or its Affiliates at 105% of the principal amount to be repaid
together with all accrued and unpaid interest due hereon; provided, however, that no prepayment
shall be made unless the Registration Condition is satisfied. Any such prepayment shall be made on
not less than thirty (30) days prior written notice provided to the Holder hereof, which notice
shall specify the prepayment date on which such prepayment will be made (the “Prepayment
Date”). The Company shall not have the right to set off or otherwise deduct from amounts
payable by it hereunder any amounts whether liquidated or unliquidated, which the Holder or any of
its Affiliates may owe to the Company, which right is hereby expressly waived to the maximum extent
permitted by applicable law. Notwithstanding the giving of any prepayment notice pursuant to this
clause (b), this Note shall continue to be convertible into shares of Common Stock as provided in
Section 5 until the close of business on the Prepayment Date or such later time as the prepayment
is effected.

     4. Repurchase of the Note at the Option of the Holder Upon Change of Control.

          (a) If a Change of Control occurs, this Note shall be purchased by the Company, at the option
of the Holder thereof, at a cash purchase price equal to (i) if the Change of Control occurs on or
prior to the Approval Date, the higher of (A) the result obtained by multiplying (1) the number of
Conversion Shares then issuable under this Note, assuming that the Note is fully
convertible(including any accrued interest thereon), by (2) the per share price paid by the
acquirer in any transaction specified in clauses (i), (ii) or (iii) of the definition of “Change of
Control” or (B) 110% of the principal amount of this Note, (ii) 110% of the principal amount of
this Note if the Change of Control occurs after the Approval Date and on or prior to the first
anniversary of the Closing Date, (iii) 105% of the principal amount of this Note if the Change of
Control occurs after both (A) the Approval Date and (B) the first anniversary of the Closing Date
and on or prior to the second anniversary of the Closing Date and (iii) 100% of the principal
amount of this Note if the Change of Control occurs after both (A) the Approval Date and (B) the
second anniversary of the Closing Date, plus, in each case (other than clause (i)(A)

-7-

 

above), accrued and unpaid interest (the “Repurchase Price”) to, but not including,
the date that is 30 days following the date of the notice of a Change of Control delivered by the
Company pursuant to clause (b) below (the “Repurchase Date”), subject to satisfaction by or
on behalf of the Holder of the requirements set forth in clause (c) below. If the Repurchase Date
is on a date that is after an Interest Record Date and on or prior to the corresponding Interest
Payment Date, the Company shall pay such interest to the holder of record on the corresponding
Interest Record Date and the Repurchase Price shall not include accrued interest.

          (b) No later than 30 days after the occurrence of a Change of Control, the Company shall give
written notice thereof to the Holder, which notice shall include a form of repurchase notice to be
completed by the Holder and shall (i) state briefly, the events causing a Change of Control and the
date of such Change of Control, (ii) specify the Repurchase Price and (iii) the Repurchase Date.

          (c) The Holder may exercise its rights specified in this Section 4 upon delivery to the
Company of (i) a written notice of purchase (a “Repurchase Notice”) to the Company at any
time on or prior to 5:00 p.m., New York time, on the Repurchase Date stating the portion of the
Note which the Holder will deliver to be purchased, which portion must be in principal amounts of
$1,000 or an integral multiple of $1,000, and irrevocably agreeing that such principal amount of
the Note shall be purchased by the Company as of the Repurchase Date and (ii) this Note.

          (d) In the event that this Note is repurchased in part, upon surrender of this Note, the
Company shall execute and deliver to the Holder a new Note equal in principal amount to the
unpurchased portion of the Note surrendered.

     5. Conversion Rights.

          (a) Prior to the Approval Date, this Note shall not be convertible. From and after the
Approval Date and subject to and upon compliance with the provisions of this Note, prior to the
Stated Maturity Date, the Holder shall have the right, at its option at any time, to convert some
or all of the Note into such number of fully paid and nonassessable shares of Common Stock as is
obtained by: (i) adding (A) the principal amount of this Note to be converted and (B) the amount of
any accrued but unpaid interest with respect to such portion of this Note to be converted; and (ii)
dividing the result obtained pursuant to clause (i) above by the Conversion Price then in effect.
The rights of conversion set forth in this Section 5 shall be exercised by the Holder by giving
written notice to the Company that the Holder elects to convert a stated amount of this Note into
Common Stock and by surrender of this Note (or, in lieu thereof, by delivery of an appropriate lost
security affidavit in the event this Note shall have been lost or destroyed) to the Company at its
principal office (or such other office or agency of the Company as the Company may designate by
notice in writing to the Holder) at any time on the date set forth in such notice (which date shall
not be earlier than the Company’s receipt of such notice), together with a statement of the name or
names (with address) in which the certificate or certificates for shares of Common Stock shall be
issued.

          (b) Promptly after receipt of the written notice referred to in Section 5(a) above and
surrender of this Note (or, in lieu thereof, by delivery of an appropriate lost security

-8-

 

affidavit in the event this Note shall have been lost or destroyed), but in no event more than
three (3) Business Days thereafter, the Company shall issue and deliver, or cause to be issued and
delivered, to the Holder, registered in such name or names as the Holder may direct in writing, a
certificate or certificates for the number of whole shares of Common Stock issuable upon the
conversion of such portion of this Note. To the extent permitted by law, such conversion shall be
deemed to have been effected, and the Conversion Price shall be determined, as of the close of
business on the date on which such written notice shall have been received by the Company and this
Note shall have been surrendered as aforesaid (or, in lieu thereof, an appropriate lost security
affidavit has been delivered to the Company), and at such time, the rights of the Holder shall
cease with respect to the principal amount of the Notes being converted, and the Person or Persons
in whose name or names any certificate or certificates for shares of Common Stock shall be issuable
upon such conversion shall be deemed to have become the holder or holders of record of the shares
represented thereby.

          (c) No fractional shares shall be issued upon any conversion of this Note into Common Stock.
If any fractional share of Common Stock would, except for the provisions of the first sentence of
this Section 5(c), be delivered upon such conversion, the Company, in lieu of delivering such
fractional share, shall pay to the Holder an amount in cash equal to the Market Price of such
fractional share of Common Stock. In case the principal amount of this Note exceeds the principal
amount being converted, the Company shall, upon such conversion, execute and deliver to the Holder,
at the expense of the Company, a new Note for the principal amount of this Note surrendered which
is not to be converted.

          (d) If the Company shall, at any time or from time to time while this Note is outstanding, pay
a dividend or make a distribution on its Common Stock in shares of Common Stock, subdivide its
outstanding shares of Common Stock into a greater number of shares or combine its outstanding
shares of Common Stock into a smaller number of shares or issue by reclassification of its
outstanding shares of Common Stock any shares of its capital stock (including any such
reclassification in connection with a consolidation or merger in which the Company is the
continuing corporation), then the Conversion Price in effect immediately prior to the date upon
which such change shall become effective, shall be adjusted by the Company so that the Holder
thereafter converting this Note shall be entitled to receive the number of shares of Common Stock
or other capital stock which the Holder would have received if the Note had been converted
immediately prior to such event upon payment of a Conversion Price that has been adjusted to
reflect a fair allocation of the economics of such event to the Holder, without regard to any
conversion limitation specified in this Section 5. Such adjustments shall be made successively
whenever any event listed above shall occur.

          (e) If any capital reorganization, reclassification of the capital stock of the Company,
consolidation or merger of the Company with another corporation in which the Company is not the
survivor, or sale, transfer or other disposition of all or substantially all of the Company’s
assets to another corporation shall be effected, then, as a condition of such reorganization,
reclassification, consolidation, merger, sale, transfer or other disposition, lawful and adequate
provision shall be made whereby the Holder shall thereafter have the right to purchase and receive
upon the basis and upon the terms and conditions herein specified and in lieu of the shares of
Common Stock immediately theretofore issuable upon conversion of this Note such shares of stock,
securities or assets as would have been issuable or payable with

-9-

 

respect to or in exchange for a number of shares of Common Stock equal to the number of shares
of Common Stock immediately theretofore issuable upon conversion of this Note, had such
reorganization, reclassification, consolidation, merger, sale, transfer or other disposition not
taken place, and in any such case appropriate provision shall be made with respect to the rights
and interests of the Holder to the end that the provisions hereof (including, without limitation,
provision for adjustment of the Conversion Price) shall thereafter be applicable, as nearly
equivalent as may be practicable in relation to any shares of stock, securities or assets
thereafter deliverable upon the conversion hereof. The Company shall not effect any such
consolidation, merger, sale, transfer or other disposition unless prior to or simultaneously with
the consummation thereof the successor corporation (if other than the Company) resulting from such
consolidation or merger, or the corporation purchasing or otherwise acquiring such assets or other
appropriate corporation or entity shall assume the obligation to deliver to the Holder, at the last
address of the Holder appearing on the books of the Company, such shares of stock, securities or
assets as, in accordance with the foregoing provisions, the Holder may be entitled to purchase,
without regard to any conversion limitation specified in Section 5, and the other obligations under
this Note. The provisions of this paragraph (e) shall similarly apply to successive
reorganizations, reclassifications, consolidations, mergers, sales, transfers or other
dispositions.

          (f) In case the Company shall fix a payment date for the making of a distribution to all
holders of Common Stock (including any such distribution made in connection with a consolidation or
merger in which the Company is the continuing corporation) of evidences of indebtedness or assets
(other than cash dividends or cash distributions payable out of consolidated earnings or earned
surplus or dividends or distributions referred to in Section 5(d)), or subscription rights or
Notes, the Conversion Price to be in effect after such payment date shall be determined by
multiplying the Conversion Price in effect immediately prior to such payment date by a fraction,
the numerator of which shall be the total number of shares of Common Stock outstanding multiplied
by the Market Price of Common Stock immediately prior to such payment date, less the fair market
value (as determined by the Board in good faith) of said assets or evidences of indebtedness so
distributed, or of such subscription rights or Notes, and the denominator of which shall be the
total number of shares of Common Stock outstanding multiplied by such Market Price immediately
prior to such payment date. Such adjustment shall be made successively whenever such a payment
date is fixed.

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

          (h) In the event that, as a result of an adjustment made pursuant to this Section 5, the
Holder shall become entitled to receive any shares of capital stock of the Company other than
shares of Common Stock, the number of such other shares so receivable upon conversion of this Note
shall be subject thereafter to adjustment from time to time in a manner and on terms as nearly
equivalent as practicable to the provisions contained in this Note.

          (i) Except as provided in Section 5(j) hereof, if and whenever the Company shall issue or
sell, or is, in accordance with any of Sections 5(i)(i) through 5(i)(viii) hereof, deemed to have
issued or sold, any shares of Common Stock for no consideration or for a

-10-

 

consideration per share less than the Conversion Price in effect immediately prior to the time
of such issue or sale, then and in each such case (a “Trigger Issuance”) the then-existing
Conversion Price, shall be reduced, as of the close of business on the effective date of the
Trigger Issuance, to a price determined as follows:

	 	 	 	 	 	 	 
	 

	 	Adjusted Conversion Price =
	 	(A x B) + D	 	 
	 

	 	 	 	 	 	 
	 

	 	 	 	A+C	 	 

                    where

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

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

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

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

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

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

          For purposes of this Section 5(i), the following subsections (i)(i) to (i)(viii) shall also be
applicable (subject, in each such case, to the provisions of Section 5(j) hereof):

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

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exercise of all such Options, plus (z), in the case of such Options which relate to
Convertible Securities, the aggregate amount of additional consideration, if any, payable upon
the issue or sale of such Convertible Securities and upon the conversion or exchange thereof,
by (ii) the total maximum number of shares of Common Stock issuable upon the exercise of such
Options or upon the conversion or exchange of all such Convertible Securities issuable upon
the exercise of such Options) shall be less than the Market Price of the Common Stock
immediately prior to the time of the granting of such Options, then the total number of shares
of Common Stock issuable upon the exercise of such Options or upon conversion or exchange of
the total amount of such Convertible Securities issuable upon the exercise of such Options
shall be deemed to have been issued for such price per share as of the date of granting of
such Options or the issuance of such Convertible Securities and thereafter shall be deemed to
be outstanding for purposes of adjusting the Conversion Price. Except as otherwise provided
in subsection 5(i)(iii), no adjustment of the Conversion Price shall be made upon the actual
issue of such Common Stock or of such Convertible Securities upon exercise of such Options or
upon the actual issue of such Common Stock upon conversion or exchange of such Convertible
Securities.

               (ii) In case the Company shall in any manner issue (directly and not by assumption in a
merger or otherwise) or sell any Convertible Securities, whether or not the rights to exchange
or convert any such Convertible Securities are immediately exercisable, and the price per
share for which Common Stock is issuable upon such conversion or exchange (determined by
dividing (i) the sum (which sum shall constitute the applicable consideration) of (x) the
total amount received or receivable by the Company as consideration for the issue or sale of
such Convertible Securities, plus (y) the aggregate amount of additional consideration, if
any, payable to the Company upon the conversion or exchange thereof, by (ii) the total number
of shares of Common Stock issuable upon the conversion or exchange of all such Convertible
Securities) shall be less than the Market Price of the Common Stock immediately prior to the
time of such issue or sale, then the total maximum number of shares of Common Stock issuable
upon conversion or exchange of all such Convertible Securities shall be deemed to have been
issued for such price per share as of the date of the issue or sale of such Convertible
Securities and thereafter shall be deemed to be outstanding for purposes of adjusting the
Conversion Price, provided that (a) except as otherwise provided in subsection 5(i)(iii), no
adjustment of the Conversion Price shall be made upon the actual issuance of such Common Stock
upon conversion or exchange of such Convertible Securities and (b) no further adjustment of
the Conversion Price shall be made by reason of the issue or sale of Convertible Securities
upon exercise of any Options to purchase any such Convertible Securities for which adjustments
of the Conversion Price have been made pursuant to the other provisions of subsection 6(i).

               (iii) Upon the happening of any of the following events, namely, if the purchase price
provided for in any Option referred to in subsection 5(i)(i) hereof, the additional
consideration, if any, payable upon the conversion or exchange of any Convertible Securities
referred to in subsections 5(i)(i) or 5(i)(ii), or the rate at which Convertible Securities
referred to in subsections 5(i)(i) or 5(i)(ii) are convertible into or exchangeable for Common
Stock shall change at any time (including, but not limited to, changes under or by reason of
provisions designed to protect against dilution), the Conversion Price in effect at the time
of such event shall forthwith be readjusted to the

-12-

 

Conversion Price which would have been in effect at such time had such Options or
Convertible Securities still outstanding provided for such changed purchase price, additional
consideration or conversion rate, as the case may be, at the time initially granted, issued or
sold. On the termination of any Option for which any adjustment was made pursuant to this
subsection 5(i) or any right to convert or exchange Convertible Securities for which any
adjustment was made pursuant to this subsection 5(i) (including without limitation upon the
redemption or purchase for consideration of such Convertible Securities by the Company), the
Conversion Price then in effect hereunder shall forthwith be changed to the Conversion Price
which would have been in effect at the time of such termination had such Option or Convertible
Securities, to the extent outstanding immediately prior to such termination, never been
issued.

               (iv) Subject to the provisions of this Section 5(i), in case the Company shall declare a
dividend or make any other distribution upon any stock of the Company (other than the Common
Stock) payable in Common Stock, Options or Convertible Securities, then any Common Stock,
Options or Convertible Securities, as the case may be, issuable in payment of such dividend or
distribution shall be deemed to have been issued or sold without consideration.

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

               (vi) In case the Company shall take a record of the holders of its Common Stock for the
purpose of entitling them (i) to receive a dividend or other

-13-

 

distribution payable in Common Stock, Options or Convertible Securities or (ii) to
subscribe for or purchase Common Stock, Options or Convertible Securities, then such record
date shall be deemed to be the date of the issue or sale of the shares of Common Stock deemed
to have been issued or sold upon the declaration of such dividend or the making of such other
distribution or the date of the granting of such right of subscription or purchase, as the
case may be.

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

               (viii) Notwithstanding any other provision in Section 5(i) to the contrary, if a
reduction in the Conversion Price pursuant to Section 5(i) (other than as set forth in this
clause (viii)) would require the Company to obtain stockholder approval of the transactions
contemplated by the Purchase Agreement pursuant to Nasdaq Marketplace Rule 4350(i) and such
stockholder approval has not been obtained, (i) the Conversion Price shall be reduced to the
maximum extent that would not require stockholder approval under such Rule, and (ii) the
Company shall use its commercially reasonable efforts to obtain such stockholder approval as
soon as reasonably practicable, including by calling a special meeting of stockholders to vote
on such Conversion Price adjustment.

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

          (k) In case at any time:

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

-14-

 

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

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

then, in any one or more of said cases, the Company shall give, by delivery in person or by
certified or registered mail, return receipt requested, addressed to the Holder at the address of
such Holder as shown on the books of the Company, (a) at least 20 Business Days’ prior written
notice of the date on which the books of the Company shall close or a record shall be taken for
such dividend, distribution or subscription rights or for determining rights to vote in respect of
any event set forth in clause (iii) of this Section 5(k) and (b) in the case of any event set forth
in clause (iii) of this Section 5(k), at least 20 Business Days’ prior written notice of the date
when the same shall take place. Such notice in accordance with the foregoing clause (a) shall also
specify, in the case of any such dividend, distribution or subscription rights, the date on which
the holders of Common Stock or such other class or series of capital stock shall be entitled
thereto and such notice in accordance with the foregoing clause (b) shall also specify the date on
which the holders of Common Stock and such other series or class of capital stock shall be entitled
to exchange their Common Stock and other stock for securities or other property deliverable upon
consummation of the applicable event set forth in clause (iii) of this Section 5(k).

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

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

-15-

 

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

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

          (p) To the extent permitted by applicable law and the listing requirements of the Nasdaq Stock
Market and any exchange on which the Common Stock is then listed, the Company from time to time may
decrease the Conversion Price by any amount for any period of time if the period is at least twenty
(20) days, the decrease is irrevocable during the period and the Board shall have made a
determination that such decrease would be in the best interests of the Company, which determination
shall be conclusive. Whenever the Conversion Price is decreased pursuant to the preceding
sentence, the Company shall provide written notice thereof to the Holder at least fifteen (15) days
prior to the date the decreased Conversion Price takes effect, and such notice shall state the
decreased Conversion Price and the period during which it will be in effect.

          (q) Notwithstanding anything to the contrary contained herein, prior to receipt by the Company
of stockholder approval of the Proposal as contemplated by the Purchase Agreement, the number of
Conversion Shares that may be acquired by the Holder upon any conversion of this Note (or otherwise
in respect hereof) shall be limited to the extent necessary to insure that, following such
conversion (or other issuance), the total number of shares of Common Stock then beneficially owned
by such Holder and its Affiliates and any other Persons whose beneficial ownership of Common Stock
would be aggregated with the Holder’s for purposes of Section 13(d) of the Exchange Act, does not
exceed 19.999% of the total number of issued and outstanding shares of Common Stock (including for
such purpose the shares of Common Stock issuable upon such conversion). For such purposes,
beneficial ownership shall be determined in accordance with Section 13(d) of the Exchange Act and
the rules and regulations promulgated thereunder. This provision shall not restrict the number of
shares of Common Stock which a Holder may receive or beneficially own in order to determine the
amount of securities or other consideration that such Holder may receive in the event of a
transaction contemplated by Section 5 of this Note. This restriction may not be waived.

     6. Mandatory Redemption or Conversion Right.

          (a) Provided that the Trading Condition and the Registration Condition are satisfied and
provided that the Company simultaneously gives a similar notice to all holders of Company Notes,
the Company, upon thirty (30) days prior written notice (the “Notice Period”) given to the
Holder, may (i) redeem the portion of this Note specified in subsection (b) below (the
“Redemption Option”) or (ii) effect the mandatory conversion of the portion of this Note
specified in subsection (b) below (the “Conversion Option”), in each case effective as of
the close of business on last day of the Notice Period (the “Mandatory Termination Date”).

-16-

 

          (b) In any three-month period no more than the lesser of (i) 20% of the original principal
amount of this Note or (ii) the remaining outstanding principal amount of this Note, may be
redeemed or mandatorily converted pursuant to Section 6(a) by the Company and the Company may not
redeem or effect the mandatory conversion of any additional principal amount of this Note in any
subsequent three-month period unless all of the conditions specified in this Section 6 are again
satisfied (including without limitation, the Trading Condition and the Registration Condition) at
the time that any subsequent notice or during the applicable Notice Period, as applicable.

          (c) As used herein, the “Trading Condition” shall mean that the closing bid price of a
share of Common Stock as traded on the Nasdaq (or such other exchange or stock market on which the
Common Stock may then be listed or quoted) has equaled or exceeded $3.75 (appropriately adjusted
for any stock split, reverse stock split, stock dividend or other reclassification or combination
of the Common Stock occurring after the date hereof) for a period of twenty (20) consecutive
Trading Days commencing any time after the first anniversary of the Closing Date and ending on the
Business Day immediately preceding the giving of the notice specified in subsection (a) above.

          (d) As used herein, “Registration Condition” shall mean that at all times during the
applicable Notice Period, all of the shares of Common Stock issuable hereunder either (A) are
registered pursuant to an effective Registration Statement (as defined in the Registration Rights
Agreement) which has not been suspended and for which no stop order is in effect, and pursuant to
which the Holder is able to sell such shares of Common Stock at all times during the applicable
Notice Period or (B) no longer constitute Registrable Securities (as defined in the Registration
Rights Agreement).

          (e) From and after such Mandatory Termination Date the portion of this Note so redeemed or
mandatorily converted shall cease to accrue interest, shall cease to be outstanding and shall
represent only the right (i) to receive payment of the principal amount and interest accrued on the
portion of this Note so redeemed as of the Mandatory Termination Date, in the case of the exercise
of the Redemption Option to (ii) to receive shares of Common Stock in respect of that portion of
this Note so mandatorily converted upon compliance with the provisions of Sections 5(a) and (b)
hereof, in the case of the Company’s exercise of the Conversion Option.

          (f) Notwithstanding the Company’s exercise of the Redemption Option, this Note shall continue
to be convertible into shares of Common Stock as provided in Section 5 prior to the close of
business on the Mandatory Termination Date.

     7. Covenants.

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

               (i) The Company shall and shall cause each of its Subsidiaries to (A) carry on and
conduct its business in substantially the same manner and in substantially the same fields of
enterprise as it is presently conducting, (B) do all things necessary to remain

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duly organized, validly existing, and in good standing as a domestic corporation under
the laws of its state of incorporation and (C) maintain all requisite authority to conduct its
business in those jurisdictions in which its business is conducted.

               (ii) The Company shall promptly notify the Holder in writing of (A) any change in the
business or the operations the Company or any Subsidiary which could reasonably be expected to
have a Material Adverse Effect, and (B) any information which indicates that any financial
statements which are the subject of any representation contained in the Transaction Documents,
or which are furnished to the Holder pursuant to the Transaction Documents, fail, in any
material respect, to present fairly, as of the date thereof and for the period covered
thereby, the financial condition and results of operations purported to be presented therein,
disclosing the nature thereof.

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

               (iv) The Company shall promptly notify the Holder of any action, suit or proceeding at
law or in equity or by or before any governmental instrumentality or other agency against the
Company or any Subsidiary or to which the Company or any Subsidiary may be subject which
alleges damages in excess of One Hundred Thousand United States Dollars ($100,000).

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

               (vi) The Company shall deliver to the Holder, within thirty (30) days after the end of
each fiscal quarter, a certificate signed by either the Chief Executive Officer or the Chief
Financial Officer of the Company (which shall include an updated perfection certification) as
to such officer’s knowledge, of the Company’s compliance with all conditions and covenants
under the Transaction Documents (without regard to any period of grace or requirement of
notice provided hereunder) and in the event any Event of Default or any event which, with the
giving of notice, the lapse of time or both would constitute an Event of Default exists, such
officer shall specify the nature thereof.

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

-18-

 

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

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

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

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

               (xii) The Company shall deliver to the Holder as soon as reasonably practicable but in
any event within three (3) Business Days, upon receipt or delivery, copies of any and all
material notices and other material communications from and to any federal or state regulatory
body with jurisdiction over the products, business and/or processes of the Company or any
Subsidiary (i) with respect to products or practices and (ii) with respect to any Intellectual
Property with counsel to the Company or any Subsidiary (including any non-infringement
opinions of counsel or advisors to the Company or any Subsidiary or any other Person), the
United States Patent & Trademark Office and any other Person. The Company shall and shall
cause each Subsidiary to as soon as reasonably practicable, notify the Holder of any
infringement or threatened infringement of its Intellectual Property may at any time come to
its notice.

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

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registrations or applications thereof and all goodwill associate therewith, to any person
or entity.

               (xiv) Promptly after the occurrence thereof, the Company shall and shall cause each
Subsidiary to inform the Holder of all material developments, including without limitation (i)
entering into material agreements outside the ordinary course of business consistent with past
practice, (ii) any issuance of debt securities by the Company or any Subsidiary, (iii) the
incurrence of any Indebtedness by the Company or any Subsidiary, (iv) a change in the number
of the Board of Directors of the Company, (v) a sale, lease or transfer of any material
portion of the assets of the Company or any Subisdiary and (v) any change in ownership of any
Subsidiary (specifying the details of any such change, including the identity and ownership
amount of any new owner).

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

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

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

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

               (iv) The Company shall not, and shall cause each of its Subsidiaries not to, directly or
indirectly, declare or pay any dividends on account of any shares of any class or series of
its capital stock now or hereafter outstanding, or set aside or otherwise deposit or invest
any sums for such purpose, or redeem, retire, defease, purchase or otherwise acquire any
shares of any class of its capital stock (or set aside or otherwise deposit or invest any sums
for such purpose) for any consideration or apply or set apart any sum, or make any other
distribution (by reduction of capital or otherwise) in respect of any such shares or pay any
interest, premium if any, or principal of any Indebtedness or redeem, retire, defease,
repurchase or otherwise acquire any Indebtedness (or set aside or otherwise deposit or invest
any sums for such purpose) for any consideration or apply or set apart any sum, or make any
other payment in respect thereof or agree to do any of the foregoing (each of the foregoing is
herein called a “Restricted Payment”); provided, that (i) the Company may make
payments of interest, premium if any, and principal of the Notes in accordance with the terms
hereof and (ii) provided that no Event of Default or event which, with the giving of notice,
the lapse of time or both would constitute an Event of Default has

-20-

 

occurred and is continuing, the Company and its Subsidiaries may make regularly scheduled
payments of interest and principal of any Permitted Indebtedness, (iii) any Subsidiary
directly or indirectly wholly owned by the Company may pay dividends on its capital stock and
(iv) the Company may repurchase capital stock from a former employee in connection with the
termination or other departure of such employee, strictly in accordance with the terms of any
agreement entered into with such employee and in effect on the Closing Date (as defined in the
Purchase Agreement), provided that (A) such repurchase is approved by a majority of the Board,
(B) payments permitted under this clause (iv) shall not exceed $1,000,000 in the aggregate,
and (C) no such payment may be made if an Event of Default or an event which, with the giving
of notice, the lapse of time or both would constitute an Event of Default has occurred and is
continuing or would result from such payment.

               (v) The Company shall not and shall cause each Subsidiary not to, directly or indirectly,
engage in any business other than the business of developing, marketing, selling and licensing
of network and application performance management solutions.

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

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

               (viii) The Company shall not and shall cause each Subsidiary not to settle, or agree to
indemnify or defend third parties against, any material lawsuit, except as may be required by
judicial or regulatory order or by agreements entered into prior to the date hereof on a basis
consistent with past practice. A material lawsuit shall be any lawsuit in which the amount in
controversy exceeds $250,000. The provisions of this Section 7(b)(viii) shall not apply to
commercial indemnities entered into by the Company or any Subsidiary in the ordinary course of
business consistent with past practices.

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

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

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

          (b) the failure of the Company to make any payment of interest on this Note, or any other
amounts due under the other Transaction Documents (as defined under the Purchase Agreement) when
due, whether at maturity, upon acceleration or otherwise, and such failure continues for more than
five (5) days;

          (c) the Company and/or its Subsidiaries fail to make a required payment or payments on
Indebtedness of One Hundred Thousand United States Dollars ($100,000) or more in aggregate
principal amount and such failure continues for more than ten (10) days;

          (d) there shall have occurred an acceleration of the stated maturity of any Indebtedness of
the Company or its Subsidiaries of One Hundred Thousand United States Dollars ($100,000) or more in
aggregate principal amount (which acceleration is not rescinded, annulled or otherwise cured within
ten (10) days of receipt by the Company or a Subsidiary of notice of such acceleration);

          (e) the Company makes an assignment for the benefit of creditors or admits in writing its
inability to pay its debts generally as they become due; or an order, judgment or decree is entered
adjudicating the Company as bankrupt or insolvent; or any order for relief with respect to the
Company is entered under the Federal Bankruptcy Code or any other bankruptcy or insolvency law; or
the Company petitions or applies to any tribunal for the appointment of a custodian, trustee,
receiver or liquidator of the Company or of any substantial part of the assets of the Company, or
commences any proceeding relating to it under any bankruptcy, reorganization, arrangement,
insolvency, readjustment of debt, dissolution or liquidation law of any jurisdiction; or any such
petition or application is filed, or any such proceeding is commenced, against the Company and
either (i) the Company by any act indicates its approval thereof, consents thereto or acquiescence
therein or (ii) such petition application or proceeding is not dismissed within sixty (60) days;

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

          (g) the Company is in breach of the requirements of Section 7(b) hereof;

-22-

 

          (h) if any representation or statement of fact made in any Transaction Document or furnished
to the Holder at any time by or on behalf of the Company proves to have been false in any material
respect when made or furnished;

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

          (j) if the Company fails to observe or perform in any material respect any of its covenants
contained in the Transaction Documents (other than any failure which is covered by Section 8(a),
(b) or (g)), and such failure continues for thirty (30) days after receipt by the Company of notice
thereof; or

          (k) the Company’s stockholders shall fail to approve the Proposal on or prior to December 6,
2005.

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

     9. No Waiver. No delay or omission on the part of the Holder in exercising any right
under this Note shall operate as a waiver of such right or of any other right of the Holder, nor
shall any delay, omission or waiver on any one occasion be deemed a bar to or waiver of the same or
any other right on any future occasion.

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

-23-

 

such waiver or consent on any one instance shall be construed to be a continuing waiver or a
waiver in any other instance unless it expressly so provides.

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

     12. Waiver of Jury Trial. THE COMPANY HEREBY WAIVES ITS RIGHT TO A JURY TRIAL OF ANY
CLAIM OR CAUSE OF ACTION ARISING OUT OF OR BASED UPON THIS NOTE OR ANY CONTEMPLATED TRANSACTION,
INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. THE COMPANY HAS REVIEWED THIS
WAIVER WITH ITS COUNSEL.

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

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

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

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

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

[Remainder of Page Intentionally Left Blank]

-24-

 

     IN WITNESS WHEREOF, Company has caused this 5% Senior Secured Convertible Note to be signed in
its name effective as of the date first above written.

	 	 	 	 	 
	 	VISUAL NETWORKS, INC.

 	 
	 	By:  	 	 
	 	 	Name:  	 	 
	 	 	Title:  	 	 
	 

-25-

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