Document:

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                                                                   EXHIBIT 10.10

                              EMPLOYMENT AGREEMENT

         THIS AGREEMENT is made as of the 25th day of January, 2000, among
STERLING FINANCIAL CORPORATION ("Corporation"), a Pennsylvania business
corporation having a place of business at 101 North Pointe Boulevard, Lancaster,
Pennsylvania 17601, BANK OF HANOVER AND TRUST COMPANY ("Bank") a state chartered
bank having a place of business at 25 Carlisle Street, Hanover, Pennsylvania
17331, and J. BRADLEY SCOVILL ("Executive"), an individual residing at 990
McCosh Street, Hanover, Pennsylvania 17331.

                                   WITNESSETH:

         WHEREAS, the Corporation is a registered bank holding company;

         WHEREAS, the Bank is a subsidiary of the Corporation;

         WHEREAS, Corporation and Bank desire to employ Executive to serve in
the capacity of Executive Vice President of Corporation and President and Chief
Executive Officer of Bank under the terms and conditions set forth herein;

         WHEREAS, Executive desires to accept employment with Corporation and
Bank on the terms and conditions set forth herein.

                                   AGREEMENT:

         NOW, THEREFORE, the parties hereto, intending to be legally bound,
agree as follows:

1.       EMPLOYMENT. Corporation and Bank hereby employ Executive and Executive
         hereby accepts employment with Corporation and Bank, under the terms
         and conditions set forth in this Agreement. As consideration for this
         Agreement, Executive hereby agrees to release Corporation, Hanover
         Bancorp Inc. and Bank of any obligations, duties or responsibilities,
         and Executive agrees to relinquish any and all rights, including but
         not limited to any payments, compensation or sums of money he may
         otherwise be entitled, or he may have, under the Severance Agreement
         dated March 22, 1995 between Executive, Hanover Bancorp Inc. and Bank.

2.       DUTIES OF EMPLOYEE. Executive shall perform and discharge well and
         faithfully such duties as an executive officer of Corporation and Bank
         as may be assigned to Executive from time to time by the Board of
         Directors of Corporation and Bank and the Chairman and President of the
         Corporation so long as the assignment is consistent with the
         Executive's office and duties. Executive shall be employed as Executive
         Vice President of Corporation and President and Chief Executive Officer
         of Bank, and shall hold such other titles as may be given to him from
         time to time by the Board of Directors of Corporation and Bank.
         Executive shall devote his full time, attention and energies to the
         business of Corporation and Bank during the Employment Period (as
         defined in Section 3 of this Agreement); provided, however, that this
         Section 2 shall not be construed as preventing Executive from
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         (a) engaging in activities incident or necessary to personal
         investments so long as such investment does not exceed 5% of the
         outstanding shares of any publicly held company, (b) acting as a member
         of the Board of Directors of any other corporation or as a member of
         the Board of Trustees of any other organization, with the prior
         approval of the Board of Directors of Corporation and Bank, or (c)
         being involved in any other activity with the prior approval of the
         Board of Directors of Corporation and Bank. The Executive shall not
         engage in any business or commercial activities, duties or pursuits
         which compete with the business or commercial activities of Corporation
         or Bank, nor may the Executive serve as a director or officer or in any
         other capacity in a company which competes with Corporation or Bank.

3.       TERM OF AGREEMENT.

         (a)      This Agreement shall be for a three (3) year period (the
                  "Employment Period") beginning on the Effective Date as set
                  forth in Section 1.1(c) of the Agreement and Plan of Merger
                  between Corporation and Hanover Bancorp, Inc. (the "Effective
                  Date") (the "Agreement and Plan of Merger"), and if not
                  previously terminated pursuant to the terms of this Agreement,
                  the Employment Period shall end three (3) years later;
                  provided however, that this Agreement will be automatically
                  renewed on the first anniversary date of the Effective Date
                  (the "Renewal Date") for the three-year period commencing on
                  such date and ending three years later, unless either party
                  gives written notice of nonrenewal to the other party at least
                  sixty (60) days prior to the Renewal Date (in which case this
                  Agreement will continue in effect for a term ending two years
                  from the Renewal Date). If this Agreement is renewed on the
                  Renewal Date, it will be automatically renewed on the first
                  anniversary date of the Renewal Date and each subsequent year
                  (the "Annual Renewal Date") for a period ending three years
                  from each Annual Renewal Date, unless either party gives
                  written notice of non renewal to the other party at least
                  sixty (60) days prior to an Annual Renewal (in which case this
                  Agreement will continue in effect for a term ending two years
                  from the Annual Renewal Date immediately following such
                  notice). If the Agreement and Plan of Merger is terminated
                  pursuant to its terms, the parties hereto shall have no
                  further obligations under this Agreement and this Agreement
                  shall be null and void.

         (b)      Notwithstanding the provisions of Section 3(a) of this
                  Agreement, this Agreement shall terminate automatically for
                  Cause (as defined herein) upon written notice from the Board
                  of Directors of each of Corporation and Bank to Executive. As
                  used in this Agreement, "Cause" shall mean any of the
                  following:

                  (i)      Executive's conviction of or plea of guilty or nolo
                           contendere to a felony, a crime of falsehood or a
                           crime involving moral turpitude, or the actual
                           incarceration of Executive for a period of forty five
                           (45) consecutive days or more;

                  (ii)     Executive's failure to follow the good faith lawful
                           instructions of the Board of Directors of Corporation
                           or Bank with respect to its operations, after

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                           written notice from Corporation or Bank and a failure
                           to cure such violation within thirty (30) days of
                           said written notice;

                  (iii)    Executive's willful failure to substantially perform
                           Executive's duties to Corporation or Bank, other than
                           a failure resulting from Executive's incapacity
                           because of physical or mental illness, as provided in
                           subsection (d) of this Section 3, after written
                           notice from Corporation or Bank and a failure to cure
                           such violation within thirty (30) days of said
                           written notice;

                  (iv)     Executive's intentional violation of the provisions
                           of this Agreement, after written notice from
                           Corporation or Bank and a failure to cure such
                           violation within thirty (30) days of said written
                           notice;

                  (v)      dishonesty of the Executive in the performance of his
                           duties;

                  (vi)     Executive's removal or prohibition from being an
                           institutional-affiliated party by a final order of an
                           appropriate federal banking agency pursuant to
                           Section 8(e) of the Federal Deposit Insurance Act or
                           by the Office of the Comptroller of the Currency
                           pursuant to national law;

                  (vii)    conduct on the part of the Executive as determined by
                           an affirmative vote of seventy percent (70%) of the
                           disinterested members of the Board of Directors of
                           Corporation and Bank which brings public discredit to
                           Corporation or Bank; or

                  (viii)   Executive's breach of fiduciary duty involving
                           personal profit.

                  If this Agreement is terminated for Cause, all of Executive's
                  rights under this Agreement shall cease as of the effective
                  date of such termination.

         (c)      Notwithstanding the provisions of Section 3(a) of this
                  Agreement, this Agreement shall terminate automatically upon
                  Executive's voluntary termination of employment (other than in
                  accordance with Section 5 of this Agreement) for Good Reason.
                  The term "Good Reason" shall mean (i) the assignment of duties
                  and responsibilities inconsistent with Executive's status as
                  Executive Vice President of Corporation and President and
                  Chief Executive Officer of Bank, (ii) a reassignment which
                  requires Executive to move his principal residence more than
                  fifty (50) miles from the Corporation's and Bank's principal
                  executive office immediately prior to this Agreement, (iii)
                  any removal of the Executive from office or any adverse change
                  in the terms and conditions of the Executive's employment,
                  except for any termination of the Executive's employment under
                  the provisions of Section 3(b) hereof, (iv) any reduction in
                  the Executive's Annual Base Salary as in effect on the date
                  hereof or as the same may be increased from time to time,
                  except such reductions that are the result of a national
                  financial depression, or national or bank emergency, or (v)
                  any failure of Corporation and Bank to provide the Executive
                  with benefits at least as

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                  favorable as those enjoyed by the Executive during the
                  Employment Period under any of the pension, life insurance,
                  medical, health and accident, disability or other employee
                  plans of Corporation and Bank, or the taking of any action
                  that would materially reduce any of such benefits unless such
                  reduction is part of a reduction applicable to all employees.
                  If such termination occurs for Good Reason, then Corporation
                  or Bank shall pay Executive an amount equal to the remaining
                  balance of the Agreed Compensation otherwise due to the
                  Executive for the remainder of the then existing Employment
                  Period, which amount shall be payable in equal monthly
                  installments and shall be subject to federal, state and local
                  tax withholdings. In addition, for the remainder of the then
                  existing Employment Period, or until Executive secures
                  substantially similar benefits through other employment,
                  whichever shall first occur, Executive shall receive a
                  continuation of all life, disability, medical insurance and
                  other normal health and welfare benefits in effect with
                  respect to Executive during the two (2) years prior to his
                  termination of employment, or, if Corporation and Bank cannot
                  provide such benefits because Executive is no longer an
                  employee, a dollar amount equal to the cost to Executive of
                  obtaining such benefits (or substantially similar benefits).
                  If permitted under the terms of the plan, Executive shall
                  receive the additional retirement benefits to which he would
                  have been entitled had his employment continued through the
                  remaining term of the Agreement. In lieu of continued pension,
                  welfare and other benefits, Executive may elect to receive a
                  lump sum cash payment equal to 25% of the payments to be
                  received for termination of the Agreement under this
                  provision. However, in the event the payment described herein,
                  when added to all other amounts or benefits provided to or on
                  behalf of the Executive in connection with his termination of
                  employment, would result in the imposition of an excise tax
                  under Code Section 4999, such payments shall be retroactively
                  (if necessary) reduced to the extent necessary to avoid such
                  excise tax imposition. Upon written notice to Executive,
                  together with calculations of Corporation's independent
                  auditors, Executive shall remit to Corporation the amount of
                  the reduction plus such interest as may be necessary to avoid
                  the imposition of such excise tax. Notwithstanding the
                  foregoing or any other provision of this contract to the
                  contrary, if any portion of the amount herein payable to the
                  Executive is determined to be non-deductible pursuant to the
                  regulations promulgated under Section 280G of the Internal
                  Revenue Code of 1986, as amended (the "Code"), the Corporation
                  shall be required only to pay to Executive the amount
                  determined to be deductible under Section 280G.

                  At the option of the Executive, exercisable by the Executive
                  within ninety (90) days after the occurrence of the event
                  constituting "Good Reason," the Executive may resign from
                  employment under this Agreement by a notice in writing (the
                  "Notice of Termination") delivered to Corporation and Bank and
                  the provisions of this Section 3(c) hereof shall thereupon
                  apply.

         (d)      Notwithstanding the provisions of Section 3(a) of this
                  Agreement, this Agreement shall terminate automatically upon
                  Executive's Disability and Executive's rights under this
                  Agreement shall cease as of the date of such termination;
                  provided,

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                  however, that Executive shall nevertheless be entitled to
                  receive any benefits that may be available under any
                  disability plan of Corporation and Bank, until the earliest of
                  (i) Executive's return to employment, (ii) his attainment of
                  age 65, or (iii) his death. In addition, Executive shall
                  receive for such period a continuation of all life,
                  disability, medical insurance and other normal health and
                  welfare benefits in effect with respect to Executive during
                  the two (2) years prior to his disability, or, if Corporation
                  and Bank cannot provide such benefits because Executive is no
                  longer an employee, a dollar amount equal to the cost to
                  Executive of obtaining such benefits (or substantially similar
                  benefits). For purposes of this Agreement, the Executive shall
                  have a Disability if, as a result of physical or mental injury
                  or impairment, Executive is unable to perform all of the
                  essential job functions of his position on a full time basis
                  with or without a reasonable accommodation and without posting
                  a direct threat to himself and others, for a period of one
                  hundred eighty (180) days. The Executive shall have no duty to
                  mitigate any payment provided for in this Section 3(d) by
                  seeking other employment.

         (e)      Executive agrees that in the event his employment under this
                  Agreement is terminated, Executive shall resign as a director
                  of Corporation and Bank, or any affiliate or subsidiary
                  thereof, if he is then serving as a director of any of such
                  entities.

         (f)      The term "Agreed Compensation" shall equal the sum of (A) the
                  Executive's highest Annual Base Salary under the Agreement,
                  and (B) the average of the Executive's annual bonuses with
                  respect to the three (3) calendar years immediately preceding
                  the Executive's termination.

         (g)      In the event that this Agreement expires by its terms in
                  accordance with the provisions of Section 3(a) and other than
                  for Cause, the Bank will pay Executive within thirty (30) days
                  following termination of the Agreement and upon the receipt of
                  a mutually agreed release an amount equal to 2.0 times the
                  Executive's Agreed Compensation.

4.       EMPLOYMENT PERIOD COMPENSATION.

         (a)      Annual Base Salary. For services performed by Executive under
                  this Agreement, Corporation or Bank shall pay Executive an
                  Annual Base Salary during the Employment Period at the rate of
                  $217,500 per year (subject to applicable withholdings and
                  deductions) payable at the same times as salaries are payable
                  to other executive employees of Corporation or Bank.
                  Corporation or Bank may, from time to time, increase
                  Executive's Annual Base Salary, and any and all such increases
                  shall be deemed to constitute amendments to this Section 4(a)
                  to reflect the increased amounts, effective as of the date
                  established for such increases by the Board of Directors of
                  Corporation or Bank or any committee of such Board in the
                  resolutions authorizing such increases.

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         (b)      Bonus. For services performed by Executive under this
                  Agreement, Corporation or Bank may, from time to time, pay a
                  bonus or bonuses to Executive as Corporation or Bank, in its
                  sole discretion, deems appropriate. The payment of any such
                  bonuses shall not reduce or otherwise affect any other
                  obligation of Corporation or Bank to Executive provided for in
                  this Agreement. Executive is entitled to participate in the
                  bonus programs available to senior executives.

         (c)      Paid Time Off and/or Vacations. During the term of this
                  Agreement, Executive shall be entitled to paid time off and/or
                  vacation in accordance with the policies as established from
                  time to time by the Boards of Directors of Corporation and
                  Bank for the Corporation's and Bank's senior management.
                  However, Executive shall not be entitled to receive any
                  additional compensation from Corporation and Bank for failure
                  to take paid time off and/or vacation, nor shall Executive be
                  able to accumulate unused paid time off and/or vacation time
                  from one year to the next, except to the extent authorized by
                  the Boards of Directors of Corporation and Bank.

         (d)      Automobile. During the term of this Agreement, Corporation and
                  Bank shall provide Executive with exclusive use of an
                  automobile mutually agreed upon by Corporation and Bank and
                  reasonably consistent with Executive's position. Corporation
                  and Bank shall be responsible and shall pay for all costs of
                  insurance coverage, repairs, maintenance and other operating
                  and incidental expenses, including license, fuel and oil.
                  Corporation and Bank shall provide Executive with a
                  replacement automobile at approximately the time Executive's
                  automobile reaches three (3) years of age or 50,000 miles,
                  whichever is first, and approximately every three (3) years or
                  50,000 miles thereafter, upon the same terms and conditions.

         (e)      Employee Benefit Plans. During the term of this Agreement,
                  Executive shall be entitled to participate in or receive the
                  benefits of any employee benefit plan currently in effect at
                  Corporation and Bank, subject to the terms of said plan, until
                  such time that the Boards of Directors of Corporation and Bank
                  authorize a change in such benefits. Corporation and Bank
                  shall not make any changes in such plans or benefits which
                  would adversely affect Executive's rights or benefits
                  thereunder, unless such change occurs pursuant to a program
                  applicable to all executive officers of Corporation and Bank
                  and does not result in a proportionately greater adverse
                  change in the rights of or benefits to Executive as compared
                  with any other executive officer of Corporation and Bank.
                  Nothing paid to Executive under any plan or arrangement
                  presently in effect or made available in the future shall be
                  deemed to be in lieu of the salary payable to Executive
                  pursuant to Section 4(a) hereof.

         (f)      Business Expenses. During the term of this Agreement,
                  Executive shall be entitled to receive prompt reimbursement
                  for all reasonable expenses incurred by him, which are
                  properly accounted for, in accordance with the policies and
                  procedures established by the Boards of Directors of
                  Corporation and Bank for their executive officers. Corporation
                  and Bank shall reimburse Executive for any and all dues and
                  reasonable related business expenses associated with the
                  Executive's membership in

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                  a country club, social club or service organization, including
                  but not limited to, The Hanover Country Club.

         (g)      Stock Options. Executive shall be entitled to participate in
                  the Corporation's stock option plans consistent with his
                  position as a member of Corporation's and Bank's senior
                  management. Upon a Change in Control (as defined in Section
                  5(b) of this Agreement), all options theretofore granted to
                  the Executive by the Corporation and not previously
                  exercisable shall become fully exercisable to the same extent
                  and in the same manner as if they had become exercisable by
                  passage of time or by virtue of the Corporation achieving
                  certain performance objectives in accordance with the relevant
                  provisions of any plan and any agreement.

5.       TERMINATION OF EMPLOYMENT FOLLOWING CHANGE IN CONTROL.

         (a)      If a Change in Control (as defined in Section 5(b) of this
                  Agreement) shall occur, then, at the option of Executive,
                  exercisable by Executive within three hundred sixty five (365)
                  days of the Change in Control, Executive may resign from
                  employment with Corporation and Bank (or, if involuntarily
                  terminated, give notice of intention to collect benefits under
                  this Agreement) by delivering a notice in writing (the "Notice
                  of Termination") to Corporation and Bank and the provisions of
                  Section 6 of this Agreement shall apply.

         (b)      As used in this Agreement, "Change in Control" shall mean the
                  occurrence of any of the following:

                  (i)      (A) a merger, consolidation or division involving
                           Corporation or Bank, (B) a sale, exchange, transfer
                           or other disposition of substantially all of the
                           assets of Corporation or Bank, or (C) a purchase by
                           Corporation or Bank of substantially all of the
                           assets of another entity, unless (y) such merger,
                           consolidation, division, sale, exchange, transfer,
                           purchase or disposition is approved in advance by
                           seventy percent (70%) or more of the members of the
                           Board of Directors of Corporation or Bank (of the
                           entity affected by the transaction) who are not
                           interested in the transaction and (z) a majority of
                           the members of the Board of Directors of the legal
                           entity resulting from or existing after any such
                           transaction and of the Board of Directors of such
                           entity's parent corporation, if any, are former
                           members of the Board of Directors of Corporation or
                           Bank (of the entity affected by the transaction);
                           provided, however, that the provisions of (y) and (z)
                           above shall not apply to the merger of Bank within
                           three (3) years of the Effective Date in which the
                           Bank is the not surviving entity; or

                  (ii)     any "person" (as such term is used in Sections 13(d)
                           and 14(d) of the Securities Exchange Act of 1934 (the
                           "Exchange Act")), other than Corporation or Bank or
                           any "person" who on the date hereof is a director or
                           officer of Corporation or Bank is or becomes the
                           "beneficial owner" (as

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                           defined in Rule 13d-3 under the Exchange Act),
                           directly or indirectly, of securities of Corporation
                           or Bank representing twenty-five (25%) percent or
                           more of the combined voting power of Corporation or
                           Bank's then outstanding securities, or

                  (iii)    during any period of two (2) consecutive years during
                           the term of Executive's employment under this
                           Agreement, individuals who at the beginning of such
                           period constitute the Board of Directors of
                           Corporation or Bank cease for any reason to
                           constitute at least a majority thereof, unless the
                           election of each director who was not a director at
                           the beginning of such period has been approved in
                           advance by directors representing at least two-thirds
                           of the directors then in office who were directors at
                           the beginning of the period; or

                  (iv)     any other change in control of Corporation and Bank
                           similar in effect to any of the foregoing.

6.       RIGHTS IN EVENT OF TERMINATION OF EMPLOYMENT FOLLOWING CHANGE IN
         CONTROL.

         (a)      In the event that Executive delivers a Notice of Termination
                  (as defined in Section 5(a) of this Agreement) to Corporation
                  and Bank, Executive shall be entitled to receive the
                  compensation and benefits set forth below:

                  If, at the time of termination of Executive's employment, a
                  "Change in Control" (as defined in Section 5(b) of this
                  Agreement) has also occurred, Corporation and Bank shall pay
                  Executive a lump sum amount equal to and no greater than 2.99
                  times the Executive's Agreed Compensation as defined in
                  subsection (f) of Section 3, (the payment of which shall be
                  subject to applicable taxes and withholdings). In addition,
                  for a period of three (3) years from the date of termination
                  of employment, or until Executive secures substantially
                  similar benefits through other employment, whichever shall
                  first occur, Executive shall receive a continuation of all
                  life, disability, medical insurance and other normal health
                  and welfare benefits in effect with respect to Executive
                  during the two (2) years prior to his termination of
                  employment, or, if Corporation and Bank cannot provide such
                  benefits because Executive is no longer an employee, a dollar
                  amount equal to the cost to Executive of obtaining such
                  benefits (or substantially similar benefits). If permitted
                  under the terms of the plan, Executive shall receive
                  additional retirement benefits to which he would have been
                  entitled had his employment continued through the then
                  remaining term of the Agreement. In lieu of continued pension,
                  welfare and other benefits, Executive may elect to receive a
                  lump sum cash payment equal to 25% of the payments to be
                  received for termination of the Agreement under this
                  provision. However, in the event the payment described herein,
                  when added to all other amounts or benefits provided to or on
                  behalf of the Executive in connection with his termination of
                  employment, would result in the imposition of an excise tax
                  under Code Section 4999, such payments shall be retroactively
                  (if necessary) reduced to the extent necessary to avoid such
                  excise tax imposition. Upon written notice to

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                  Executive, together with calculations of Corporation's
                  independent auditors, Executive shall remit to Corporation the
                  amount of the reduction plus such interest as may be necessary
                  to avoid the imposition of such excise tax. Notwithstanding
                  the foregoing or any other provision of this contract to the
                  contrary, if any portion of the amount herein payable to the
                  Executive is determined to be non-deductible pursuant to the
                  regulations promulgated under Section 280G of the Code, the
                  Corporation shall be required only to pay to Executive the
                  amount determined to be deductible under Section 280G.

         (b)      Executive shall not be required to mitigate the amount of any
                  payment provided for in this Section 6 by seeking other
                  employment or otherwise. Unless otherwise agreed to in
                  writing, the amount of payment or the benefit provided for in
                  this Section 6 shall not be reduced by any compensation earned
                  by Executive as the result of employment by another employer
                  or by reason of Executive's receipt of or right to receive any
                  retirement or other benefits after the date of termination of
                  employment or otherwise.

7.       RIGHTS IN EVENT OF TERMINATION OF EMPLOYMENT ABSENT CHANGE IN CONTROL.

         (a)      In the event that Executive's employment is involuntarily
                  terminated by Corporation and/or Bank without Cause and no
                  Change in Control shall have occurred at the date of such
                  termination, Corporation and Bank shall pay Executive an
                  amount equal to 2.0 times the Executive's Agreed Compensation
                  or the remaining balance of the Agreed Compensation otherwise
                  due to the Executive for the remainder of the then existing
                  Employment Period, whichever is greater, and shall be payable
                  in equal monthly installments and shall be subject to federal,
                  state and local tax withholdings. In addition, for the
                  remainder of the then existing Employment Period or until
                  Executive secures substantially similar benefits through other
                  employment, whichever shall first occur, Executive shall
                  receive a continuation of all life, disability, medical
                  insurance and other normal health and welfare benefits in
                  effect with respect to Executive during the two (2) years
                  prior to his termination of employment, or, if Corporation and
                  Bank cannot provide such benefits because Executive is no
                  longer an employee, a dollar amount equal to the cost to
                  Executive of obtaining such benefits (or substantially similar
                  benefits). In addition, if permitted pursuant to the terms of
                  the plan, Executive shall receive additional retirement
                  benefits to which he would have been entitled had his
                  employment continued through the then remaining term of the
                  Agreement. In lieu of continued pension, welfare and other
                  benefits, Executive may elect to receive a lump sum cash
                  payment equal to 25% of the payments to be received for
                  termination of the Agreement under this provision. However, in
                  the event the payment described herein, when added to all
                  other amounts or benefits provided to or on behalf of the
                  Executive in connection with his termination of employment,
                  would result in the imposition of an excise tax under Code
                  Section 4999, such payments shall be retroactively (if
                  necessary) reduced to the extent necessary to avoid such
                  excise tax imposition. Upon written notice to Executive,
                  together with calculations of Corporation's independent
                  auditors,

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                  Executive shall remit to Corporation the amount of the
                  reduction plus such interest as may be necessary to avoid the
                  imposition of such excise tax. Notwithstanding the foregoing
                  or any other provision of this contract to the contrary, if
                  any portion of the amount herein payable to the Executive is
                  determined to be non-deductible pursuant to the regulations
                  promulgated under Section 280G of the Code, the Corporation
                  shall be required only to pay to Executive the amount
                  determined to be deductible under Section 280G.

         (b)      Executive shall not be required to mitigate the amount of any
                  payment provided for in this Section 7 by seeking other
                  employment or otherwise. Unless otherwise agreed to in
                  writing, the amount of payment or the benefit provided for in
                  this Section 7 shall not be reduced by any compensation earned
                  by Executive as the result of employment by another employer
                  or by reason of Executive's receipt of or right to receive any
                  retirement or other benefits after the date of termination of
                  employment or otherwise.

8.       COVENANT NOT TO COMPETE.

         (a)      Executive hereby acknowledges and recognizes the highly
                  competitive nature of the business of Corporation and Bank and
                  accordingly agrees that, during and for the applicable period
                  set forth in Section 8(c) hereof, Executive shall not, except
                  as otherwise permitted in writing by the Corporation and the
                  Bank:

                  (i)      be engaged, directly or indirectly, either for his
                           own account or as agent, consultant, employee,
                           partner, officer, director, proprietor, investor
                           (except as an investor owning less than 5% of the
                           stock of a publicly owned company) or otherwise of
                           any person, firm, corporation or enterprise engaged
                           in (1) the banking (including bank holding company)
                           or financial services industry, or (2) any other
                           activity in which Corporation or Bank or any of their
                           subsidiaries are engaged during the Employment
                           Period, and remain so engaged at the end of the
                           Employment Period, in any area in which, at any time
                           during the Employment Period or at the date of
                           termination of the Executive's employment, is within
                           thirty (30) miles of any branch location, office or
                           other facility of Corporation or Bank or any of their
                           subsidiaries, unless Executive exclusively performs
                           all such activity outside of said thirty (30) mile
                           area (the "Non-Competition Area"); or

                  (ii)     provide financial or other assistance to any person,
                           firm, corporation, or enterprise engaged in (1) the
                           banking (including bank holding company) or financial
                           services industry, or (2) any other activity in which
                           Corporation or Bank or any of their subsidiaries are
                           engaged during the Employment Period, in the
                           Non-Competition Area; or

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                  (iii)    if employed in a capacity provided in (i) and (ii),
                           solicit current customers, during the term of this
                           Agreement, of Corporation, Bank or any Corporation
                           subsidiary in the Non-Competition Area; or

                  (iv)     solicit employees of Corporation, Bank or any
                           Corporation subsidiary who are employed during the
                           term of this Agreement.

         (b)      It is expressly understood and agreed that, although Executive
                  and Corporation and Bank consider the restrictions contained
                  in Section 8(a) hereof reasonable for the purpose of
                  preserving for Corporation and Bank and their subsidiaries
                  their good will and other proprietary rights, if a final
                  judicial determination is made by a court having jurisdiction
                  that the time or territory or any other restriction contained
                  in Section 8(a) hereof is an unreasonable or otherwise
                  unenforceable restriction against Executive, the provisions of
                  Section 8(a) hereof shall not be rendered void but shall be
                  deemed amended to apply as to such maximum time and territory
                  and to such other extent as such court may judicially
                  determine or indicate to be reasonable.

         (c)      The provisions of this Section 8 shall be applicable
                  commencing on the date of this Agreement and ending on one of
                  the following dates, as applicable:

                  (i)      if Executive's employment terminates in accordance
                           with the provisions of Section 3(c), the end of the
                           then existing Employment Period; or

                  (ii)     if Executive's employment terminates in accordance
                           with the provisions of Section 3(b) of this Agreement
                           (relating to termination for Cause), the second
                           anniversary date of the effective date of termination
                           of employment; or

                  (iii)    if the Executive voluntarily terminates his
                           employment in accordance with the provisions of
                           Section 5 hereof, the third anniversary date of the
                           effective date of termination of employment; or

                  (iv)     if the Executive's employment is involuntarily
                           terminated in accordance with the provisions of
                           Section 7 hereof, the second anniversary date of the
                           effective date of termination of employment;

                  (v)      if the Agreement expires by its terms in accordance
                           with the provisions of Section 3(a) and other than
                           for Cause, the second anniversary date of the
                           effective date of termination of employment.

9.       UNAUTHORIZED DISCLOSURE. During the term of his employment hereunder,
         or at any later time, the Executive shall not, without the written
         consent of the Boards of Directors of Corporation and Bank or a person
         authorized thereby, knowingly disclose to any person, other than an
         employee of Corporation or Bank or a person to whom disclosure is
         reasonably necessary or appropriate in connection with the performance
         by the Executive of his duties as an executive of Corporation and Bank,
         any material confidential information

                                       11
<PAGE>   12
         obtained by him while in the employ of Corporation and Bank with
         respect to any of Corporation and Bank's services, products,
         improvements, formulas, designs or styles, processes, customers,
         methods of business or any business practices the disclosure of which
         could be or will be damaging to Corporation or Bank; provided, however,
         that confidential information shall not include any information known
         generally to the public (other than as a result of unauthorized
         disclosure by the Executive or any person with the assistance, consent
         or direction of the Executive) or any information of a type not
         otherwise considered confidential by persons engaged in the same
         business of a business similar to that conducted by Corporation and
         Bank or any information that must be disclosed as required by law.

10.      LIABILITY INSURANCE. Corporation and Bank shall use their best efforts
         to obtain insurance coverage for the Executive under an insurance
         policy covering officers and directors of Corporation and Bank against
         lawsuits, arbitrations or other legal or regulatory proceedings;
         however, nothing herein shall be construed to require Corporation
         and/or Bank to obtain such insurance, if the Board of Directors of the
         Corporation and/or Bank determine that such coverage cannot be obtained
         at a reasonable price.

11.      NOTICES. Except as otherwise provided in this Agreement, any notice
         required or permitted to be given under this Agreement shall be deemed
         properly given if in writing and if mailed by registered or certified
         mail, postage prepaid with return receipt requested, to Executive's
         residence, in the case of notices to Executive, and to the principal
         executive offices of Corporation and Bank, in the case of notices to
         Corporation and Bank.

12.      WAIVER. No provision of this Agreement may be modified, waived or
         discharged unless such waiver, modification or discharge is agreed to
         in writing and signed by Executive and an executive officer
         specifically designated by the Boards of Directors of Corporation and
         Bank. No waiver by either party hereto at any time of any breach by the
         other party hereto of, or compliance with, any condition or provision
         of this Agreement to be performed by such other party shall be deemed a
         waiver of similar or dissimilar provisions or conditions at the same or
         at any prior or subsequent time.

13.      ASSIGNMENT. This Agreement shall not be assignable by any party, except
         by Corporation and Bank to any successor in interest to their
         respective businesses.

14.      ATTORNEY'S FEES AND COSTS. If any action at law or in equity is
         necessary to enforce or interpret the terms of this Agreement, the
         prevailing party shall be entitled to reasonable attorney's fees,
         costs, and necessary disbursements in addition to any other relief that
         may be proper.

15.      INDEMNIFICATION. The Corporation will indemnify the Executive, to the
         fullest extent permitted under Pennsylvania and federal law, with
         respect to any threatened, pending or completed legal or regulatory
         action, suit or proceeding brought against him by reason of the fact
         that he is or was a director, officer, employee or agent of the
         Corporation, or is or was serving at the request of the Corporation as
         a director, officer, employee or agent of another person or entity. To
         the fullest extent permitted by Pennsylvania and federal law, the

                                       12
<PAGE>   13
         Corporation will, in advance of final disposition, pay any and all
         expenses incurred by the Executive in connection with any threatened,
         pending or completed legal or regulatory action, suit or proceeding
         with respect to which he may be entitled to indemnification hereunder.

16.      ENTIRE AGREEMENT. This Agreement supersedes any and all agreements,
         either oral or in writing, between the parties with respect to the
         employment of the Executive by the Bank and/or Corporation and this
         Agreement contains all the covenants and agreements between the parties
         with respect to employment.

17.      SUCCESSORS; BINDING AGREEMENT.

         (a)      Corporation and Bank will require any successor (whether
                  direct or indirect, by purchase, merger, consolidation, or
                  otherwise) to all or substantially all of the businesses
                  and/or assets of Corporation and Bank to expressly assume and
                  agree to perform this Agreement in the same manner and to the
                  same extent that Corporation and Bank would be required to
                  perform it if no such succession had taken place. Failure by
                  Corporation and Bank to obtain such assumption and agreement
                  prior to the effectiveness of any such succession shall
                  constitute a breach of this Agreement and the provisions of
                  Section 3 of this Agreement shall apply. As used in this
                  Agreement, "Corporation" and "Bank" shall mean Sterling
                  Financial Corporation and Bank of Hanover and Trust Company,
                  as defined previously and any successor to their respective
                  businesses and/or assets as aforesaid which assumes and agrees
                  to perform this Agreement by operation of law or otherwise.

         (b)      This Agreement shall inure to the benefit of and be
                  enforceable by Executive's personal or legal representatives,
                  executors, administrators, heirs, distributees, devisees and
                  legatees. If Executive should die after a Notice of
                  Termination is delivered by Executive, or following
                  termination of Executive's employment without Cause, and any
                  amounts would be payable to Executive under this Agreement if
                  Executive had continued to live, all such amounts shall be
                  paid in accordance with the terms of this Agreement to
                  Executive's devisee, legatee, or other designee, or, if there
                  is no such designee, to Executive's estate.

18.      ARBITRATION. Corporation, Bank and Executive recognize that in the
         event a dispute should arise between them concerning the interpretation
         or implementation of this Agreement, lengthy and expensive litigation
         will not afford a practical resolution of the issues within a
         reasonable period of time. Consequently, each party agrees that all
         disputes, disagreements and questions of interpretation concerning this
         Agreement are to be submitted for resolution, in Philadelphia,
         Pennsylvania, to the American Arbitration Association (the
         "Association") in accordance with the Association's National Rules for
         the Resolution of Employment Disputes or other applicable rules then in
         effect ("Rules"). Corporation, Bank or Executive may initiate an
         arbitration proceeding at any time by giving notice to the other in
         accordance with the Rules. Corporation and Bank and Executive may, as a
         matter of right, mutually agree on the appointment of a particular
         arbitrator from the Association's pool. The

                                       13
<PAGE>   14
         arbitrator shall not be bound by the rules of evidence and procedure of
         the courts of the Commonwealth of Pennsylvania but shall be bound by
         the substantive law applicable to this Agreement. The decision of the
         arbitrator, absent fraud, duress, incompetence or gross and obvious
         error of fact, shall be final and binding upon the parties and shall be
         enforceable in courts of proper jurisdiction. Following written notice
         of a request for arbitration, Corporation, Bank and Executive shall be
         entitled to an injunction restraining all further proceedings in any
         pending or subsequently filed litigation concerning this Agreement,
         except as otherwise provided herein.

19.      NO MITIGATION OR OFFSET. The Executive will not be required to mitigate
         the amount of any payment provided for in this Agreement by seeking
         employment or otherwise; nor will any amounts or benefits payable or
         provided hereunder be reduced in the event he does not secure
         employment, except as otherwise provided herein.

20.      VALIDITY. The invalidity or unenforceability of any provision of this
         Agreement shall not affect the validity or enforceability of any other
         provision of this Agreement, which shall remain in full force and
         effect.

21.      APPLICABLE LAW. This Agreement shall be governed by and construed in
         accordance with the domestic, internal laws of the Commonwealth of
         Pennsylvania, without regard to its conflicts of laws principles.

22.      HEADINGS. The section headings of this Agreement are for convenience
         only and shall not control or affect the meaning or construction or
         limit the scope or intent of any of the provisions of this Agreement.

         IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first above written.

ATTEST:                                      STERLING FINANCIAL CORPORATION

 /s/ Ronald L. Bowman                        By /s/ John E. Stefan
 ---------------------                          ---------------------------

                                             BANK OF HANOVER AND TRUST COMPANY

/s/ Thomas J. Paholsky                       By /s/ Terrence L. Hormel
 ---------------------                          ---------------------------

WITNESS:

/s/ Paul G. Mattaini                            /s/ J. Bradley Scovill
 ---------------------                          ---------------------------
                                                       "Executive"

                                       14EXHIBIT 4.5(a)
                                                             PREFERRED STOCK S-3

                   CERTIFICATE OF DESIGNATION OF VOTING POWER,
                            PREFERENCES AND RELATIVE,
                           PARTICIPATING, OPTIONAL AND
                              OTHER SPECIAL RIGHTS
                AND QUALIFICATIONS, LIMITATIONS AND RESTRICTIONS

                                       OF

                     2% SERIES A CONVERTIBLE PREFERRED STOCK

                                       OF

                                APA OPTICS, INC.

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

                       Pursuant to Section 302A.401 of the
                       Minnesota Business Corporation Act

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

         APA Optics, Inc., a Minnesota corporation (the "Company"), certifies
that pursuant to the authority contained in Article 3.03 of its Articles of
Incorporation, as amended (the "Articles of Incorporation"), and in accordance
with the provisions of Sections 302A.401 and 302A.239 of the Minnesota Business
Corporation Act, the Board of Directors of the Company (the "Board of
Directors"), pursuant to minutes of action effective March 13, 2000, duly
approved and adopted the following resolution which resolution remains in full
force and effect on the date hereof:

         RESOLVED, that pursuant to the authority vested in the Board of
Directors by the Articles of Incorporation, the Board of Directors does hereby
designate, create, authorize and provide for the issue of preferred stock having
a par value of $.01 per share, which shall be designated as 2% Series A
Convertible Preferred Stock (the "Preferred Stock") consisting of 500 shares,
including 1,000 shares reserved for possible future issuance from time to time
and shall have the voting powers, preferences and relative participating,
optional and other special rights, and qualifications, limitations, and
restrictions thereon as follows:

<PAGE>

                            TERMS OF PREFERRED STOCK

            Section 1. Designation, Amount and Par Value. The series of
preferred stock shall be designated as its 2% Series A Convertible Preferred
Stock (the "Preferred Stock") and the number of shares so designated shall be
500 (which shall not be subject to increase without the consent of the holders
of the Preferred Stock (each, a "Holder" and collectively, the "Holders")). Each
share of Preferred Stock shall have a par value of $.01 and a stated value equal
to the sum of $10,000 plus all unpaid and accrued dividends to the date of
determination to the extent not previously paid in cash in accordance with the
terms hereof (the "Stated Value").

            Section 2. Dividends.

            (a) Holders shall be entitled to receive, out of funds legally
available therefor, and the Company shall pay, cumulative dividends at the rate
per share (as a percentage of the Stated Value per share) of 2% per annum,
payable on each Conversion Date (as defined in Section 5(a)) for such share, in
cash or by accretion of the Stated Value. Subject to the terms and conditions
herein, the decision whether to accrete dividends hereunder to the Stated Value
or to pay for dividends in cash shall be at the discretion of the Company. The
Company shall provide the Holders written notice of its intention to accrete
dividends hereunder to the Stated Value or pay dividends in cash not less than
ten days prior to each Conversion Date for so long as shares of Preferred Stock
are outstanding (the Company may indicate in such notice that the election
contained in such notice shall continue for later periods until revised).
Failure to timely provide such written notice shall be deemed (if permitted
hereunder) an election by the Company to accrete dividends hereunder to the
Stated Value. Dividends on the Preferred Stock shall be calculated on the basis
of a 360-day year, shall accrue daily commencing on the Original Issue Date (as
defined in Section 8), and shall be deemed to accrue from such date whether or
not earned or declared and whether or not there are profits, surplus or other
funds of the Company legally available for the payment of dividends. Except as
otherwise provided herein, if at any time the Company pays less than the total
amount of dividends then accrued on account of the Preferred Stock, such payment
shall be distributed ratably among the Holders based upon the number of shares
of Preferred Stock held by each Holder. Any dividends to be paid in cash
hereunder that are not paid within three Trading Days (as defined in Section 8)
following a dividend payment date shall continue to accrue and shall entail a
late fee, which must be paid in cash, at the rate of 18% per annum or the lesser
rate permitted by applicable law (such fees to accrue daily, from the date such
dividend is due hereunder through and including the date of payment).

            (b) Notwithstanding anything to the contrary contained herein, the
Company must pay dividends in cash if:

                  (i) the number of shares of Common Stock (as defined in
Section 8) at the time authorized, unissued and unreserved for all purposes is
insufficient to accrete such dividends to the Stated Value to permit conversion
in full of all outstanding Stated Value;

                  (ii) after the Dividend Effectiveness Date (as defined in
Section 8), Underlying Shares (as defined in Section 8) (x) are not registered
for resale pursuant to an effective Underlying Shares Registration Statement (as
defined in Section 8) and (y) may not be

                                       2
<PAGE>

sold without volume restrictions pursuant to Rule 144 promulgated under the
Securities Act (as defined in Section 8), as determined by counsel to the
Company pursuant to a written opinion letter, addressed to the Company's
transfer agent in the form and substance acceptable to the applicable Holder and
such transfer agent (if the Company is permitted and elects to pay dividends in
shares of Common Stock under this clause (ii) prior to the Dividend
Effectiveness Date and thereafter an Underlying Shares Registration Statement
shall be declared effective by the Commission (as defined in Section 8), the
Company shall, within three Trading Days after the date of such declaration of
effectiveness, exchange such Underlying Shares for shares of Common Stock that
are free of restrictive legends of any kind);

                  (iii) the Common Stock is not then listed or quoted on the
Nasdaq SmallCap Market ("NASDAQ"), or on the New York Stock Exchange, American
Stock Exchange or Nasdaq National Market (each, a "Subsequent Market"); or

                  (iv) the accretion of such dividends to the Stated Value and
subsequent conversions of all then outstanding Stated Value would result in a
violation of Section 5(a)(iii) or the rules of the Nasdaq Stock Market or any
other rules and regulations governing any Subsequent Market on which the Common
Stock is then listed or quoted for trading.

            (c) So long as any Preferred Stock shall remain outstanding, neither
the Company nor any subsidiary thereof shall redeem, purchase or otherwise
acquire directly or indirectly any Junior Securities (as defined in Section 8),
nor shall the Company directly or indirectly pay or declare any dividend or make
any distribution (other than a dividend or distribution described in Section 5
or dividends due and paid in the ordinary course on preferred stock of the
Company at such times when the Company is in compliance with its payment and
other obligations hereunder) upon, nor shall any distribution be made in respect
of, any Junior Securities, nor shall any monies be set aside for or applied to
the purchase or redemption (through a sinking fund or otherwise) of any Junior
Securities or shares pari passu with the Preferred Stock. However, the Company
may accept shares of Junior Securities as payment of the exercise price of stock
options by the Company's employees, officers and directors.

            Section 3. Voting Rights. Except as otherwise provided herein and as
otherwise required by law, the Preferred Stock shall have no voting rights.
However, so long as any shares of Preferred Stock are outstanding, the Company
shall not, without the affirmative vote of the Holders of a majority of the
shares of the Preferred Stock then outstanding, (a) alter or change adversely
the powers, preferences or rights given to the Preferred Stock or alter or amend
this Certificate of Designation, (b) authorize or create any class of stock
ranking as to dividends or distribution of assets upon a Liquidation (as defined
in Section 4) senior to or otherwise pari passu with the Preferred Stock, (c)
amend its certificate or articles of incorporation or other charter documents so
as to affect adversely any rights of the Holders, (d) increase the authorized
number of shares of Preferred Stock, or (e) enter into any agreement with
respect to the foregoing.

            Section 4. Liquidation. Upon any liquidation, dissolution or
winding-up of the Company, whether voluntary or involuntary (a "Liquidation"),
the Holders shall be entitled to receive out of the assets of the Company,
whether such assets are capital or surplus, for each share of Preferred Stock an
amount equal to the Stated Value per share before any distribution or

                                       3
<PAGE>

payment shall be made to the holders of any Junior Securities, and if the assets
of the Company shall be insufficient to pay in full such amounts, then the
entire assets to be distributed to the Holders shall be distributed among the
Holders ratably in accordance with the respective amounts that would be payable
on such shares if all amounts payable thereon were paid in full. A sale,
conveyance or disposition of 50% or more of the assets of the Company or the
effectuation by the Company of a transaction or series of related transactions
in which more than 33% of the voting power of the Company is disposed of, or a
consolidation or merger of the Company with or into any other company or
companies into one or more companies not wholly-owned by the Company shall not
be treated as a Liquidation, but instead shall be subject to the provisions of
Section 5. The Company shall mail written notice of any such Liquidation, not
less than 45 days prior to the payment date stated therein, to each record
Holder.

            Section 5. Conversion.

            (a)(i) Conversions at Option of Holder. Each share of Preferred
Stock shall be convertible into shares of Common Stock (subject to the
limitations set forth in Section 5(a)(iii)), at the Conversion Ratio (as defined
in Section 8), at the option of the Holder at any time and from time to time for
a period of three years (unless extended pursuant to the terms hereof) from and
after the Original Issue Date (the "Initial Conversion Date"). Holders shall
effect conversions by surrendering the certificate or certificates representing
the shares of Preferred Stock to be converted to the Company, together with the
form of conversion notice attached hereto as Exhibit A (a "Conversion Notice").
Each Conversion Notice shall specify the number of shares of Preferred Stock to
be converted and the date on which such conversion is to be effected, which date
may not be prior to the date the Holder delivers such Conversion Notice pursuant
to the terms of Section 5(h) hereof (the "Conversion Date"). If no Conversion
Date is specified in a Conversion Notice, the Conversion Date shall be the date
that a Conversion Notice is deemed delivered hereunder. If the Holder is
converting less than all shares of Preferred Stock represented by the
certificate or certificates tendered by the Holder with the Conversion Notice,
or if a conversion hereunder cannot be effected in full for any reason, the
Company shall promptly deliver to such Holder (in the manner and within the time
set forth in Section 5(b)) a certificate representing the number of shares of
Preferred Stock not converted.

                  (ii) Automatic Conversion. Subject to the provisions of this
paragraph and Section 5(a)(iii)(B), all outstanding shares of Preferred Stock
for which a Conversion Notice has not previously been received or of which
redemption has not been made or required hereunder shall be automatically
converted on the earlier of (i) the third anniversary of the Original Issue Date
at the then applicable Conversion Price (as defined in Section 5(c)(i)), and
(ii) the Trading Day, following the date on which the Underlying Shares
Registration Statement is declared effective (the "Effective Date") on which the
Closing Price (as defined in Section 8) is higher than $50.00 (subject to
equitable adjustment for stock split, combinations and similar events) for 20
consecutive Trading Days. The conversion contemplated by this paragraph shall
not occur without the consent of the Holder at such time as (a)(1) an Underlying
Shares Registration Statement is not then effective or (2) the Holder is not
permitted to resell Underlying Shares pursuant to Rule 144(k) promulgated under
the Securities Act, without volume restrictions, as evidenced by an opinion
letter of counsel acceptable to the Holder and the transfer agent for the Common
Stock; (b) there are not sufficient shares of Common Stock authorized and
reserved for issuance upon such conversion; or (c) the Company shall have

                                       4
<PAGE>

defaulted in any material respect on its covenants and obligations hereunder or
under the Purchase Agreement or Registration Rights Agreement (each as defined
in Section 7). Notwithstanding the foregoing, the three-year period for
conversion under clause (i) of this Section shall be extended (on a day-for-day
basis) for any Trading Days after the Effective Date that a Holder is unable to
resell Underlying Shares under an Underlying Shares Registration Statement due
to (a) the Common Stock not being listed or quoted for trading on the NASDAQ or
any Subsequent Market, (b) the failure of such Underlying Shares Registration
Statement to be declared effective, or if so declared, to remain effective
during the Effectiveness Period (as defined in the Registration Rights
Agreement) as to all Underlying Shares, or (c) the suspension of the Holder's
right to resell Underlying Shares thereunder. The provisions of Sections
5(a)(iii)(A) and (B) shall not apply to any automatic conversion pursuant to
this Section 5(a)(ii).

                  (iii) Certain Conversion Restrictions.

                  (A) A Holder may not convert shares of Preferred Stock or
receive shares of Common Stock as payment of dividends hereunder to the extent
such conversion or receipt of such dividend payment would result in the Holder,
together with any affiliate thereof, beneficially owning (as determined in
accordance with Section 13(d) of the Exchange Act (as defined in Section 8) and
the rules promulgated thereunder) in excess of 9.999% of the then issued and
outstanding shares of Common Stock, including shares issuable upon conversion
of, and payment of dividends on, the shares of Preferred Stock held by such
Holder after application of this Section. Since the Holder will not be obligated
to report to the Company the number of shares of Common Stock it may hold at the
time of a conversion hereunder, unless the conversion at issue would result in
the issuance of shares of Common Stock in excess of 9.999% of the then
outstanding shares of Common Stock without regard to any other shares which may
be beneficially owned by the Holder or an affiliate thereof, the Holder shall
have the authority and obligation to determine whether the restriction contained
in this Section will limit any particular conversion hereunder and to the extent
that the Holder determines that the limitation contained in this Section
applies, the determination of which portion of the shares of Preferred Stock are
convertible shall be the responsibility and obligation of the Holder. If the
Holder has delivered a Conversion Notice for shares of Preferred Stock that,
without regard to any other shares of Common Stock that the Holder or its
affiliates may beneficially own, would result in the issuance of shares of
Common Stock in excess of the permitted amount hereunder, the Company shall
notify the Holder of this fact and shall honor the conversion for the maximum
number of shares of Preferred Stock permitted to be converted on such Conversion
Date in accordance with the periods described in Section 5(b) and, at the option
of the Holder, either retain shares of Preferred Stock tendered for conversion
in excess of the permitted amount hereunder for future conversions or return
such excess shares of Preferred Stock to the Holder. The provisions of this
Section may be waived by a Holder (but only as to itself and not as to any other
Holder) upon not less than 61 days prior notice to the Company. Other Holders
shall be unaffected by any such waiver.

                  (B) If the Common Stock is then listed for trading on the
NASDAQ or the Nasdaq National Market and the Company has not obtained the
Shareholder Approval (as defined below), then the Company may not issue in
excess of 1,749,507 of Common Stock upon conversions of Preferred Stock at a
price per share that is less than the Closing Price on the Trading Day
immediately preceding the Original Issue Date (such number of shares, the

                                       5
<PAGE>

"Issuable Maximum"). The Issuable Maximum equals 19.999% of the number of shares
of Common Stock outstanding immediately prior to the closing of transactions set
forth in the Purchase Agreement. Each Holder shall be entitled to a portion of
the Issuable Maximum equal to the quotient obtained by dividing (x) the number
of shares of Preferred Stock issued and sold to such Holder on the Original
Issue Date by (y) the aggregate number of shares of Preferred Stock issued and
sold by the Company on the Original Issue Date. If any Holder shall no longer
hold shares of Preferred Stock, then such Holder's remaining portion of the
Issuable Maximum shall be allocated pro-rata among the remaining Holders. If on
any Conversion Date (A) the shares of Common Stock are listed for trading on the
NASDAQ or the Nasdaq National Market, (B) the Conversion Price then in effect is
such that the aggregate number of shares of Common Stock that would then be
issuable upon conversion in full of all then outstanding shares of Preferred
Stock, together with any shares of Common Stock previously issued upon
conversion of shares of Preferred Stock, would exceed the Issuable Maximum, and
(C) the Company shall not have previously obtained the vote of shareholders (the
"Shareholder Approval"), if any, as may be required by the applicable rules and
regulations of the Nasdaq Stock Market (or any successor entity) applicable to
approve the issuance of shares of Common Stock in excess of the Issuable Maximum
pursuant to the terms hereof, then the Company shall issue to the Holder
requesting a conversion a number of shares of Common Stock equal to such
Holder's pro-rata portion (which shall be calculated pursuant to the terms
hereof) of the Issuable Maximum and, with respect to the remainder of the
aggregate Stated Value of the shares of Preferred Stock then held by such Holder
for which a conversion in accordance with the Conversion Price would result in
an issuance of shares of Common Stock in excess of such Holder's pro-rata
portion (which shall be calculated pursuant to the terms hereof) of the Issuable
Maximum (the "Excess Stated Value"), the converting Holder shall have the option
to require the Company to either (1) use its best efforts to obtain the
Shareholder Approval applicable to such issuance as soon as is possible, but in
any event not later than the 90th day after such request, or (2) pay cash to the
converting Holder in an amount equal to the Mandatory Redemption Amount (as
defined in Section 8) for the Excess Stated Value. If the converting Holder
shall have elected the first option pursuant to the immediately preceding
sentence and the Company shall have failed to obtain the Shareholder Approval on
or prior to the 90th day after such request, then within three (3) days of such
90th day, the Company shall pay cash to the converting Holder in an amount equal
to the Mandatory Redemption Amount for the Excess Stated Value. If the Company
fails to pay the Mandatory Redemption Amount in full pursuant to this Section
within seven days after the date payable, the Company will pay interest thereon
at a rate of 18% per annum or such lesser maximum amount that is permitted to be
paid by applicable law, to the converting Holder, accruing daily from the
Conversion Date until such amount, plus all such interest thereon, is paid in
full. The Company and the Holder understand and agree that shares of Common
Stock issued to and then held by the Holder as a result of conversions of
Preferred Stock shall not be entitled to cast votes on any resolution to obtain
Shareholder Approval pursuant hereto.

            (b)(i) Not later than three Trading Days after each Conversion Date,
the Company will deliver to the Holder (A) a certificate or certificates which
shall be free of restrictive legends and trading restrictions (other than those
required by Section 3.1(b) of the Purchase Agreement) representing the number of
shares of Common Stock being acquired upon the conversion of shares of Preferred
Stock, (B) one or more certificates representing the number of shares of
Preferred Stock not converted and (C) a bank check in the amount of accrued and
unpaid dividends (if the Company has elected or is required to pay accrued
dividends in cash).

                                       6
<PAGE>

Notwithstanding the foregoing or anything to the contrary contained herein, the
Company shall not be obligated to issue certificates evidencing the shares of
Common Stock issuable upon conversion of any shares of Preferred Stock until one
Trading Day after certificates evidencing such shares of Preferred Stock are
delivered for conversion to the Company, or the Holder of such Preferred Stock
notifies the Company that such certificates have been lost, stolen or destroyed
and provides a bond (or other adequate security) reasonably satisfactory to the
Company to indemnify the Company from any loss incurred by it in connection
therewith. The Company shall, upon request of the Holder, if available, use its
best efforts to deliver any certificate or certificates required to be delivered
by the Company under this Section electronically through the Depository Trust
Corporation or another established clearing corporation performing similar
functions. If in the case of any Conversion Notice such certificate or
certificates are not delivered to or as directed by the applicable Holder by the
third Trading Day after the Conversion Date, the Holder shall be entitled to
elect by written notice to the Company at any time on or before its receipt of
such certificate or certificates thereafter, to rescind such conversion, in
which event the Company shall immediately return the certificates representing
the shares of Preferred Stock tendered for conversion.

                  (ii) In addition to any other rights available to the Holder,
if the Company fails to deliver to the Holder such certificate or certificates
pursuant to Section 5(b)(i), by the third Trading Day after the Conversion Date,
and if after such third Trading Day the Holder purchases (in an open market
transaction or otherwise) Common Stock to deliver in satisfaction of a sale by
such Holder of the Underlying Shares which the Holder was entitled to receive
upon such conversion (a "Buy-In"), then the Company shall (A) pay in cash to the
Holder the amount by which (x) the Holder's total purchase price (including
brokerage commissions, if any) for the Common Stock so purchased exceeds (y) the
product of (1) the aggregate number of shares of Common Stock that such Holder
was entitled to receive from the conversion at issue multiplied by (2) the
market price of the Common Stock at the time of the sale giving rise to such
purchase obligation and (B) at the option of the Holder, either return the
shares of Preferred Stock for which such conversion was not honored or deliver
to such Holder the number of shares of Common Stock that would have been issued
had the Company timely complied with its conversion and delivery obligations
under Section 5(b)(i). For example, if the Holder purchases Common Stock having
a total purchase price of $11,000 to cover a Buy-In with respect to an attempted
conversion of shares of Preferred Stock with respect to which the market price
of the Underlying Shares on the date of conversion totaled $10,000, under clause
(A) of the immediately preceding sentence the Company shall be required to pay
the Holder $1,000. The Holder shall provide the Company written notice
indicating the amounts payable to the Holder in respect of the Buy-In. Nothing
herein shall limit a Holder's right to pursue any other remedies available to it
hereunder, at law or in equity, including, without limitation, a decree of
specific performance and/or injunctive relief with respect to the Company's
failure to timely deliver certificates representing shares of Common Stock upon
conversion of the shares of Preferred Stock as required pursuant to the terms
hereof.

            (c)(i) The conversion price (the "Conversion Price") for each share
of Preferred Stock shall, subject to adjustment as hereinafter set forth, be as
follows:

      1.    On and after the Initial Conversion Date, the Conversion Price shall
            equal $35.00 (the "Fixed Conversion Price").

                                       7
<PAGE>

      2.    Commencing September 14, 2000, and during each monthly period
            thereafter (each, a "Reset Date"), the Conversion Price will equal
            the lower of (a) the Fixed Conversion Price and (b) the Reset
            Conversion Price (as defined in Section 8).

      3.    For any conversion that occurs pursuant to clause (ii) of Section
            5(a)(ii), the Conversion Price shall equal the Fixed Conversion
            Price.

                  (ii) If the Company, at any time while any shares of Preferred
Stock are outstanding, shall (a) pay a stock dividend or otherwise make a
distribution or distributions on shares of its Junior Securities or pari passu
securities payable in shares of Common Stock, (b) subdivide outstanding shares
of Common Stock into a larger number of shares, (c) combine outstanding shares
of Common Stock into a smaller number of shares, or (d) issue by
reclassification and exchange of the Common Stock any shares of capital stock of
the Company, then the Fixed Conversion Price shall be multiplied by a fraction
of which the numerator shall be the number of shares of Common Stock outstanding
before such event and of which the denominator shall be the number of shares of
Common Stock outstanding after such event. Any adjustment made pursuant to this
Section 5(c)(ii) shall become effective immediately after the record date for
the determination of shareholders entitled to receive such dividend or
distribution and shall become effective immediately after the effective date in
the case of a subdivision, combination or re-classification.

                  (iii) If the Company, at any time while any shares of
Preferred Stock are outstanding, shall issue rights, warrants or options to all
holders of Common Stock entitling them to subscribe for or purchase shares of
Common Stock at a price per share less than the Per Share Market Value at the
record date mentioned below, then the Conversion Price shall be multiplied by a
fraction, the numerator of which shall be the number of shares of Common Stock
outstanding immediately prior to the issuance of such rights, warrants or
options, plus the number of shares of Common Stock which the aggregate offering
price of the total number of shares so offered would purchase at such Per Share
Market Value, and the denominator of which shall be the sum of the number of
shares of Common Stock outstanding immediately prior to such issuance plus the
number of shares of Common Stock offered for subscription or purchase. Such
adjustment shall be made whenever such rights or warrants are issued, and shall
become effective immediately after the record date for the determination of
shareholders entitled to receive such rights or warrants. However, upon the
expiration of any right, warrant or option to purchase shares of Common Stock
the issuance of which resulted in an adjustment in the Conversion Price pursuant
to this Section 5(c)(iii), if any such right, warrant or option shall expire and
shall not have been exercised, the Conversion Price shall immediately upon such
expiration shall be recomputed and effective immediately upon such expiration
shall be increased to the price which it would have been (but reflecting any
other adjustments in the Conversion Price made pursuant to the provisions of
this Section 5 upon the issuance of other rights or warrants) had the adjustment
of the Conversion Price made upon the issuance of such rights, warrants, or
options been made on the basis of offering for subscription or purchase only
that number of shares of Common Stock actually purchased upon the exercise of
such rights, warrants or options actually exercised.

                                       8
<PAGE>

                  (iv) If the Company or any subsidiary thereof, as applicable
with respect to Common Stock Equivalents (as defined below), at any time while
any shares of Preferred Stock are outstanding, shall issue shares of Common
Stock or rights, warrants, options or other securities or debt that is
convertible into or exchangeable for shares of Common Stock ("Common Stock
Equivalents"), entitling any Person to acquire shares of Common Stock at a price
per share less than the Conversion Price (if the holder of the Common Stock or
Common Stock Equivalent so issued shall at any time, whether by operation of
purchase price adjustments, reset provisions, floating conversion, exercise or
exchange prices or otherwise, or due to warrants, options or rights issued in
connection with such issuance, be entitled to receive shares of Common Stock at
a price less than the Conversion Price, such issuance shall be deemed to have
occurred for less than the Conversion Price), then the Conversion Price shall be
multiplied by a fraction, the numerator of which shall be the number of shares
of Common Stock outstanding immediately prior to the issuance of such Common
Stock or such Common Stock Equivalents plus the number of shares of Common Stock
which the offering price for such shares of Common Stock or Common Stock
Equivalents would purchase at the Conversion Price, and the denominator of which
shall be the sum of the number of shares of Common Stock outstanding immediately
prior to such issuance plus the number of shares of Common Stock so issued or
issuable, provided, that for purposes hereof, all shares of Common Stock that
are issuable upon conversion, exercise or exchange of Common Stock Equivalents
shall be deemed outstanding immediately after the issuance of such Common Stock
Equivalents. Such adjustment shall be made whenever such Common Stock or Common
Stock Equivalents are issued. However, upon the expiration of any Common Stock
Equivalents the issuance of which resulted in an adjustment in the Conversion
Price pursuant to this Section, if any such Common Stock Equivalents shall
expire and shall not have been exercised, the Conversion Price shall immediately
upon such expiration be recomputed and effective immediately upon such
expiration be increased to the price which it would have been (but reflecting
any other adjustments in the Conversion Price made pursuant to the provisions of
this Section after the issuance of such Common Stock Equivalents) had the
adjustment of the Conversion Price made upon the issuance of such Common Stock
Equivalents been made on the basis of offering for subscription or purchase only
that number of shares of the Common Stock actually purchased upon the exercise
of such Common Stock Equivalents actually exercised. Notwithstanding anything
herein to the contrary, the following shall not be subject to the provisions of
this Section: (1) issuances of any stock or stock options under any employee
benefit plan of the Company whether now existing or approved by the Company and
its stockholders in the future, (2) the rights, options and warrants outstanding
prior to the date hereof and specified in Schedule 2.1(c) to the Purchase
Agreement, but not any modifications thereof and (3) the issuance of shares of
Common Stock in payment of the purchase price of a Strategic Transaction (as
defined below). For purposes of this Section, a "Strategic Transaction" shall
mean a transaction or relationship in which the Company issues shares of Common
Stock to an entity which is, itself or through its subsidiaries, an operating
company in a business related to the business of the Company and in which the
Company receives material benefits in addition to the investment of funds, but
shall not include a transaction in which the Company is issuing securities
primarily for the purpose of raising capital.

                  (v) If the Company, at any time while shares of Preferred
Stock are outstanding, shall distribute to all holders of Common Stock (and not
to Holders) evidences of its indebtedness or assets or rights or warrants to
subscribe for or purchase any security (excluding

                                       9
<PAGE>

those referred to in Sections 5(c)(ii)-(iv) above), then in each such case the
Conversion Price at which each share of Preferred Stock shall thereafter be
convertible shall be determined by multiplying the Conversion Price in effect
immediately prior to the record date fixed for determination of shareholders
entitled to receive such distribution by a fraction of which the denominator
shall be the Per Share Market Value determined as of the record date mentioned
above, and of which the numerator shall be such Per Share Market Value on such
record date less the then fair market value at such record date of the portion
of such assets or evidence of indebtedness so distributed applicable to one
outstanding share of Common Stock as determined by the Board of Directors in
good faith. In either case the adjustments shall be described in a statement
provided to the Holders of the portion of assets or evidences of indebtedness so
distributed or such subscription rights applicable to one share of Common Stock.
Such adjustment shall be made whenever any such distribution is made and shall
become effective immediately after the record date mentioned above.

                  (vi) All calculations under this Section 5 shall be made to
the nearest cent or the nearest 1/100th of a share, as the case may be. 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, and the disposition
of any such shares shall be considered an issue or sale of Common Stock.

                  (vii) Whenever the Fixed Conversion Price or the Conversion
Price is adjusted pursuant to Section 5(c)(ii),(iii), (iv) or (v), the Company
shall promptly mail to each Holder a notice setting forth the Conversion Price
or Fixed Conversion Price (as applicable) after such adjustment and setting
forth a brief statement of the facts requiring such adjustment.

                  (viii) In case of any reclassification of the Common Stock, or
any compulsory share exchange pursuant to which the Common Stock is converted
into other securities, cash or property (other than compulsory share exchanges
which constitute Change of Control Transactions (as defined in Section 8)), the
Holders of the Preferred Stock then outstanding shall have the right thereafter
to convert such shares only into the shares of stock and other securities, cash
and property receivable upon or deemed to be held by holders of Common Stock
following such reclassification or share exchange, and the Holders of the
Preferred Stock shall be entitled upon such event to receive such amount of
securities, cash or property as a holder of the number of shares of Common Stock
of the Company into which such shares of Preferred Stock could have been
converted immediately prior to such reclassification or share exchange would
have been entitled. This provision shall similarly apply to successive
reclassifications or share exchanges.

                  (ix) In case of any merger or consolidation of the Company
with or into another Person, or sale by the Company of more than one-half of the
assets of the Company (on an as valued basis) in one or a series of related
transactions, a Holder shall have the right thereafter to (A) convert its shares
of Preferred Stock into the shares of stock and other securities, cash and
property receivable upon or deemed to be held by holders of Common Stock
following such merger, consolidation or sale, and such Holder shall be entitled
upon such event or series of related events to receive such amount of
securities, cash and property as the shares of Common Stock into which such
shares of Preferred Stock could have been converted immediately prior to such
merger, consolidation or sale would have been entitled or (B) in the

                                       10
<PAGE>

case of a merger or consolidation, (x) require the surviving entity to issue
shares of convertible preferred stock or convertible debentures with such
aggregate stated value or in such face amount, as the case may be, equal to the
Stated Value of the shares of Preferred Stock then held by such Holder, plus all
accrued and unpaid dividends and other amounts owing thereon, which newly issued
shares of preferred stock or debentures shall have terms identical (including
with respect to conversion) to the terms of the Preferred Stock (except, in the
case of debentures, as may be required to reflect the differences between debt
and equity) and shall be entitled to all of the rights and privileges of a
Holder of Preferred Stock set forth herein and in the agreements pursuant to
which the Preferred Stock was issued (including, without limitation, as such
rights relate to the acquisition, transferability, registration and listing of
such shares of stock or other securities issuable upon conversion thereof), and
(y) simultaneously with the issuance of such convertible preferred stock or
convertible debentures, shall have the right to convert such instrument only
into shares of stock and other securities, cash and property receivable upon or
deemed to be held by holders of Common Stock following such merger or
consolidation. In the case of clause (B), the conversion price applicable for
the newly issued shares of convertible preferred stock or convertible debentures
shall be based upon the amount of securities, cash and property that each share
of Common Stock would receive in such transaction, the Conversion Ratio
immediately prior to the effectiveness or closing date for such transaction and
the Conversion Price stated herein. The terms of any such merger, sale or
consolidation shall provide the Holders of Preferred Stock the right to receive
the securities, cash and property set forth in this Section upon any conversion
or redemption following such event. This provision shall similarly apply to
successive such events. The rights set forth in this Section 5(c)(ix) shall not
alter the rights of a Holder set forth in Section 7, provided, that, a Holder
may only exercise the rights set forth in this Section 5(c)(ix) or the rights
set forth in Section 7 with respect to a single event giving rise to such
rights.

                  (x) If (a) the Company shall declare a dividend (or any other
distribution) on the Common Stock, (b) the Company shall declare a special
nonrecurring cash dividend on or a redemption of the Common Stock, (c) the
Company shall authorize the granting to all holders of Common Stock rights or
warrants to subscribe for or purchase any shares of capital stock of any class
or of any rights, (d) the approval of any shareholders of the Company shall be
required in connection with any reclassification of the Common Stock, any
consolidation or merger to which the Company is a party, any sale or transfer of
all or substantially all of the assets of the Company, or any compulsory share
exchange whereby the Common Stock is converted into other securities, cash or
property, or (e) the Company shall authorize the voluntary or involuntary
dissolution, liquidation or winding-up of the affairs of the Company, then the
Company shall notify the Holders at their last addresses as they shall appear
upon the stock books of the Company, at least 10 calendar days prior to the
applicable record or effective date hereinafter specified, a notice stating (x)
the date on which a record is to be taken for the purpose of such dividend,
distribution, redemption, rights or warrants, or if a record is not to be taken,
the date as of which the holders of Common Stock of record entitled to such
dividend, distribution, redemption, rights or warrants are to be determined or
(y) the date on which such reclassification, consolidation, merger, sale,
transfer or share exchange is expected to become effective or close, and the
date as of which it is expected that holders of Common Stock of record shall be
entitled to exchange their Common Stock for securities, cash or other property
deliverable upon such reclassification, consolidation, merger, sale, transfer or
share exchange.

                                       11
<PAGE>

Holders are entitled to convert shares of Preferred Stock during the 20-day
period commencing the date of such notice to the effective date of the event
triggering such notice.

            (d) The Company covenants that it will at all times reserve and keep
available out of its authorized and unissued shares of Common Stock solely for
the purpose of issuance upon conversion of Preferred Stock, free from preemptive
rights or any other actual contingent purchase rights of persons other than the
Holders, not less than such number of shares of Common Stock as shall be
issuable (taking into account the provisions of Section 5(a) and Section 5(c))
upon the conversion of all outstanding shares of Preferred Stock. The Company
covenants that all shares of Common Stock that shall be so issuable shall, upon
issuance, be duly and validly authorized and issued and fully paid and
nonassessable.

            (e) Upon a conversion hereunder the Company shall not be required to
issue stock certificates representing fractions of shares of Common Stock, but
may, if otherwise permitted, make a cash payment in respect of any final
fraction of a share based on the Per Share Market Value at such time. If any
fraction of an Underlying Share would, except for the provisions of this
Section, be issuable upon a conversion hereunder, the Company shall pay an
amount in cash equal to the Conversion Ratio multiplied by such fraction.

            (f) The issuance of certificates for Common Stock on conversion of
Preferred Stock shall be made without charge to the Holders thereof for any
documentary stamp or similar taxes that may be payable in respect of the issue
or delivery of such certificate, provided that the Company shall not be required
to pay any tax that may be payable in respect of any transfer involved in the
issuance and delivery of any such certificate upon conversion in a name other
than that of the Holder of such shares of Preferred Stock so converted.

            (g) Shares of Preferred Stock converted into Common Stock or
redeemed in accordance with the terms hereof shall be canceled and may not be
reissued.

            (h) Any and all notices or other communications or deliveries to be
provided by the Holders of the Preferred Stock hereunder, including, without
limitation, any Conversion Notice, shall be in writing and delivered personally,
by facsimile or sent by a nationally recognized overnight courier service,
addressed to the attention of the Chief Financial Officer of the Company
addressed to 2950 N.E. 84th Lane, Blaine, Minnesota 55449 or to facsimile number
763-784-2038, or to such other address or facsimile number as shall be specified
in writing by the Company for such purpose. Any and all notices or other
communications or deliveries to be provided by the Company hereunder shall be in
writing and delivered personally, by facsimile or sent by a nationally
recognized overnight courier service, addressed to each Holder at the facsimile
telephone number or address of such Holder appearing on the books of the
Company, or if no such facsimile telephone number or address appears, at the
principal place of business of the Holder. Any notice or other communication or
deliveries hereunder shall be deemed given and effective on the earliest of (i)
the date of transmission, if such notice or communication is delivered via
facsimile at the facsimile telephone number specified in this Section prior to
6:30 p.m. (New York City time)(with confirmation of transmission), (ii) the date
after the date of transmission, if such notice or communication is delivered via
facsimile at the facsimile telephone number specified in this Section later than
6:30 p.m. (New York City time) on any date and earlier than 11:59 p.m. (New York
City time) on such date (with confirmation of

                                       12
<PAGE>

transmission), (iii) the next business day, if sent by a nationally recognized
overnight courier service, or (iv) upon actual receipt by the party to whom such
notice is required to be given.

            Section 6. Optional Redemption.

            (a) Subject to the provisions of this Section 6, from and after the
Original Issue Date, the Company shall have the right, upon 30 calendar days'
notice (an "Optional Redemption Notice") to the Holders, to redeem all or any
portion of the shares of Preferred Stock which have not previously been redeemed
or for which Conversion Notices shall not have been delivered, at a price equal
to the Optional Redemption Price (as defined in Section 8). If on the date of
the delivery of the Optional Redemption Notice the Conversion Price shall be
equal to or greater than $30.00, then the Company may only deliver an Optional
Redemption Notice if: (i) the number of shares of Common Stock at the time
authorized, unissued and unreserved for all purposes is sufficient to satisfy
the Company's conversion obligations of all shares of Preferred Stock then
outstanding, (ii) the Underlying Shares then outstanding are registered for
resale pursuant to an effective Underlying Shares Registration Statement
pursuant to which the Holders are permitted to sell Underlying Shares or the
Underlying Shares may be resold without volume restrictions pursuant to Rule
144(k) promulgated under the Securities Act, and (iii) the Common Stock is
listed for trading on the NASDAQ or on a Subsequent Market. If on the date of
the delivery of the Optional Redemption Notice the Conversion Price shall be
equal to or greater than $30.00, then each of clauses (i) - (iii) of the
immediately preceding sentence must be true during the entire 30 calendar days
between the date of delivery of an Optional Redemption Notice and the date of
payment of the Optional Redemption Price. The entire Optional Redemption Price
shall be paid in cash. If on the date of the delivery of the Optional Redemption
Notice the Conversion Price shall be equal to or greater than $30.00, then a
Holder may, subject to Section 5(a)(i) hereof, convert (and the Company shall
honor such conversions in accordance with the terms hereof) any or all of the
shares of Preferred Stock subject to an Optional Redemption Notice, provided,
that the Conversion Notice for such shares is delivered prior to the 27th
calendar day following the receipt by such Holder of such an Optional Redemption
Notice.

            (b) Failure by the Company to pay any portion of the Optional
Redemption Price by the 30th calendar day following the date of the delivery by
the Company of an Optional Redemption Notice shall result in the invalidation ab
initio of the unpaid portion of such optional redemption, and, notwithstanding
anything herein to the contrary, the Company shall thereafter have no further
rights to optionally redeem any shares of Preferred Stock. In such event, the
Company shall, at the option of the Holder, either, (i) not later than three
Trading Days from receipt of Holder's request for such election, return to the
Holder all of the shares of Preferred Stock for which such Optional Redemption
Price has not been paid in full (the "Unpaid Redemption Shares") or (ii) convert
all or any portion of the Unpaid Redemption Shares, in which event the Per Share
Market Value for such shares shall be the lower of the Per Share Market Value
calculated on the date the payment of the Optional Redemption Price was
originally due and the Per Share Market Value as of the Holder's written demand
for conversion. If the Holder elects option (ii) above, the Company shall within
three Trading Days of its receipt of such election deliver to the Holder the
shares of Common Stock issuable upon conversion of the Unpaid Redemption Shares
subject to such Holder's conversion demand and otherwise perform its obligations
hereunder with respect thereto.

                                       13
<PAGE>

            Section 7. Redemption Upon Triggering Events.

            (a) Upon the occurrence of a Triggering Event, each Holder shall (in
addition to all other rights it may have hereunder or under applicable law),
have the right, exercisable at the sole option of such Holder, to require the
Company to redeem all or a portion of the Preferred Stock then held by such
Holder for a redemption price, in cash, equal to the sum of (i) the Mandatory
Redemption Amount plus (ii) the product of (A) the number of Underlying Shares
issued in respect of conversions hereunder and then held by the Holder and (B)
the Per Share Market Value on the date such redemption is demanded or the date
the redemption price hereunder is paid in full, whichever is greater (such sum,
the "Redemption Price"). The Redemption Price shall be due and payable within
five Trading Days of the date on which the notice for the payment therefor is
provided by a Holder. If the Company fails to pay the Redemption Price hereunder
in full pursuant to this Section on the date such amount is due in accordance
with this Section, the Company will pay interest thereon at a rate of 18% per
annum (or the lesser amount permitted by applicable law), accruing daily from
such date until the Redemption Price, plus all such interest thereon, is paid in
full. For purposes of this Section, a share of Preferred Stock is outstanding
until such date as the Holder shall have received Underlying Shares upon a
conversion (or attempted conversion) thereof that meets the requirements hereof.

            A "Triggering Event" means any one or more of the following events
(whatever the reason and whether it shall be voluntary or involuntary or
effected by operation of law or pursuant to any judgment, decree or order of any
court, or any order, rule or regulation of any administrative or governmental
body):

                  (i) the failure of an Underlying Shares Registration Statement
to be declared effective by the Commission on or prior to the 180th day after
the Original Issue Date;

                  (ii) if, during the Effectiveness Period, the effectiveness of
the Underlying Shares Registration Statement lapses for any reason for more than
an aggregate of seven Trading Days (which need not be consecutive Trading Days),
or the Holder shall not be permitted to resell Registrable Securities under the
Underlying Shares Registration Statement for more than an aggregate of seven
Trading Days (which need not be consecutive Trading Days);

                  (iii) the failure of the Common Stock to be listed for trading
on the NASDAQ or on a Subsequent Market or the suspension of the Common Stock
from trading on the NASDAQ or on a Subsequent Market, in either case, for more
than seven Trading Days (which need not be consecutive Trading Days);

                  (iv) the Company shall fail for any reason to deliver
certificates representing Underlying Shares issuable upon a conversion hereunder
that comply with the provisions hereof prior to the tenth day after the
Conversion Date or the Company shall provide notice to any Holder, including by
way of public announcement, at any time, of its intention not to comply with
requests for conversion of any shares of Preferred Stock in accordance with the
terms hereof;

                                       14
<PAGE>

                  (v) the Company shall be a party to any Change of Control
Transaction, or shall redeem more than a de minimis number of shares of Common
Stock or other Junior Securities (other than redemptions of Underlying Shares);

                  (vi) an Event (as defined in the Registration Rights
Agreement) shall not have been cured to the satisfaction of the Holders prior to
the expiration of 60 days from the Event Date (as defined in the Registration
Rights Agreement) relating thereto (other than an Event resulting from a failure
of an Underlying Shares Registration Statement to be declared effective by the
Commission on or prior to the 180th day after the Original Issue Date, which
shall be covered by Section 7(a)(i));

                  (vii) the Company shall fail for any reason to pay in full the
amount of cash due pursuant to a Buy-In within seven days after notice therefor
is delivered hereunder or shall fail to pay all amounts owed on account of an
Event within seven days of the date due;

                  (viii) the Company shall fail to have available a sufficient
number of authorized and unreserved shares of Common Stock to issue to such
Holder upon a conversion hereunder; or

                  (ix) the Company shall fail to observe or perform any other
covenant, agreement or warranty contained in, or otherwise commit any breach of
the Transaction Documents (as defined in Section 8), and such failure or breach
shall not, if subject to the possibility of a cure by the Company, have been
remedied within twenty Business Days after the date on which written notice of
such failure or breach shall have been given.

            Section 8. Definitions. For the purposes hereof, the following terms
shall have the following meanings:

            "Change of Control Transaction" means the occurrence of any of (i)
an acquisition after the date hereof by an individual or legal entity or "group"
(as described in Rule 13d-5(b)(1) promulgated under the Exchange Act) of
effective control (whether through legal or beneficial ownership of capital
stock of the Company, by contract or otherwise) of in excess of 33% of the
voting securities of the Company, (ii) a replacement at one time or over time of
more than one-half of the members of the Company's board of directors which is
not approved by a majority of those individuals who are members of the board of
directors on the date hereof (or by those individuals who are serving as members
of the board of directors on any date whose nomination to the board of directors
was approved by a majority of the members of the board of directors who are
members on the date hereof), (iii) the merger of the Company with or into
another entity that is not wholly-owned by the Company, consolidation or sale of
50% or more of the assets of the Company in one or a series of related
transactions, or (iv) the execution by the Company of an agreement to which the
Company is a party or by which it is bound, providing for any of the events set
forth above in (i), (ii) or (iii).

            "Closing Price" means on any particular date (a) the closing sales
price per share of Common Stock on such date on the NASDAQ or on the Subsequent
Market on which the Common Stock is then listed or quoted, or if there is no
such price on such date, then the closing sales price on the NASDAQ or on such
Subsequent Market on the date nearest preceding such

                                       15
<PAGE>

date, or (b) if the Common Stock is not then listed or quoted on the NASDAQ or
on a Subsequent Market, the closing sales price for a share of Common Stock in
the over-the-counter market, as reported by the National Quotation Bureau
Incorporated (or similar organization or agency succeeding to its functions of
reporting prices) at the close of business on such date, or (c) if the Common
Stock is not then reported by the National Quotation Bureau Incorporated (or
similar organization or agency succeeding to its functions of reporting prices),
then the average of the "Pink Sheet" quotes for the relevant conversion period,
as determined in good faith by the Holder, or (d) if the Common Stock is not
then publicly traded the fair market value of a share of Common Stock as
determined by an Appraiser selected in good faith by the Holders of a majority
of the shares of the Preferred Stock.

            "Commission" means the Securities and Exchange Commission.

            "Common Stock" means the Company's common stock, par value $.01 per
share, and stock of any other class into which such shares may hereafter have
been reclassified or changed.

            "Conversion Ratio" means, at any time, a fraction, the numerator of
which is Stated Value (or Excess Stated Value, as the case may be) and the
denominator of which is the Conversion Price at such time.

            "Dividend Effectiveness Date" means the earlier to occur of (x) the
Effectiveness Date (as defined in the Registration Rights Agreement) and (y) the
date that an Underlying Shares Registration Statement is declared effective by
the Commission.

            "Exchange Act" means the Securities Exchange Act of 1934, as
amended.

            "Junior Securities" means the Common Stock and all other equity
securities of the Company other than those securities that are outstanding on
the Original Issue Date and which are explicitly senior in rights or liquidation
preference to the Preferred Stock.

            "Mandatory Redemption Amount" for each share of Preferred Stock
means the sum of (i) the greater of (A) 120% of the Stated Value (or Excess
Stated Value, as the case may be) and (B) the product of (a) the Per Share
Market Value on the Trading Day immediately preceding (x) the date of the
Triggering Event or the Conversion Date, as the case may be, or (y) the date of
payment in full by the Company of the applicable redemption price, whichever is
greater, and (b) the Conversion Ratio calculated on the date of the Triggering
Event, or the Conversion Date, as the case may be, and (ii) all other amounts,
costs, expenses and liquidated damages due in respect of such share of Preferred
Stock.

            "Optional Redemption Price" shall be sum of (i) 100% of the Stated
Value of the shares of Preferred Stock to be redeemed pursuant to Section 6 and
(ii) any other amounts or liquidated damages due in respect of such shares of
Preferred Stock.

            "Original Issue Date" shall mean the date of the first issuance of
any shares of the Preferred Stock regardless of the number of transfers of any
particular shares of Preferred Stock and regardless of the number of
certificates which may be issued to evidence such Preferred Stock.

                                       16
<PAGE>

            "Per Share Market Value" means on any particular date (a) the
closing bid price per share of Common Stock on such date on the NASDAQ or on the
Subsequent Market on which the Common Stock is then listed or quoted, or if
there is no such price on such date, then the closing bid price on the NASDAQ or
on such Subsequent Market on the date nearest preceding such date, or (b) if the
Common Stock is not then listed or quoted on the NASDAQ or on a Subsequent
Market, the closing bid price for a share of Common Stock in the
over-the-counter market, as reported by the National Quotation Bureau
Incorporated (or similar organization or agency succeeding to its functions of
reporting prices) at the close of business on such date, or (c) if the Common
Stock is not then reported by the National Quotation Bureau Incorporated (or
similar organization or agency succeeding to its functions of reporting prices),
then the average of the "Pink Sheet" quotes for the relevant conversion period,
as determined in good faith by the Holder, or (d) if the Common Stock is not
then publicly traded, the fair market value of a share of Common Stock as
determined by an Appraiser selected in good faith by the Holders of a majority
of the shares of the Preferred Stock.

            "Person" means a corporation, an association, a partnership, an
organization, a business, an individual, a government or political subdivision
thereof or a governmental agency.

            "Purchase Agreement" means the Convertible Preferred Stock Purchase
Agreement, dated as of the Original Issue Date, to which the Company and the
original Holder are parties, as amended, modified or supplemented from time to
time in accordance with its terms.

            "Registration Rights Agreement" means the Registration Rights
Agreement, dated as of the Original Issue Date, to which the Company and the
original Holder are parties, as amended, modified or supplemented from time to
time in accordance with its terms.

            "Reset Conversion Price" means the average of the Per Share Market
Values during the five Trading Days preceding the applicable Reset Date;
provided, that (1) such five Trading Day period shall be extended for the number
of Trading Days during such period in which (A) trading in the Common Stock is
suspended by the NASDAQ or a Subsequent Market on which the Common Stock is then
listed, or (B) after the date declared effective by the Commission, the
Underlying Shares Registration Statement is not effective, or (C) after the date
declared effective by the Commission, the Prospectus included in the Underlying
Shares Registration Statement may not be used by the Holder for the resale of
Underlying Shares; and (2) the Reset Conversion Price that will control during
any monthly period shall equal the lowest Reset Conversion Price determined from
the initial Reset Date.

            "Securities Act" means the Securities Act of 1933, as amended.

            "Trading Day" means (a) a day on which the Common Stock is traded on
the NASDAQ or on the Subsequent Market on which the Common Stock is then listed
or quoted, as the case may be, or (b) if the Common Stock is not listed on the
NASDAQ or on a Subsequent Market, a day on which the Common Stock is traded in
the over-the-counter market, as reported by the OTC Bulletin Board, or (c) if
the Common Stock is not quoted on the OTC Bulletin Board, a day on which the
Common Stock is quoted in the over-the-counter market as reported by the
National Quotation Bureau Incorporated (or any similar organization or agency

                                       17
<PAGE>

succeeding to its functions of reporting prices); provided, however, that in the
event that the Common Stock is not listed or quoted as set forth in (a), (b) and
(c) hereof, then Trading Day shall mean any day except Saturday, Sunday and any
day which shall be a legal holiday or a day on which banking institutions in the
State of New York or the State of Minnesota are authorized or required by law or
other government action to close.

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

            "Underlying Shares" means, collectively, the shares of Common Stock
into which the shares of Preferred Stock are convertible in accordance with the
terms hereof.

            "Underlying Shares Registration Statement" means a registration
statement that meets the requirements of the Registration Rights Agreement and
registers the resale of all Underlying Shares by the Holder, who shall be named
as a "selling stockholder" thereunder.

                                       18
<PAGE>

                                    EXHIBIT A

                              NOTICE OF CONVERSION

(To be Executed by the Registered Holder
in order to Convert shares of Preferred Stock)

         The undersigned hereby elects to convert the number of shares of 2%
Series A Convertible Preferred Stock indicated below, into shares of common
stock, par value $.01 per share (the "Common Stock"), of APA Optics Inc., a
Minnesota corporation (the "Company"), according to the conditions hereof, as of
the date written below. If shares are to be issued in the name of a person other
than undersigned, the undersigned will pay all transfer taxes payable with
respect thereto and is delivering herewith such certificates and opinions as
reasonably requested by the Company in accordance therewith. No fee will be
charged to the Holder for any conversion, except for such transfer taxes, if
any.

Conversion calculations:

                      ----------------------------------------------------------
                      Date to Effect Conversion

                      ----------------------------------------------------------
                      Number of shares of Preferred Stock to be Converted

                      ----------------------------------------------------------
                      Stated Value of shares of Preferred Stock to be Converted

                      ----------------------------------------------------------
                      Number of shares of Common Stock to be Issued

                      ----------------------------------------------------------
                      Applicable Conversion Price

                      ----------------------------------------------------------
                      Signature

                      ----------------------------------------------------------
                      Name

                      ----------------------------------------------------------
                      Address

                                       19
<PAGE>

         IN WITNESS WHEREOF, the Company has caused this Certificate to be duly
executed by the President of the Company this 13th day of March, 2000.

                                       APA OPTICS, INC.

                                       By: /s/ Anil K. Jain
                                           -------------------------------------
                                           Name:  Anil K. Jain
                                           Title: President

                                    [STAMP]
                               STATE OF MINNESOTA
                              DEPARTMENT OF STATE
                                     FILED    DUP COPY
                                  MAR 15 2000

                                 Mary Kiffmeyer

                               SECRETARY OF STATE

                                       20

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