Prepared by MERRILL CORPORATION

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F7Mr3Bk8fd97+le4JHx7PgW5Ndjvll5bWL/FjEpipzmh0baYXQ5AoQEwvQeJMuBt Oda6Xdjx2kve65LIBGt2OA== 0000912057-01-528576.txt : 20010815 0000912057-01-528576.hdr.sgml : 20010815 ACCESSION NUMBER: 0000912057-01-528576 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HYBRID NETWORKS INC CENTRAL INDEX KEY: 0000900091 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 770250931 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-23289 FILM NUMBER: 1711852 BUSINESS ADDRESS: STREET 1: 6409 GUADALUPE MINES ROAD CITY: SAN JOSE STATE: CA ZIP: 95120 BUSINESS PHONE: 4083236500 MAIL ADDRESS: STREET 1: 6409 GUADALUPE MINES ROAD CITY: SAN JOSE STATE: CA ZIP: 95120 10-Q 1 a2056568z10-q.htm 10-Q Prepared by MERRILL CORPORATION
QuickLinks -- Click here to rapidly navigate through this document

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

/x/	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2001

/ /	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-23289

HYBRID NETWORKS, INC.
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		77-0252931 (I.R.S. Employer Identification No.)
6409 Guadalupe Mines Road, San Jose, California (Address of principal executive offices)		95120 (Zip Code)

(408) 323-6500
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

Common shares outstanding at June 30, 2001: 22,379,780

HYBRID NETWORKS, INC.

INDEX

PART 1. FINANCIAL INFORMATION		PAGE NO.
ITEM 1.	FINANCIAL STATEMENTS
	Unaudited Condensed Balance Sheets as of June 30, 2001 and December 31, 2000	3
	Unaudited Condensed Statements of Operations for the Three and Six Months Ended June 30, 2001 and 2000	4
	Unaudited Condensed Statements of Cash Flows for the Six Months Ended June 30, 2001 and 2000	5
	Notes to Unaudited Condensed Financial Statements	6
ITEM 2.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	10
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	21
PART II. OTHER INFORMATION
ITEM 2.	CHANGES IN SECURITIES	22
ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K	22
SIGNATURES		23

As used in this report on Form 10-Q, unless the context otherwise requires, the terms "we," "us," "the Company" or "Hybrid" refer to Hybrid Networks, Inc., a Delaware corporation.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HYBRID NETWORKS, INC.

UNAUDITED CONDENSED BALANCE SHEETS

(in thousands, except per share data)

			June 30, 2001			December 31, 2000*
ASSETS
Current assets:
	Cash and cash equivalents		$	3,959		$	1,878
	Accounts receivable, net of allowance for doubtful accounts of $200 in 2001 and 2000 (Includes related party receivables of $599 and $6,164 in 2001 and 2000, respectively)			1,247			7,699
	Inventories (Includes inventory subject to acceptance by related party of $0 and $2,472 in 2001 and 2000, respectively)			4,987			7,303
	Prepaid expenses and other current assets			169			519

		Total current assets		10,362			17,399
Property and equipment, net				1,985			2,000
Intangibles and other assets				943			265

		Total assets	$	13,290		$	19,664

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable			2,138			4,529
	Convertible debenture			5,500			—
	Current portion of capital lease obligations			—			29
	Accrued liabilities and other (Includes deferred revenue from a related party of $0 and $3,710 in 2001 and 2000, respectively)			2,604			6,517

		Total current liabilities		10,242			11,075
Convertible debentures (Includes related party convertible debenture of $1 and $1 in 2001 and 2000, respectively)				2,787			5,501
Other long-term liabilities				135			131

		Total liabilities		13,164			16,707
Stockholders' equity:
	Convertible preferred stock, $.001 par value: Authorized: 5,000 shares; Issued and outstanding: no shares in 2001 or 2000			—			—
	Common stock, $.001 par value: Authorized: 100,000 shares; Issued and outstanding: 22,380 shares in 2001 and 21,935 in 2000			22			22
	Additional paid-in capital			132,484			125,899
	Accumulated deficit			(132,380	)		(122,964	)

		Total stockholders' equity		126			2,957

		Total liabilities and stockholders' equity	$	13,290		$	19,664

*Condensed from audited financial statements

The accompanying notes are an integral part of these condensed financial statements

HYBRID NETWORKS, INC.

UNAUDITED CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

				Three Months Ended June 30,						Six Months Ended June 30,
				2001			2000			2001			2000
Net Sales
	Products (Includes related party sales of $4,943, $0, $9,217 and $0 for the three and six months ended June 30, 2001 and 2000, respectively)			$	5,156		$	2,453		$	9,943		$	3,819
	Services and software (Includes related party sales of $228, $2, $371, and $68 for the three and six months ended June 30, 2001 and 2000, respectively)				309			294			611			605

Total net sales					5,465			2,747			10,554			4,424
Cost of sales
	Products (Includes related party cost of sales of $2,482, $2,169, $7,116, and $2,169 for the three and six months ended June 30, 2001 and 2000, respectively)				3,119			4,105			8,853			5,815
	Services and software				331			200			826			357

Total cost of sales					3,450			4,305			9,679			6,172

Gross margin (loss)					2,015			(1,558	)		875			(1,748	)
Operating expenses:
	Research and development				1,859			1,788			3,743			3,180
	Sales and marketing (Includes related party expense of $0, $1,410, $0, and $3,793 for the three and six months ended June 30, 2001 and 2000, respectively)				757			2,115			1,553			5,120
	General and administrative				1,292			3,533			3,114			6,658

		Total operating expenses			3,908			7,436			8,410			14,958

			Loss from operations		(1,893	)		(8,994	)		(7,535	)		(16,706	)
Interest income and other expense, net (Includes expense for inducement to convert related party convertible debenture of $0, $711, $0, and $711 for the three and six months ended June 30, 2001 and 2000, respectively)					68			(1,208	)		91			(999	)
Interest expense (Includes related party interest expense of $0, $158, $0, and $314 for the three and six months ended June 30, 2001 and 2000, respectively)					(1,317	)		(465	)		(1,973	)		(924	)

	NET LOSS				(3,142	)		(10,667	)		(9,417	)		(18,629	)
Other comprehensive loss:
	Realized gain on available-for-sale securities included in net loss				—			(10	)		—			(66	)

		Total comprehensive loss		$	(3,142	)	$	(10,677	)	$	(9,417	)	$	(18,695	)

Basic and diluted net loss per share				$	(0.14	)	$	(0.73	)	$	(0.42	)	$	(1.30	)

Shares used in basic and diluted per share calculation					22,304			14,602			22,181			14,297

The accompanying notes are an integral part of these condensed financial statements

HYBRID NETWORKS, INC.

UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

			Six Months Ended June 30,
			2001			2000
Cash flows from operating activities:
	Net loss		$	(9,417	)	$	(18,629	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation and amortization		688			572
		Amortization of discount relative to convertible debenture		1,125
		Sales discounts recognized on issuance of warrants to a related party		—			5,943
		Stock for services		30			—
		Common stock issued to induce conversion of debenture (Includes expense for inducement to convert related party convertible debenture)		—			1,170
		Compensation recognized on issuance of stock and stock options		265			2,281
		Interest added to principal of convertible debentures (Includes interest to a related party of $0 and $224 for the six months ended June 30, 2001 and 2000, respectively)		162			368
		Provision for excess and obsolete inventory		(424	)		235
		Beneficial conversion of convertible debentures		—			149
		Change in unrealized gain on securities		—			(66	)
	Change in assets and liabilities:			—			—
		Accounts receivable		6,452			(1,326	)
		Inventories		2,740			(498	)
		Prepaid expenses and other assets		(532	)		116
		Accounts payable		(2,392	)		182
		Other long term liabilities		4			4
		Accrued liabilities and other		(3,912	)		2,503

	Net cash used in operating activities			(5,211	)		(6,996	)

Cash flows from investing activities:
	Purchase of short term investments			—			(1,166	)
	Purchase of property and equipment			(469	)		(206	)

		Net cash used in investing activities		(469	)		(1,372	)

Cash flows from financing activities:
	Proceeds from issuance of convertible debenture			7,500			—
	Repayment of capital lease obligations			(29	)		(213	)
	Net proceeds from issuance of common stock			290			676

		Net cash provided by financing activities		7,761			463

Increase (Decrease) in cash and cash equivalents				2,081			(7,905	)
Cash and cash equivalents, beginning of period				1,878			13,394

Cash and cash equivalents, end of period			$	3,959		$	5,489

SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES:
	Common stock issued upon conversion of convertible debentures		$	—		$	18,694
	Discount relative to convertible debenture			4,874			—
	Common stock issued to settle class action liability			—			1,303
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
	Interest paid			484			514
	Income taxes paid			—			—

The accompanying notes are an integral part of these condensed financial statements.

HYBRID NETWORKS, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

BASIS OF PRESENTATION

The accompanying condensed financial statements of Hybrid Networks, Inc. (the "Company" or "Hybrid") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The balance sheet as of June 30, 2001, the statements of operations for the three and six months ended June 30, 2001 and June 30, 2000 and the statements of cash flows for the six month periods ended June 30, 2001 and June 30, 2000, are unaudited but include all adjustments (consisting only of normal recurring adjustments) which the Company considers necessary for a fair presentation of the financial position at such dates and the operating results and cash flows for those periods. Although the Company believes that the disclosures in the accompanying financial statements are adequate to make the information presented not misleading, certain information normally included in financial statements and related footnotes prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The December 31, 2000 condensed balance sheet data included herein were derived from audited financial statements but do not include all disclosures required by generally accepted accounting principles. The accompanying financial statements should be read in conjunction with the financial statements as contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2000.

Results for any interim period are not necessarily indicative of results for any other interim period or for the entire year.

The Company was organized in 1990 and has had operating losses since then. The Company's accumulated deficit was $132,380,000 as of June 30, 2001 and $122,964,000 as of December 31, 2000. In 1997, we raised $42.5 million in net proceeds through our initial public offering and other debt and equity financing. In September 1999, we raised $18.1 million through the issuance and sale of convertible debentures to Sprint Corporation and certain venture capital sources. In February 2001, we issued and sold to a fund managed by the Palladin Group L.P., $7.5 million in convertible debentures. This transaction also included a common stock Purchase Warrant which would, under certain conditions, provide up to an additional $7.5 million to the Company. Other than the agreement with Palladin, as of June 30, 2001, we have no available line of credit or other source of borrowings or financing. We believe that, with respect to our current operations, our cash balance, after giving effect to the financing completed in February 2001, plus revenues from operations and non-operating cash receipts will be sufficient to meet our working capital and expenditure needs through 2001. We may seek additional financing during 2001 through debt, equity or equipment lease financing, or through a combination of financing vehicles. There is no assurance that additional financing will be available to us on acceptable terms, or at all, when we require it.

REVENUE RECOGNITION

related to shipments to distributors is normally recognized upon receipt of payment for such transactions. As of June 30, 2001 the total amount of shipments not recognized as revenue due to acceptance or testing criteria or because they were sold to a distributor was $212,000.

We generally sell our software together with a one-year technical support contract, for which we charge separately, to provide upgrades, maintenance, system support and service. We recognize revenue on the software sale without reference to the maintenance contract, and we recognize revenue on the technical support contract over its term on a straight-line basis. Other service revenue, primarily training, is generally recognized at the time the service is performed.

In September 1999, Sprint committed to purchase $10 million of our products subject to certain conditions. In connection with Sprint's commitment, we issued to Sprint warrants to purchase up to $8,397,873 in debentures that are convertible into 2,946,622 shares of our common stock at $2.85 per share. In accordance with the Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," transactions in equity instruments with non-employees for goods or services are accounted for using the fair value method prescribed by SFAS 123. SFAS 123 requires that in each period in which the warrants are earned, a non-cash charge is to be recorded. Using the Black-Scholes valuation model, we determined that the estimated value of the warrant was $20.8 million. We applied $7.2 million of this amount as sales discounts during the four quarters of 2000 and the balance of $13.6 million was charged as an expense of the Sales and Marketing department over the first three quarters of 2000. There were no charges related the Sprint purchase warrants in the quarter ending June 30, 2001.

CONVERTIBLE DEBENTURES

We have outstanding a senior secured convertible debenture in the face amount of $5.5 million due in April 2002 and bearing interest at 12% per annum, payable quarterly. The conversion price is subject to weighted average antidilution provisions whereby, if we issue shares in the future for consideration below the existing conversion price, then (with certain exceptions) the conversion price will automatically be decreased, allowing the holder of the debenture to receive additional shares of common stock upon conversion.

Under a securities purchase agreement between us and the Halifax Fund, a fund managed by the Palladin Group, we issued and sold to the Halifax Fund on February 16, 2001 securities, including:

•: a $7.5 million principal amount 6% convertible debenture due 2003, which was convertible into shares of our common stock;
•: a common stock purchase warrant to purchase 833,333 shares of common stock at $9.00 per share (subject to adjustment) which is exercisable at the election of the Halifax Fund, or at our election at a price per share equal to the lower of $9.00 or 94% of the daily volume weighted average price;
•: an adjustment warrant.

In consideration for such securities, Halifax paid an initial purchase price of $7.5 million. We granted to Halifax in the purchase agreement, rights of first refusal, preemptive rights and other rights. Pursuant to the purchase agreement, we also entered into a Registration Rights Agreement with Halifax.

On August 13, 2001, Halifax entered into an exchange agreement with the Company to exchange the $7.5 million debenture for 6% Cumulative Convertible Preferred Stock, amend the Registration Rights Agreement, and eliminate the previously issued adjustment warrant. The existing 6% convertible debenture and accompanying adjustment warrant will be exchanged for that number of shares equal to $7.5 million, plus accrued but unpaid interest, divided by the $1,000 face value of the newly designated

$.001 par value Preferred Stock which will accrete in value at a rate of 6% per annum. Such accretions will compound on June 30 and December 31 of each year until converted or redeemed.

The preferred stock is convertible into common stock at the Conversion Price. The Conversion Price is $1.25 for the conversion of the first 1,875 shares of preferred stock. The Conversion Price for the remaining 5,685 shares, is equal to the sum of a floor price plus one-half of the excess of the then-current market price of Hybrid's common stock over the floor price. The floor price will be determined not later than April 1, 2002, and will be based on average market prices during a specified pricing period proximate to the date of fixing the floor price. The floor price cannot be less than $1.25 per share, resulting in a maximum number of 6 million common shares (before giving effect to liquidation value accretion) to be issued on conversion. The floor price cannot be greater than $5.00 per share. The preferred stock is also subject to forced conversion and early redemption by Hybrid in certain instances, subject to limits on the number of shares to be issued at any one time. The preferred shares are also subject to premium redemption at the holder's election in the event of a change in control. In addition, the transaction documents contain provisions for the payment of penalties and/or reductions of the conversion rates if Hybrid does not satisfy various contract provisions. Among other things, Hybrid is required to complete a resale registration statement for the common shares underlying the preferred shares and purchase warrant not later than October 16, 2001, and maintain listing of our common stock on an approved market.

On February 16, 2006, if not previously converted, the Preferred Shares will automatically be redeemed, with the holders having the right to delay redemption for up to one year. The redemption price is in be paid in cash, but Hybrid may elect, provided certain conditions are satisfied, to pay the redemption price in shares of common stock, valued at 95% of the average of the daily volume-weighted average sales price for the 30 days prior to and 30 days subsequent to the anniversary date.

Assuming certain conditions are met, we may require Halifax to convert the Preferred Shares if the closing price for our stock is at least $6.3212 per share for 20 out of 30 consecutive days or on any day on which the prior day's closing bid price of the stock was at least 120% of the then current conversion price subject to certain restrictions. The number of shares that can be forcibly converted is subject to limits on the number of common shares that the holder owns at any one time.

Under the related agreements, we must comply with certain covenants including, but not limited to, certain prohibitions on incurring debt, issuing dividends, and repurchasing shares, redeeming the Halifax Preferred Stock at 120% of market value upon any change in control, and issuing any senior or pari passu preferred stock.

COMPUTATION OF BASIC AND DILUTED LOSS PER SHARE

Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. All such securities or other contracts were anti-dilutive for all periods presented and, therefore, excluded from the computation of earnings per share.

INVENTORIES

Inventories are comprised of the following (in thousands):

	June 30, 2001		December 31, 2000
Raw materials	$	3,088	$	2,633
Work in progress		1,214		1,144
Finished goods		685		3,526

	$	4,987	$	7,303

At June 30, 2001 and December 31, 2000, finished goods inventory included $94,000 and $2,730,000, respectively, of equipment that had been shipped to customers but for which the related revenue was deferred pending final customer acceptance.

The allowance for excess and obsolete inventory was $1,556,000 and $1,980,000 at June 30, 2001 and December 31, 2000, respectively. The provision for excess and obsolete inventory included in cost of sales was $530,000 and $235,000 for the six months ended June 30, 2001 and for the year ended December 31, 2000, respectively.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion in this Item should be read in conjunction with the Condensed Financial Statements and the Notes thereto included in Item 1 of this report on Form 10-Q. The discussion in this Item contains forward-looking statements relating to future events or financial results, such as statements indicating that "we believe," "we expect," "we anticipate" or "we intend" that certain events may occur or certain trends may continue. Other forward-looking statements include statements about the future development of products or technologies, matters relating to our proprietary rights, facilities needs, our liquidity and capital needs and other statements about future matters. All these forward-looking statements involve risks and uncertainties. You should not rely too heavily on these statements; although they reflect the good faith judgment of our management, they involve future events that might not occur. We can only base such statements on facts and factors that we currently know. Our actual results could differ materially from those in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors" and elsewhere in this report on Form 10-Q.

OVERVIEW

GENERAL

We are a broadband access equipment company that designs, develops, manufactures and markets wireless systems that provide high-speed access to the Internet for businesses and consumers. Our products greatly accelerate the response time for accessing bandwidth-intensive information. Since 1996, our principal product line has been the Hybrid Series 2000, which consists of head end routers, network and subscriber management tools and a line of wireless end-user routers or modems.

We currently sell our products primarily in the United States and Canada, although we are pursuing opportunities in other countries and we think that international sales may represent an increasingly greater proportion of our sales in the future. Our customers primarily include broadband wireless system operators and national and regional telephone companies. A small number of customers have accounted for a substantial portion of our net sales, and we expect that trend to continue. As a result, we have experienced, and expect to continue to experience, significant fluctuations in our results of operations on a quarterly and an annual basis. The sales cycle for our products has been lengthy, and is subject to a number of significant risks, including customers' budgetary constraints and internal acceptance reviews. Any delay or loss of an order that is expected in a quarter can have a major effect on our sales and operating results for that quarter. The same is true of any failure of a customer to pay for products on a timely basis.

The market for high-speed network connectivity products and services is intensely competitive and is characterized by rapid technological change, new product development, product obsolescence, and evolving industry standards. Our ability to develop and offer competitive products on a timely basis could have a material effect on our business. The market for our products has historically experienced significant price erosion over the life of a product, and we have experienced, and expect to continue to experience, pressure on our unit average selling prices. While we have initiated cost reduction programs to offset pricing pressures on our products, there can be no assurance that we will keep pace with competitive price pressures or improve our gross margins. Further, we anticipate that in the future the sales mix of our products will be increasingly weighted toward lower-margin products, thereby adversely affecting our gross margins.

At June 30, 2001, we had 73 full-time employees and 4 part time employees.

REVENUE RECOGNITION

We normally ship our products based upon a bona fide purchase order and volume purchase agreement. We recognize revenue at the time a transaction is shipped and collection of the resulting account receivable is probable. Shipments on customer orders with acceptance criteria, installation criteria or rights of return are recognized as revenue only when the criteria are satisfied. Revenue related to shipments to distributors is normally recognized upon receipt of payment for such transactions. As of June 30, 2001 the total amount of shipments not recognized as revenue due to acceptance or testing criteria or because they were sold to a distributor was $212,000.

We generally sell our software together with a one-year technical support contract, for which we charge separately, to provide upgrades, maintenance, system support and service. We recognize revenue on the software sale without reference to the maintenance contract, and we recognize revenue on the technical support contract over its term on a straight-line basis. Other service revenue, primarily training and consulting, is generally recognized at the time the service is performed.

RESULTS OF OPERATIONS

NET SALES. Our net sales increased by 99% to $5,465,000 for the quarter ended June 30, 2001 from $2,747,000 for the quarter ended June 30, 2000. The increase was due primarily to final acceptance of base station equipment that was shipped to Sprint in prior periods in the amount of $4,907,000, and the recognition of revenue from that sale, which was subject to acceptance criteria. For the three months ended June 30, 2001, broadband wireless systems operators accounted for 100% of net sales. During the same period in 2000, broadband wireless system operators accounted for 75% of net sales and cable system operators accounted for 25% of net sales. One customer, Sprint Corporation, accounted for 90% of net sales during the second quarter of 2001 compared to three customers who accounted for 52%, 22%, and 8% of net sales during the second quarter of 2000. International sales accounted for less than 1% of net sales during the three months ended June 30, 2001, and 52% for the comparable period in 2000.

GROSS MARGIN. Gross margin was a positive 37% and a negative 57% of net sales for the quarters ended June 30, 2001 and 2000, respectively. The increase in gross margin was primarily due to the higher ratio of base station equipment to CPE's in the sales mix for the period. In the second quarter of 2001, 91% of net sales were in higher margin base station equipment compared to 18% in the comparable period in 2000.

RESEARCH AND DEVELOPMENT. Research and development expenses include ongoing head end, customer premises,equipment, and software development expenses, as well as expenditures associated with cost reduction programs for existing products. Research and development expenses increased 4% to $1,859,000 for the quarter ended June 30, 2001 from $1,788,000 for the quarter ended June 30, 2000. Research and development expenses as a percentage of net sales were 34% and 65% for the second quarters of 2001 and 2000, respectively. Personnel and related costs increased $358,000 during the quarter ending June 30, 2001 compared to the second quarter of 2000.

SALES AND MARKETING. Sales and marketing expenses consist of salaries and related payroll costs for sales and marketing personnel, commissions, advertising, promotions, and travel. Sales and marketing expenses decreased 64% to $757,000 for the quarter ended June 30, 2001 from $2,115,000 for the quarter ended June 30, 2000. Sales and marketing expenses as a percentage of net sales were 14% and 77% for the second quarters of 2001 and 2000, respectively. Personnel and related costs decreased by $44,000 during the quarter. The largest component of the sales and marketing expenses for the second quarter of 2000 was the non-cash discount of $1,410,000 resulting from scheduled shipments to Sprint during the quarter. This discount and the related sales discount are described under the heading "Revenue Recognition" above.

GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of executive personnel compensation,, travel expenses, legal fees and other costs of outside services. General and administrative expenses decreased 63% to $1,292,000 for the quarter ended June 30, 2001 from $3,533,000 for the quarter ended June 30, 2000. General and administrative expenses as a percentage of net sales were 24% and 129% for the second quarters of 2001 and 2000, respectively. The decline in general and administrative expenses for the second quarter of 2001 was due primarily to a reduction in legal expenses during the period. Legal expenses were $272,000 and $2,170,000 for the three months ending June 30, 2001 and June 30, 2000, respectively. Personnel and related costs decreased by $205,000 during the quarter.

INTEREST INCOME (EXPENSE) AND OTHER EXPENSE, NET. We incurred net interest expense of $1,249,000 for the three months ended June 30, 2001 compared to net interest expense of $1,673,000 for the three months ended June 30, 2000. Interest expense during the second quarter of 2001 included:

•: Interest on debentures of $425,000.
•: Amortization of loan fees related to the debenture of $141,000.
•: Amortization of the discount related to the debenture of $750,000.

We expect to incur substantial interest and amortization expense until the $7.5 million debenture is converted, at which time the unamortized discount and fees will be recognized in full.

LIQUIDITY AND CAPITAL RESOURCES

We have historically financed our operations primarily through a combination of debt, equity and equipment lease financing. In 1997, we raised $42.5 million in net proceeds through our initial public offering (in November 1997) and other debt and equity financing. In September 1999, we raised $18.1 million through the issuance and sale of convertible debentures to Sprint (in the amount of $11.0 million) and certain venture capital sources (in the amount of $7.1 million). During the quarter ended June 30, 2000, at the request of the Company, the holders agreed to convert the entire principal, amounting to a face value of $18.1 million plus accrued interest through June 30, 2000 of $594,000, into 6,559,310 shares of common stock. Upon the conversion, we paid a premium, as an inducement to the holder's, equivalent to the interest that would have been added to the principal of the debentures for the third and fourth quarters of 2000, amounting to $375,750. The premium was paid in the form of additional shares of common stock calculated at the conversion price of $2.85 per share and was equivalent to 131,842 shares of common stock.

Additionally, Sprint acquired warrants to purchase up to $8.4 million of additional convertible debentures, which debentures were convertible at December 31, 2000 into 2,946,622 shares of common stock common stock, on the same terms as the convertible debentures referred to above. The warrants were issued in consideration for Sprint's obligation to accept shipments of at least $10 million of our products. The amount of shipments in 2000 totaled at least $10,000,000. In accordance with the Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," transactions in equity instruments with non-employees for goods or services are accounted for using the fair value method prescribed by SFAS 123. SFAS 123 requires that in each period in which the warrants are earned, a non-cash charge is to be recorded. Using the Black-Scholes valuation model, we determined that the estimated value of the warrant was $20.8 million. We applied $7.2 million of this amount as sales discounts during the four quarters of 2000 and the balance of $13.6 million was charged as an expense of the Sales and Marketing department over the first three quarters of 2000. There were no charges relating to the Sprint purchase warrants in the quarter ending June 30, 2001.

Assuming that as of June 30, 2001, Sprint exercised all its warrants, it would own 7,013,068 shares of our common stock, representing approximately 27.7% of the 25,294,089 shares of our common stock that would then be outstanding (assuming no other security holders exercised their options, warrants or conversion privileges). On a fully diluted basis, assuming that as of June 30, 2001 all other security holders exercised their options, warrants and conversion privileges as well as Sprint, Sprint would own approximately 19.8% of the 35,344,311 fully diluted shares of our common stock that would then be outstanding.

In addition to the above financing, we have outstanding a senior secured convertible debenture in the face amount of $5.5 million due in April 2002 and bearing interest at 12% per annum, payable quarterly. The conversion price is subject to weighted average antidilution provisions whereby, if we issue shares in the future for consideration below the existing conversion price, then (with certain exceptions) the conversion price will automatically be decreased, allowing the holder of the debenture to receive additional shares of common stock upon conversion.

Under a securities purchase agreement between us and the Halifax Fund, a fund managed by the Palladin Group, we issued and sold to the Halifax Fund on February 16, 2001 securities, including:

•: a $7.5 million principal amount 6% convertible debenture due 2003, which was convertible into shares of our common stock;
•: a common stock purchase warrant to purchase 833,333 shares of common stock at $9.00 per share (subject to adjustment) which is exercisable at the election of the Halifax Fund, or at our election at a price per share equal to the lower of $9.00 or 94% of the daily volume weighted average price;
•: an adjustment warrant.

the preferred shares and purchase warrant not later than October 16, 2001, and maintain listing of our common stock on an approved market.

Net cash used in operating activities was $5,211,000 and $6,996,000 during the second half of 2001 and 2000, respectively. The net cash used in operating activities in the second half of 2001 was primarily due to our net loss of $9,417,000, a decrease in accounts payable of $2,392,000, and an offsetting decrease in accounts receivable of $6,452,000. Net cash used in operating activities in the second half of 2000 was primarily the result of our net loss of $18,629,000, an increase in accounts receivable of $1,326,000 and an increase in other accrued liabilities of $2,503,000, offset by non-cash charges attributable to (i) sales discounts recognized on the issuance of warrants of $5,943,000 (see "Revenue Recognition"), (ii) compensation of $2,281,000 recognized on the issuance of stock and the vesting of stock options and (iii) a decrease in the provision for excess and obsolete inventory of $235,000.

Net cash used in investing activities was $469,000 and $1,372,000 during the second half of 2001 and 2000, respectively, and was used in both periods for purchases of property and equipment (primarily computers, and engineering test equipment). At June 30, 2001, we did not have any material commitments for capital expenditures.

Net cash provided by financing activities was $7,761,000 and $463,000 during the second half of 2001 and 2000, respectively. Net cash provided by financing activities during the second half of 2001 was primarily due to the $7,500,000 convertible debenture issued in February 2001. Net cash provided by financing activities during the second half of 2000 was primarily due to the exercise of stock options by employees and others, offset by the repayment of capital lease obligations.

At June 30, 2001, the Company's liquidity consisted of cash and cash equivalents of $3,959,000 and working capital of $120,000. The Company's principal indebtedness consisted of $5,500,000 in convertible debentures due in April 2002 and $7,662,000 in convertible debentures due in February 2003. We have no available line of credit or other source of borrowings or financing. While we believe that, with respect to our current operations, our cash balance, plus revenues from operations and non-operating cash receipts will be sufficient to meet our working capital and expenditure requirements over the balance of 2001, we may seek additional financing during 2001 through debt, equity or equipment lease financing, or through a combination of financing vehicles. There is no assurance that additional financing will be available to us on acceptable terms, or at all, when we require it.

SEASONALITY AND INFLATION

We do not believe that our business is seasonal or is impacted by inflation.

RISK FACTORS

AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW AND THE OTHER INFORMATION IN THIS REPORT ON FORM 10-Q BEFORE INVESTING IN OUR COMMON STOCK. THE RISKS DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE NOT AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY BECOME IMPORTANT FACTORS THAT AFFECT OUR BUSINESS. IF ANY OF THE FOLLOWING RISKS OCCUR, OR IF OTHERS OCCUR, OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION COULD BE SERIOUSLY HARMED AND THE PRICE OF OUR COMMON STOCK COULD DECLINE.

WE EXPECT THAT WE WILL NEED ADDITIONAL CAPITAL TO CONTINUE OUR OPERATIONS

Although we raised over $35 million in net proceeds from our initial public offering in November 1997, our capital resources were nearly exhausted by September 1999. In September 1999, we raised $18.1 million through the issuance and sale of convertible debentures. In February 2001, we entered an agreement with the Halifax Fund, L.P., under which we have raised $7.5 million. We believe we have sufficient capital to continue operations through the year 2001. However, we expect that we will need to raise additional cash in the future to support further growth in our business. If we engage in research and development under our agreement with Sprint, we may need additional capital.

Our ability to raise additional capital may be limited by a number of factors, including:

•: Sprint's veto rights, right of first refusal and other substantial rights and privileges,
•: Halifax's substantial rights and privileges,
•: our dependence upon Sprint's business and, to a lesser extent, the business of our other customers,
•: uncertainties and concerns resulting from our past financial reporting difficulties, class action litigation and related issues,
•: our need to increase our work force quickly and effectively and to reduce the cost of our existing products and develop new products,
•: uncertainty about our financial condition and results of operations and,
•: our history of heavy losses,

We can give no assurance that we will be able to raise the additional capital we will need in the future. Further, any financing we may be able to obtain may be on terms that are harmful to our business and our ability to raise additional capital. We may not have sufficient capital or other resources necessary to meet the requirements of our equipment purchase agreements with Sprint or with other large customers in the future.

WE ARE LARGELY DEPENDENT ON SPRINT FOR OUR FUTURE BUSINESS, AND SPRINT HAS A GREAT DEAL OF INFLUENCE OVER OUR CORPORATE GOVERNANCE.

We expect that a substantial portion of our future business will primarily come from wireless customers who hold spectrum license rights. Sprint has acquired a significant portion of the wireless spectrum licenses in the United States, so our future business will be substantially dependent upon orders from Sprint. Sprint accounted for 84% of our gross sales in the quarter ending March 31, 2001 and 90% of our gross sales in the quarter ending June 30, 2001. Sprint uses our products in its initial offering of wireless Internet access services. We have only a small number of other customers.

Sprint also has significant control over our corporate governance. For example, Sprint may designate two directors to serve on our board of directors. Further, we cannot issue any securities, with limited exceptions, or, in most cases, take important corporate action without Sprint's approval. Sprint has other rights and privileges, including a right of first refusal as to any proposed change in our control. This right of first refusal is assignable by Sprint to any third party. Further, if Sprint exercises warrants it currently holds, and assuming that no other warrant holders exercise, Sprint would beneficially own as of June 30, 2001, approximately 27.7% of our common stock. As a result, Sprint will have a great deal of influence on us in the future. We cannot be sure that Sprint will exercise this influence in our best interests, as Sprint's interests are in many respects different than ours.

We have entered into an equipment purchase agreement with Sprint that imposes substantial requirements on us. We must:

•: meet Sprint's schedule for the manufacture and shipment of products;
•: satisfy commitments for product development;
•: satisfy installation and maintenance obligations; and
•: license our technology to specified third parties.

Sprint's obligation to purchase our products is subject to extensive testing and acceptance procedures. If we fail to meet the requirements of the agreement, we could be subject to heavy penalties, including the obligation to license our intellectual property rights to Sprint on a royalty-free basis. Sprint may also gain access to the key source code of our products.

CHANGES IN PLANS OR CIRCUMSTANCES AT OUR LARGEST CUSTOMERS COULD SERIOUSLY HARM OUR SALES.

In late 2000, Sprint, our largest customer for that year, completed a reorganization of its operations including the business to which we sell our products. As part of this reorganization, Sprint announced that it was focusing its broadband efforts in 14 geographical markets in the residential and small business areas. In light of these plans, we have sold a relatively smaller amount of our higher margin base station equipment to Sprint as compared to our earlier plans. Further changes in their business plan to stretch out or delay implementation of service in these markets could further reduce our sales and harm our business.

In late 2000, Look Communications, our second largest customer for that year, encountered difficulties in securing additional financing to support the continued growth of its operations. We believe that Look Communications is exploring alternatives to obtaining additional financing but cannot be sure that it will succeed. We had negligible sales to Look Communication during the six months ending June 30, 2001.

WE HAVE NOT BEEN PROFITABLE, AND WE MAY NEVER BE PROFITABLE. WE EXPECT CONTINUING LOSSES IN THE FUTURE.

We have not been profitable and we cannot assure you that we will ever achieve or sustain profitability. We were organized in 1990 and have had operating losses every year. Our accumulated deficit was $132 million as of June 30, 2001. The potential of our business to produce revenue and profit is unproven. The market for our products has only recently begun to develop and is rapidly changing. Our market has an increasing number of competing technologies and competitors, and several of our competitors are significantly larger than us. We have experienced pressure to lower the price of our products in the past and we expect that these pressures will continue. We expect to incur losses in the future.

WE MUST BE ABLE TO QUICKLY AND EFFECTIVELY DEVELOP NEW PRODUCTS AND ENHANCEMENTS FOR OUR EXISTING PRODUCTS, AND DEPLOY OUR PRODUCTS ON A MUCH LARGER SCALE THAN WE HAVE IN THE PAST. WE MIGHT NOT BE ABLE TO MEET THESE CHALLENGES.

To meet the existing and future demands of the broadband wireless market, we must develop new products and enhance our existing products. Further, Sprint and other potential large scale customers require us to successfully deploy our system to an ever increasing number of users. We might not be able to meet these challenges.

Sprint and other customers are working to reduce the cost of residential customer equipment installation with a goal of end user self install. This requires the ability to deploy equipment in locations that do not have direct line-of-sight to the wireless operator's antenna. We are developing products to serve this requirement. If another company is successful in meeting this need before we do, our business will be harmed.

WE DEPEND ON THE BROADBAND WIRELESS MARKET, WHICH IS A NEWLY DEVELOPING MARKET THAT IS SUBJECT TO UNCERTAINTIES.

Before 2000, over half our sales were to cable customers. The cable industry has now developed a standard known as the Data Over Cable System Interface Specification. Our products do not conform to this standard, and we have experienced substantially reduced sales to cable customers. We are now focusing our business on the wireless industry, which is new and subject to uncertainties.

The wireless industry competes with other technologies, including cable and digital subscriber lines to provide high-speed Internet access. The cable and digital subscriber line technologies avoid the principal disadvantage of wireless, which requires direct line-of-sight between the wireless operator's antenna and the customer's location. Wireless system operators also face a number of licensing and regulatory restrictions. Conditions in the wireless market could change rapidly and significantly from technological changes. Further, the development and market acceptance of alternative technologies could decrease the demand for our products or make them obsolete. There can be no assurance that the wireless industry market will grow or that our products will be accepted in the emerging market. We expect to face substantial competition in this market, which could limit our sales and impair our business.

In addition, during the first six months of 2001, the market for telecommunications equipment declined significantly, which has adversely affected the entire telecommunications industry, including service providers, systems integrators, and equipment providers, and has reduced the business outlook and visibility of the industry. If the telecommunications market, and in particular the market for broadband access equipment, does not improve and grow, our business would be substantially harmed.

WE FACE SIGNIFICANT COMPETITION, INCLUDING COMPETITION FROM LARGE COMPANIES.

Our market is intensely competitive, and we expect even more competition in the future. Several of our competitors are substantially larger and have greater financial, technical, marketing, distribution, customer support, name recognition, and access to customers, than we have. One of our principal competitors, Cisco, has recently announced that it has a competitive wireless technology that will offer cost effective performance and will operate successfully in environments in which it is difficult to obtain a line-of-sight between the customer's location and the wireless operators' antennae. Cisco's system may provide benefits superior to ours. We believe that other companies also have similar products under development. Further, our product development may be harmed by our lack of engineering resources. There can be no assurance that we will be able to compete successfully in the future.

We have agreed with Sprint that in the future we will allow third parties to license our technology. These third parties may offer products that compete with ours, using our technology. This could create significant new competitive challenges for us. Our business depends upon the technical success and working relationships of companies that produce other parts of our system. These companies may decide to compete with us in the future, which could limit our growth and harm our business.

WE MAY BECOME INVOLVED IN LITIGATION OVER OUR INTELLECTUAL PROPERTY WHICH COULD RESULT IN SIGNIFICANT COSTS AND MIGHT DIVERT THE ATTENTION OF OUR MANAGEMENT.

Litigation may be necessary in the future to enforce our intellectual property rights, to determine the validity and scope of our patents, and to determine the validity and scope of the proprietary rights of others. This litigation might result in substantial costs and could divert the attention of our management. Further, others may claim that our products infringe upon their proprietary rights. These claims, with or without merit, could result in significant litigation costs, diversion of the attention of our management and serious harm to our business. We may be required to enter into royalty and license agreements that may have terms that are disadvantageous to us. If litigation is successful against us, it could result in the invalidation of our proprietary rights and our incurring liability for damages, which could have a harmful effect on our business. In the past, we initiated one patent infringement litigation to enforce our patent rights. This litigation resulted in a settlement in which we granted licenses to the defendants containing terms that are in some respects favorable to them. For example, we granted to one of the defendants, Com21, Inc., a right of first refusal to purchase our patents. We may find it necessary to institute further infringement litigation, and third parties may institute litigation against us challenging the validity of our patents.

MARKET PRESSURE TO REDUCE THE PRICE OF OUR PRODUCTS HAS HURT OUR BUSINESS, AND THE PRESSURE IS LIKELY TO INCREASE.

We have experienced pressure from our customers, including Sprint, to lower prices for our products, and we expect that this pressure to lower the prices of our products will continue and increase. Market acceptance of our products, and our future success, will depend in part on reductions in the unit cost of our products. Our ability to reduce our prices has been limited by several factors, including our reliance on one manufacturer of our modems and on limited sources for other components of our products. Our research and development efforts seek to reduce the cost of our products through design and engineering changes. We have no assurance that we will be able to redesign our products to achieve substantial cost reductions or that we will otherwise be able to reduce our manufacturing and other costs. Any reductions in cost may not be sufficient to improve our gross margins, which must substantially improve for us to operate profitably.

WE RELY ON A SINGLE MANUFACTURER FOR OUR END-USER PRODUCTS AND ON LIMITED SOURCES FOR OUR COMPONENTS, SOME OF WHICH ARE BECOMING OBSOLETE.

We outsource manufacturing of our Series 2000 modem products to a single manufacturer, Sharp Corporation, while maintaining only a limited manufacturing capability for pre-production assembly and testing. Since we have only one manufacturing source for our modems, our ability to reduce our manufacturing costs may be limited.

We are dependent upon key suppliers for a number of components within our Series 2000 products, including Texas Instruments, Hitachi, and Intel. There can be no assurance that these and other single-source components will continue to be available to us, or that deliveries to us will not be interrupted or delayed due to shortages. Having single-source components also makes it more difficult for us to reduce our costs for these components and makes us vulnerable to price increases by the

component manufacturer. Any significant interruption or delay in the supply of components for our products or any increase in our costs for components could seriously harm our business.

OUR LONG SALES CYCLE MAKES IT DIFFICULT FOR US TO FORECAST REVENUES, REQUIRES US TO INCUR HIGH SALES COSTS AND AGGRAVATES FLUCTUATIONS IN QUARTERLY OPERATING RESULTS. OUR SALES CYCLE MAY GET LONGER.

The sale of our products typically takes between six and twelve months. Customers usually want to perform significant technical evaluation before making a purchase. There are often delays resulting from our customers' internal procedures to approve the large capital expenditures that are typically involved in purchasing our products. This makes it difficult for us to predict revenue. Since we incur sales costs before we make a sale or recognize related revenues, the length and uncertainty of our sales cycle increases the volatility of our operating results because we have high costs without offsetting revenues. Over the last year, our industry has consolidated so that our principal and potential customers are large service providers, including telecommunications companies. These larger customers tend to have longer and more exhaustive review and testing processes, which have increased our selling expenses and lengthened our sales cycle.

INTERNATIONAL SALES COULD INVOLVE GREATER RISKS.

Although we have sold our products primarily in the United States and Canada, we are pursuing opportunities in other countries. We believe that international sales may represent an increasingly greater proportion of our sales in the future. International sales accounted for less than 1% and 30% of gross sales for the quarters ending June 30, 2001 and 2000, respectively. International sales will be subject to a number of risks, including longer payment cycles, export and import restrictions, foreign regulatory requirements, greater difficulty in accounts receivable collection, potentially adverse tax consequences, political and economic instability and reduced intellectual property protection. To increase our international coverage we rely on value added resellers, commonly known as VARs, or integrators. These VARs may not remain our exclusive distributors. They also compete with each other in some areas so it may be difficult for us to protect our international distribution channels. Further, the frequency spectrum and amount of spectrum available internationally varies from country to country. We will depend on our VARs to develop radio equipment that complies with local licenses, which may slow deployment in some international markets.

WE DEPEND ON OUR KEY PERSONNEL, AND HIRING AND RETAINING QUALIFIED EMPLOYEES IS DIFFICULT.

Our success depends in significant part upon the continued services of our key technical, sales and management personnel. Our officers or employees can terminate their relationships with us at any time. Our future success also depends on our ability to attract, train, retain and motivate highly qualified technical, marketing, sales and management personnel. There can be no assurance that we will be able to attract and retain key personnel. The loss of the services of one or more of our key personnel or our failure to attract additional qualified personnel could prevent us from meeting our product development goals and could significantly impair our business.

WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY.

We rely on a combination of patent, trade secret, copyright and trademark laws and contractual restrictions to establish and protect our intellectual property rights. We cannot assure that our patents will cover all the aspects of our technology that require patent protection or that our patents will not be challenged or invalidated, or that the claims allowed in our patents may not be of sufficient scope or strength to provide meaningful protection or commercial advantage to us. We initiated one patent infringement lawsuit to enforce our rights, which resulted in a settlement. We do not know whether we

will need to bring litigation in the future to assert our patent rights, or whether other companies will bring litigation challenging our patents. This litigation could be time consuming and costly and could result in our patents being held invalid or unenforceable. Even if the patents are upheld or are not challenged, third parties might be able to develop other technologies or products without infringing any of these patents.

We have entered into confidentiality and invention assignment agreements with our employees, and we enter into non-disclosure agreements with some of our suppliers, distributors, and customers, to limit access to and disclosure of our proprietary information. These contractual arrangements or the other steps we take to protect our intellectual property may not be sufficient to prevent misappropriation of our technology or deter independent third-party development of similar technologies. The laws of foreign countries may not protect our products or intellectual property rights to the same extent, as the laws of the United States.

We have in the past received, and may in the future receive, notices from persons claiming that our products, software or asserted proprietary rights infringe the proprietary rights of these persons. We expect that developers of wireless technologies will be increasingly subject to infringement claims as the number of products and competitors as our market grows. While we are not subject to any infringement claims, any future claim, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements might not be available on terms acceptable to us or at all.

DEFECTS IN OUR PRODUCTS COULD CAUSE PRODUCT RETURNS AND PRODUCT LIABILITY.

Products as complex as ours frequently contain undetected errors, defects or failures, especially when introduced or when new versions are released. In the past, our products have contained these errors, and there can be no assurance that errors will not be found in our current and future products. The occurrence of errors, defects or failures could result in product returns and other losses. They could also result in the loss of or delay in market acceptance of our products. These might also subject us to claims for product liability.

GOVERNMENT REGULATION MAY NEGATIVELY IMPACT OUR FUTURE GROWTH.

We are subject to federal, state and local government regulation. For instance, the regulations of the Federal Communications Commission, or FCC, extend to high-speed Internet access products such as ours. Further, governmental regulation of our customers may limit our growth and hurt our business. Each of our customers has filed applications to operate within a frequency spectrum regulated by the FCC. Delays in approvals by the FCC may limit our future growth. If the FCC changes its decision to open the frequency spectrum for full utilization, the future growth of the wireless industry could be limited.

IF WE ARE DE-LISTED FROM THE NASDAQ NATIONAL MARKET, THE PRICE OF OUR COMMON STOCK COULD DROP, AND IT MAY BE MORE DIFFICULT TO TRADE OUR COMMON STOCK.

Our common stock trades on the Nasdaq National Market, which imposes requirements to maintain the continued listing of our common stock on that market, including that we must maintain a minimum bid price of $5.00 per share for our common stock and have a market capitalization of at least $50 million, or maintain a minimum bid price of $1.00 per share for our common stock and maintain net worth above $4 million. Our common stock was de-listed from the Nasdaq National Market and did not trade on Nasdaq between mid-June 1998 and July 6, 2000. We have received notices from Nasdaq indicating that we failed to meet certain of its requirements and that our common

stock may be de-listed from trading on the Nasdaq National Market. On June 7, 2001, we received a determination letter from the staff of Nasdaq indicating that we had failed to comply with the minimum market capitalization requirement for continued listing on the Nasdaq National Market, and that our common stock would be de-listed. Further, the staff denied our application to transfer the listing of our stock to the Nasdaq Small Cap Market. We requested a hearing before the Nasdaq Listing Qualifications Panel to review the determination by the staff of Nasdaq. This hearing was held on July 19, 2001, and defers the de-listing of our common stock by Nasdaq pending a decision by the Listing Qualifications Panel.

De-listing of our common stock could reduce our stockholders' ability to buy or sell shares as quickly and as inexpensively as they have done historically. This reduced liquidity would make it more difficult for us to raise capital in the future. The trading price of our common stock could decline due to the change in liquidity and reduced publicity resulting from being de-listed from the Nasdaq National Market.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

PART II. OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES

EXCHANGE OF SECURITIES WITH HALIFAX FUND, L.P.

Pursuant to an Exchange Agreement, dated August 13, 2001 between us and the Halifax Fund, L.P., or, the Exchange Agreement, we completed an exchange of shares of a new series of convertible preferred stock for the $7.5 million convertible debenture, and related adjustment warrant, issued to Halifax Fund, L. P. in February 2001. We did not receive any consideration in this transaction other than the cancellation of the previously issued debenture and adjustment Warrant. This transaction, with a single accredited investor, was exempt from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 of Regulation D. For a description of this transaction and the securities issued, see "Notes to Unaudited Financial Statements—Convertible Debentures."

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a): Exhibits

The following exhibits are filed as part of this report:

Exhibit No.		Description of Exhibit
3.01		Certificate of Designations of Series K Cumulative Convertible Preferred Stock of the Registrant
4.01		Exchange Agreement between Halifax Fund, L.P. and the Registrant, dated as of August 13, 2001
4.02		Registration Rights Agreement between Halifax Fund, L.P. and the Registrant, dated as of August 13, 2001

(b): Reports on Form 8-K

Not applicable.

HYBRID NETWORKS, INC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: August 14, 2001		HYBRID NETWORKS, INC.
		/s/ Michael D. Greenbaum Michael D. Greenbaum Chief Executive Officer
		/s/ Judson W. Goldsmith Judson W. Goldsmith Chief Financial Officer (Principal Accounting Officer)

QuickLinks

INDEX
PART I. FINANCIAL INFORMATION
UNAUDITED CONDENSED BALANCE SHEETS
UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
RISK FACTORS
PART II. OTHER INFORMATION
SIGNATURES
EX-3.01 3 a2056568zex-3_01.htm EXHIBIT 3.01 Prepared by MERRILL CORPORATION
QuickLinks -- Click here to rapidly navigate through this document

Exhibit 3.01

CERTIFICATE OF DESIGNATIONS OF THE POWERS,
PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL
AND OTHER SPECIAL RIGHTS OF PREFERRED STOCK AND
QUALIFICATIONS, LIMITATIONS AND RESTRICTIONS
THEREOF
of
SERIES K CUMULATIVE CONVERTIBLE PREFERRED STOCK
for
HYBRID NETWORKS, INC.

HYBRID NETWORKS, INC., a Delaware corporation (the "Corporation"), pursuant to the provisions of Section 151 of the General Corporation Law of the State of Delaware (the "DGCL"), does hereby make this Certificate of Designations and does hereby state and certify that pursuant to the authority expressly vested in the Board of Directors of the Corporation by the Certificate of Incorporation of the Corporation, the Board of Directors duly adopted the following resolutions, which resolutions remain in full force and effect as of the date hereof:

RESOLVED, that, pursuant to Article IV of the Certificate of Incorporation of the Corporation, the Board of Directors hereby authorizes the issuance of, and fixes the designation and preferences and relative, participating, optional and other special rights, and qualifications, limitations and restrictions of, a series of preferred stock of the Corporation consisting of 7,560 shares, par value $0.001 per share, to be designated "Series K Cumulative Convertible Preferred Stock".

RESOLVED, that each of the shares of Series K Cumulative Convertible Preferred Stock shall rank equally in all respects and shall be subject to the following terms and provisions:

1. Designation. There is hereby created out of the authorized and unissued shares of the preferred stock of the Corporation a series of preferred stock designated as the "Series K Cumulative Convertible Preferred Stock". The number of shares (the "Preferred Shares") constituting such series shall be 7,560.

2. Dividend Preference/Accretion.

(a) Dividend Preference. The holders of the Preferred Shares shall be entitled to receive, when, as and if declared by the Board of Directors out of any funds and assets of the Corporation legally available therefore, cumulative dividends at the per share rate of six percent (6%) per annum (i.e., three percent (3%) semi-annually) of the Liquidation Value (as defined below) of each outstanding Preferred Share, accruing daily from the date of issuance and compounded on June 30^th and December 31^st of each year (each a "Dividend Payment Date") commencing with the first Dividend Payment Date occurring after the original issuance date of such share, in preference and priority to any payment of any dividend on the Common Stock (as defined below) or any other class or series of equity security of the Corporation. Such dividends shall accrue on any given share from the most recent date on which a dividend has been paid with respect to such share, or if no dividends have been paid, from the date of the original issuance of such share, and such dividends shall accrue from day to day whether or not declared, based on the actual number of days elapsed. Upon the payment of dividends as required by the immediately preceding sentence, such dividends will be deemed paid in full. For so long as any Preferred Shares are outstanding, the Corporation shall not pay any dividends on any shares of Common Stock (other than stock dividends of Common Stock to the Corporation's Common Stock holders) or any shares of any other capital stock, or repurchase any shares of Common Stock or capital stock, without having received written consent of the holders of 75% of the Preferred Shares outstanding. For purposes of computing any per diem accrual, calculations shall be made using a 360-day year.

(b) Accretion. On June 30^th and December 31^st of each year (each an "Accretion Date"), the Liquidation Value (as defined below) of each outstanding Preferred Share shall be

automatically increased by an amount equal to six percent (6%) per annum of the then Liquidation Value of such Preferred Share (i.e. three percent (3%) semi-annually) less the amount of any dividend declared and paid on the Preferred Shares since the immediately prior Accretion Date. Notwithstanding the foregoing, the Corporation may pay dividends in cash if on 15 days irrevocable prior written notice, it informs the holders of the Preferred Shares of its election to pay cash dividends. Following notice of payment of cash dividends by the Corporation, all dividends on the Preferred Shares shall be paid in cash on each Dividend Payment Date, until such time as the Corporation provides 15 days irrevocable written notice to the holders of Preferred Shares of its election to accrete the amount of such dividends as provided herein instead of paying cash dividends.

3. Liquidation Value. In the event of any liquidation, dissolution or winding up of the Corporation, either voluntary or involuntary, the holders of the Preferred Shares shall be entitled to receive, out of the assets of the Corporation available for distribution to stockholders, prior and in preference to any distribution of any assets of the Corporation to the holders of any other class or series of equity securities, the amount of $1,000 per share plus (i) dividends added to the Liquidation Value in accordance with Section 2(b) above, (ii) all accrued but unpaid dividends hereunder (other than dividends previously added to the Liquidation Value), and (iii) all "Monthly Delay Payments" or other default payments owing under the Transaction Documents but not previously paid or added to the Liquidation Value (collectively, the "Liquidation Value"). The foregoing shall not affect any rights which holders of Preferred Shares may have with respect to any requirement that the Corporation repurchase the Preferred Shares or for any right to monetary damages.

4. Issuance of Preferred Shares. The Preferred Shares shall be issued by the Corporation pursuant to an Exchange Agreement dated on or about the date hereof ("Exchange Agreement") between the Corporation and the initial subscriber for the Preferred Shares thereunder ("Subscriber"), and holders of the Preferred Shares shall enjoy the benefits of the Registration Rights Agreement ("Registration Rights Agreement") dated on or about the date hereof between such parties entered into in connection with the Exchange Agreement.

5. Conversion. Subject to the terms hereof, each holder of the Preferred Shares shall have the right at any time and from time to time, at the option of such holder, to convert any or all Preferred Shares held by such holder for such number of fully paid, validly issued and nonassessable shares ("Common Shares") of the Corporation's common stock, $0.001 par value ("Common Stock"), free and clear of any liens, claims or encumbrances, as is determined by dividing (i) the Liquidation Value multiplied by the number of Preferred Shares being converted, by (ii) the applicable Conversion Price (as defined in Section 5(b) below) determined as hereinafter provided in effect on the Conversion Date (subject to the limitations set forth in this Section 5). Immediately following such conversion, the rights of the holders of converted Preferred Shares shall cease and the persons entitled to receive the Common Shares upon the conversion of Preferred Shares shall be treated for all purposes as having become the owners of such Common Shares, subject to the rights provided herein to holders.

(a) Mechanics of Conversion. To convert Preferred Shares into Common Shares, the holder shall give written notice ("Conversion Notice") to the Corporation in the form of page 1 of Exhibit A hereto (which Conversion Notice may be given by facsimile transmission) no later than the Conversion Date stating that such holder elects to convert the same and shall state therein the number of Preferred Shares to be converted and the name or names in which such holder wishes the certificate or certificates for Common Shares to be issued (the conversion date specified in such Conversion Notice shall be referred to herein as the "Conversion Date"). Within one Trading Day following delivery of any such Conversion Notice, the holder shall deliver (which also may be delivered by facsimile transmission) page 2 to Exhibit A hereto indicating the computation of the number of Common Shares to be received. As soon as possible after delivery of the Conversion Notice and subject to the book-entry provisions set forth below, such holder shall surrender the

certificate or certificates representing the Preferred Shares being converted, duly endorsed, at the office of the Corporation or, if identified in writing to all the holders by the Corporation, at the offices of any transfer agent for such shares. The Corporation shall, immediately upon receipt of such Conversion Notice, issue and deliver to or upon the order of such holder a certificate or certificates for the number of Common Shares to which such holder shall be entitled (with the number of and denomination of such certificates designated by such holder), and the Corporation shall immediately issue and deliver to such holder a certificate or certificates for the number of Preferred Shares (including any fractional shares) which such holder has not yet elected to convert hereunder but which are evidenced in part by the certificate(s) delivered to the Corporation in connection with such Conversion Notice. The Corporation shall effect such issuance of Common Shares (and certificates for unconverted Preferred Shares) within three (3) Trading Days of the Conversion Date and shall transmit the certificates by messenger or reputable overnight delivery service to reach the address designated by such holder within three (3) Trading Days after the receipt of such Conversion Notice. If certificates evidencing the Common Shares are not received by the holder within five (5) Trading Days of the Conversion Notice, then the holder will be entitled to revoke and withdraw its Conversion Notice, in whole or in part, at any time prior to its receipt of those certificates. In lieu of delivering physical certificates representing the Common Shares issuable upon conversion or redemption of Preferred Shares, provided the Corporation's transfer agent is participating in the Depository Trust Company ("DTC") Fast Automated Securities Transfer ("FAST") program, upon request of the holder, the Corporation shall use its commercially reasonable best efforts to cause its transfer agent to electronically transmit the Common Shares issuable upon conversion or redemption to the holder, by crediting the account of the holder's prime broker with DTC through its Deposit Withdrawal Agent Commission ("DWAC") system. The time periods for delivery described above, and for delivery of Common Stock in payment of any redemption price hereunder, shall apply to the electronic transmittals through the DWAC system. The parties agree to coordinate with DTC to accomplish this objective. The conversion pursuant to this Section 5 shall be deemed to have been made immediately prior to the close of business on the Conversion Date. The person or persons entitled to receive the Common Shares issuable upon such conversion shall be treated for all purposes as the record holder or holders of such Common Shares at the close of business on the Conversion Date.

The Corporation's obligation to issue Common Shares upon conversion of Preferred Shares shall be absolute, is independent of any covenant of any holder of Preferred Shares, and shall not be subject to: (i) any offset or defense; or (ii) any claims against the holders of Preferred Shares whether pursuant to this Certificate of Designations, the Exchange Agreement, the Registration Rights Agreement, the Warrant (as defined in the Exchange Agreement) or otherwise.

Book-Entry. Notwithstanding anything to the contrary set forth herein, upon conversion of any Preferred Shares in accordance with the terms hereof, the holder thereof shall not be required to physically surrender such holder's certificates for Preferred Shares to the Corporation unless such holder is converting all of the Preferred Shares then held by such holder. The holders of Preferred Shares and the Corporation shall maintain records showing the number of Preferred Shares so converted hereunder, the number of Common Shares received upon conversion and the dates of such conversions, or shall use such other method, reasonably satisfactory to the holders and the Corporation, so as not to require physical surrender of certificates for Preferred Shares upon each such conversion. Notwithstanding the foregoing, if any Preferred Shares are converted as aforesaid, such holder of Preferred Shares may not transfer its Preferred Shares unless such holder first physically surrenders to the Corporation all certificates representing any Preferred Shares which have previously been converted in whole or in part, whereupon the Corporation will forthwith issue and deliver upon the order of such holder new certificate(s) evidencing Preferred Shares, registered as

such holder may request, representing in the aggregate, together with all other certificates evidencing Preferred Shares held by such holder, the remaining number of Preferred Shares held by such holder. Each holder of Preferred Shares (and any successor in interest or assignee), by acceptance of Preferred Shares, acknowledges that, by reason of the provisions of this paragraph, following conversion of any Preferred Shares, the number of Preferred Shares actually owned by such holder may be less than the number of Preferred Shares set forth on the face of the certificates representing Preferred Shares and held by such holder.

(b) Definitions.

For purposes of this Certificate of Designations, the following terms shall have meanings ascribed to them below:

"Automatic Redemption Date" shall initially mean February 16, 2006, provided, however, that by written notice of the holders of at least 75% of the Preferred Shares delivered to the Corporation prior to February 16, 2006, such date may be extended to a later date selected by such holders but in no event shall such Automatic Redemption Date extend beyond February 16, 2007.

"Change in Control Transaction" will be deemed to exist if (i) there occurs any consolidation, merger or other business combination of the Corporation with or into any other corporation or other entity or person (whether or not the Corporation is the surviving corporation), or any other corporate reorganization or transaction or series of related transactions in which in any of such events the voting stockholders of the Corporation prior to such event cease to own 50% or more of the voting stock, or corresponding voting equity interests, of the surviving corporation after such event (including without limitation any "going private" transaction under Rule 13e-3 promulgated pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or tender offer by the Corporation under Rule 13e-4 promulgated pursuant to the Exchange Act for 20% or more of the Corporation's Common Stock), (ii) any person (as defined in Section 13(d) of the Exchange Act), together with its affiliates and associates (as such terms are defined in Rule 405 under the Act), beneficially owns or is deemed to beneficially own (as described in Rule 13d-3 under the Exchange Act without regard to the 60-day exercise period) in excess of 50% of the Corporation's voting power, (iii) there is a replacement of more than one-half of the members of the Corporation's Board of Directors which is not approved by those individuals who are members of the Corporation's Board of Directors on the date thereof, or (iv) in one or a series of related transactions, there is a sale or transfer of all or substantially all of the assets of the Corporation, determined on a consolidated basis, or (v) the Corporation enters into an agreement providing for an event set forth in (i), (ii), (iii) or (iv) above pursuant to which the Common Stock is converted or reclassified into other securities, cash or property.

"Conversion Price" shall mean the following:

(i) Subject to clause (iii) below, from the Exchange Date (as defined in the Exchange Agreement) until the Reset Date, the Conversion Price for the first 1,875 Preferred Shares converted shall equal the Floor Price (the Corporation shall provide written notice to all holders of Preferred Shares immediately following the time (the "Reset Time") at which 1,875 Preferred Shares have been so converted);

(ii) Subject to clause (iii) below, on and after the earlier of the Reset Date or the Reset Time, the Conversion Price shall thereafter equal the sum of (a) the then applicable Floor Price, plus (b) 50% of the amount by which the VWAP on the Trading Day immediately preceding the Conversion Date (or other date as of which the

Conversion Price is being determined) exceeds such Floor Price, if any, provided that the Conversion Price shall not be less than the then applicable Floor Price; and

(iii) Notwithstanding clauses (i) and (ii) above, following the occurrence of any Interfering Event (as defined in the Registration Rights Agreement) upon which the holders of Preferred Shares have a right to sell any or all Preferred Shares to the Corporation, the Conversion Price hereunder shall equal the lesser of (a) the then applicable Conversion Price, and (b) the lowest closing bid price for the Common Stock on the Principal Market over the five Trading Days immediately preceding the Conversion Date or redemption date;

in each case such Conversion Price shall be subject to adjustment (or further adjustment, as the case may be) from time to time pursuant to the terms of this Certificate of Designations (including without limitation pursuant to Section 5(c) below).

"Convertible Securities" means any convertible securities, warrants, options or other rights to subscribe for or to purchase or exchange for, shares of Common Stock.

"First Pricing Period" shall mean the period of fifteen (15) consecutive Trading Days immediately following the earlier of (a) April 1, 2001 and (b) the later of (1) February 15, 2002, or (2) the date on which the Company announces or discloses publicly its financial results for the year or quarter ended December 31, 2001.

"Floating Price" shall equal the lesser of the Conversion Price and the lowest VWAP during the five (5) Trading Days immediately preceding the applicable Conversion Date.

"Floor Price" shall equal $1.25, as such figure shall be appropriately and equitably adjusted pursuant to any stock splits, stock dividends and similar events ("Initial Floor Price"); provided, however, that if at all times from October 16, 2001 through the Reset Date all of the conditions precedent set forth in clauses (A) through (C) of Section 5(i)(5) below exist, then on the Reset Date the Floor Price hereunder shall be automatically adjusted to (and shall thereafter equal, until further adjusted) a price equal to the average of the daily VWAPs during the First Pricing Period, provided that the Floor Price shall not be adjusted to a figure that is less than the Initial Floor Price or greater than the Maximum Price, except pursuant to an adjustment required under Section 5(c) below.

"Forced Conversion Limit", for any Forced Conversion Period (as defined in Section 5(i)(2)(B) below), shall mean 10% of the total number of shares of Common Stock traded on the Principal Market during the Forced Conversion Period (excluding (i) individual trades of 20,000 shares or more of Common Stock, (ii) all transactions other than bona fide, arm's length transactions between unaffiliated and unrelated persons and entities, and (iii) the total number of shares of Common Stock traded on the Principal Market on any Trading Day during such Forced Conversion Period in which any sale price per share of Common Stock on the Principal Market is less than 120% of the Conversion Price in effect on such Trading Day).

"Maximum Price" shall mean $5.00, as such figure shall be appropriately and equitably adjusted pursuant to any stock splits, stock dividends and similar events.

"MFN Transaction" shall mean a transaction in which the Corporation issues or sells any securities in a capital raising transaction or series of related transactions (the "MFN Offering") which grants to the investor (the "MFN Investor") the right to receive additional securities based upon future capital raising transactions of the Corporation on terms more favorable than those granted to the MFN Investor in the MFN Offering.

"Per Share Selling Price" shall include the amount actually paid by third parties for each share of Common Stock in a sale or issuance by the Corporation. In the event a fee is paid by the Corporation in connection with such transaction directly or indirectly to such third party or its affiliates, any such fee shall be deducted from the selling price pro rata to all shares sold in the transaction to arrive at the Per Share Selling Price. A sale of shares of Common Stock shall include the sale or issuance of rights, options, warrants or convertible, exchangeable or exercisable securities under which the Corporation is or may become obligated to issue shares of Common Stock, and in such circumstances the Per Share Selling Price of the Common Stock covered thereby shall also include the exercise, exchange or conversion price thereof (in addition to the consideration received by the Corporation upon such sale or issuance less the fee amount as provided above). In case of any such security issued in a Variable Rate Transaction or an MFN Transaction, the Per Share Selling Price shall be deemed to be the lowest conversion or exercise price at which such securities are converted or exercised or might have been converted or exercised in the case of a Variable Rate Transaction, or the lowest adjustment price in the case of an MFN Transaction, over the life of such securities. If shares are issued for a consideration other than cash, the Per Share Selling Price shall be the fair value of such consideration as determined in good faith by the Corporation's Board of Directors, provided that if the holders of at least 75% of the outstanding Preferred Shares reasonably object to such fair value determination, then such fair value shall be determined by independent certified public accountants mutually acceptable to the Corporation and the holders of at least 75% of the outstanding Preferred Shares. In the event the Corporation directly or indirectly effectively reduces the conversion, exercise or exchange price for any Convertible Securities which are currently outstanding, then the Per Share Selling Price shall equal such effectively reduced conversion, exercise or exchange price.

"Principal Market" shall mean the NASDAQ National Market System or such other principal market or exchange on which the Common Stock is then listed for trading.

"Reset Date" shall mean the Trading Day immediately following the last Trading Day of the First Pricing Period.

"Second Pricing Period" shall mean the period of sixty (60) consecutive Trading Days consisting of the thirty (30) consecutive Trading Days immediately preceding the Automatic Redemption Date and the thirty (30) consecutive Trading Days commencing on and immediately following the Automatic Redemption Date.

"Trading Day" shall mean a day on which there is trading on the NASDAQ National Market System or such other market or exchange on which the Common Stock is then principally traded.

"Variable Rate Transaction" shall mean a transaction in which the Corporation issues or sells (a) any debt or equity securities that are convertible into, exchangeable or exercisable for, or include the right to receive additional shares of Common Stock either (x) at a conversion, exercise or exchange rate or other price that is based upon and/or varies with the trading prices of or quotations for the Common Stock at any time after the initial issuance of such debt or equity securities, or (y) with a fixed conversion, exercise or exchange price that is subject to being reset at some future date after the initial issuance of such debt or equity security or upon the occurrence of specified or contingent events directly or indirectly related to the business of the Corporation or the market for the Common Stock (but excluding standard stock split anti-dilution provisions), or (b) any securities of the Corporation pursuant to an "equity line" structure which provides for the sale, from time to time, of securities of the Corporation which are registered for sale or resale pursuant to the Securities Act.

"VWAP" shall mean the daily volume-weighted average sale price for the Common Stock on the Principal Market on any particular Trading Day as reported on Bloomberg's, as such figure may be adjusted pursuant hereto.

(i) Stock Splits, etc. If the Corporation or any of its subsidiaries, at any time while the Preferred Shares are outstanding (A) shall pay a stock dividend or otherwise make a distribution or distributions on any equity securities (including instruments or securities convertible into or exchangeable for such equity securities) in shares of Common Stock, (B) subdivide outstanding Common Shares into a larger number of shares, or (C) combine outstanding Common Stock into a smaller number of shares, then each Affected Conversion Price (as defined below) shall be multiplied by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding before such event and the denominator of which shall be the number of shares of Common Stock outstanding after such event. Any adjustment made pursuant to this Section 5(c)(i) shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision or combination.

As used herein, the Affected Conversion Prices (each an "Affected Conversion Price") shall refer to: (i) the Conversion Price; (ii) the Floor Price; (iii) the Maximum Price; and (iv) each VWAP occurring on any Trading Day included in the First Pricing Period or Second Pricing Period, as the case may be, which Trading Day occurred before the record date in the case of events referred to in clause (A) of this subparagraph 5(c)(i) and before the effective date in the case of the events referred to in clauses (B) and (C) of this subparagraph 5(c)(i).

(ii) Distributions. If the Corporation or any of its subsidiaries, at any time while the Preferred Shares are outstanding, shall distribute to all holders of Common Stock evidences of its indebtedness or assets or cash or rights or warrants to subscribe for or purchase any security of the Corporation or any of its subsidiaries (excluding those referred to in Sections 5(c)(i) above), then concurrently with such distributions to the holders of Common Stock, the Corporation shall distribute to holders of the Preferred Shares, the amount of such indebtedness, assets, cash or rights or warrants which the holders of Preferred Shares would have received had they converted all their Preferred Shares into Common Shares immediately prior to the record date for such distribution.

(iii) Common Stock Issuances. In the event that the Corporation or any of its subsidiaries (A) issues or sells any Common Stock or securities which are convertible into or exercisable or exchangeable for Common Stock, or any warrants or other rights to subscribe for or to purchase or any options for the purchase of its Common Stock or (B) directly or indirectly effectively reduces the conversion, exercise or exchange price for any Convertible Securities which are currently outstanding, in either case at or to an effective Per Share Selling Price which is less than the greater of (A) the closing sale price per share of the Common Stock on the Principal Market on the Trading Day next preceding such issue or sale or, in the case of issuances to holders of its Common Stock, the date fixed for the determination of stockholders entitled to receive such warrants, rights, or options ("Fair Market Price"), or (B) the Conversion Price, then in each such case, each Affected Conversion Price in effect immediately prior to such issue or sale or record date, as applicable, shall be automatically reduced effective concurrently with such issue or sale to an amount determined by multiplying the Affected Conversion Price then in effect by a fraction, (x) the numerator of which shall be the sum of (1) the number of shares of Common Stock outstanding immediately prior to such issue or sale, plus (2) the number of shares of Common

Stock which the aggregate consideration received by the Corporation for such additional shares would purchase at such Fair Market Price or Conversion Price, as the case may be, and (y) the denominator of which shall be the number of shares of Common Stock of the Corporation outstanding immediately after such issue or sale.

The foregoing provision of this subsection (iii) shall not apply to issuances, sales or reductions pursuant to (i) the Corporation's current or future employee, director or bona fide consultant options plans and/or compensation arrangements, (ii) strategic corporate alliances not undertaken principally for financing purposes, (iii) revolving or term loans provided to the Corporation by federal or state chartered banks or thrifts, and (iv) a stock split or subdivision of the outstanding Common Stock.

For the purposes of the foregoing adjustments, in the case of the issuance of any Convertible Securities, the maximum number of shares of Common Stock issuable upon exercise, exchange or conversion of such Convertible Securities shall be deemed to be outstanding, provided that no further adjustment shall be made upon the actual issuance of Common Stock upon exercise, exchange or conversion of such Convertible Securities.

For purposes of this Section 5(c)(iii), if an event occurs that triggers more than one of the above adjustment provisions, then only one adjustment shall be made and the calculation method which yields the greatest downward adjustment in the Conversion Price shall be used.

(iv) All calculations under this Section 5(c) shall be made to the nearest cent or to the nearest 1/100^th of a share, as the case may be.

(v) No adjustment in the Conversion Price shall reduce the Conversion Price below the then par value of the Common Stock, provided that the Corporation shall not increase such par value so long as any Preferred Shares are outstanding.

(vi) The Corporation from time to time may reduce the Conversion Price by any amount for any period of time if the reduction is irrevocable during the period. Whenever the Conversion Price is so reduced, the Corporation shall mail to the holders of Preferred Shares a notice of the reduction. The Corporation shall mail, first class, postage prepaid, the notice at least three (3) days before the date the reduced Conversion Price takes effect. The notice shall state the reduced Conversion Price and the period it will be in effect. Such reduction of the Conversion Price does not change or adjust the Conversion Price otherwise in effect for purposes of Sections 5(c)(i) or (ii) above.

(d) Notice of Record Date. In the event of any taking by the Corporation of a record date of the holders of any class of securities for the purpose of determining the holders thereof who are entitled to receive any dividend or other distribution, any security or right convertible into or entitling the holder thereof to receive additional Common Shares, or any right to subscribe for, purchase or otherwise acquire any shares of stock of any class or any other securities or property, or to receive any other right, the Corporation shall deliver to each holder of Preferred Shares at least 15 days prior to the date specified therein, a notice specifying the date on which any such record is to be taken for the purpose of such dividend, distribution, security or right and the amount and character of such dividend, distribution, security or right.

(e) Issue Taxes. The Corporation shall pay any and all issue, documentary, stamp and other taxes, excluding any income, franchise or similar taxes, that may be payable in respect of any issue or delivery of Common Shares on conversion of, or payment of dividends on, Preferred Shares pursuant hereto. However, the holder of any Preferred Shares shall pay any tax that is due because the Common Shares issuable upon conversion thereof or dividend payment thereon are issued in a name other than such holder's name.

(f) Reservation of Stock Issuable upon Conversion. The Corporation shall at all times reserve and keep available out of its authorized but unissued Common Stock, solely for the purposes of effecting the conversion of the Preferred Shares, an amount of Common Shares equal to 200% of the number of shares issuable upon conversion (including redemption) of the Preferred Shares at the then applicable Floating Price or Conversion Price, whichever is lower (in each case without regard to any limitations or restrictions set forth herein). The Corporation promptly will take such corporate action as may, in the opinion of its outside counsel, be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purpose, including without limitation engaging in commercially reasonable best efforts to obtain any requisite stockholder approval.

(g) Fractional Shares. No fractional shares shall be issued upon the conversion of any Preferred Shares. All Common Shares (including fractions thereof) issuable upon conversion of more than one Preferred Share by a holder thereof shall be aggregated for purposes of determining whether the conversion would result in the issuance of any fractional share. If, after the aforementioned aggregation, the conversion would result in the issuance of a fraction of a share of Common Stock, the Corporation shall, in lieu of issuing any fractional share, either round up the number of shares to the next highest whole number or, at the Corporation's option, pay the holder otherwise entitled to such fraction a sum in cash equal to the fair market value of such fraction on the Conversion Date (as determined in good faith by the Board of Directors of the Corporation).

(h) Reorganization, Merger or Going Private. In case of any reorganization or any reclassification of the capital stock of the Corporation or any consolidation or merger of the Corporation with or into any other corporation or corporations or a sale or transfer of all or substantially all of the assets of the Corporation to any other person or a "going private" transaction under Rule 13e-3 promulgated pursuant to the Exchange Act, then, as part of such reorganization, consolidation, merger, or transfer if the holders of shares of Common Stock receive any publicly traded securities as part or all of the consideration for such reorganization, consolidation, merger or sale, then it shall be a condition precedent of any such event or transaction that provision shall be made such that each Preferred Share shall thereafter be convertible into such new securities at a conversion price and pricing formula which places the holders of Preferred Shares in an economically equivalent position as they would have been if not for such event. In addition to the foregoing, if the holders of shares of Common Stock receive any non-publicly traded securities or other property or cash as part or all of the consideration for such reorganization, consolidation, merger or sale, then such distribution shall be treated to the extent thereof as a distribution under Section 5(c) above and such Section shall also apply to such distribution. Notwithstanding the above, this Section 5(h) shall not apply to any Change in Control Transaction described in Section 5(m) below and nothing contained in this paragraph shall affect the repurchase rights of holders of Preferred Shares set forth in such Section 5(m).

(i) Automatic Redemption, Forced Conversion and Forced Redemption.

(1) Automatic Redemption. On the Automatic Redemption Date, the Corporation shall redeem all outstanding Preferred Shares for cash or shares of Common Stock at a redemption price per share equal to the Liquidation Value. Subject to the terms hereof, the Corporation shall have the right to satisfy payment of such redemption price either in cash or in shares of Common Stock or a combination thereof, at the Corporation's option. The Corporation shall deliver to all holders of Preferred Shares a written irrevocable notice electing to pay such redemption price on such Automatic Redemption Date solely in cash or in Common Stock or a combination thereof ("Election Notice") (the date of any such notice being hereinafter referred to as the "Notice Date"). Such Election Notice shall be delivered prior to January 1, 2006, and, if the Automatic Redemption Date is extended by the holders, such Election Notice

shall again be delivered at least forty-five (45) days prior to the then applicable Automatic Redemption Date (provided that if the Automatic Redemption Date is extended less than 50 days, the original Election Notice shall constitute the Election Notice for such extended Automatic Redemption Date). If such Election Notice is not delivered within the prescribed period set forth in the preceding sentence, then the redemption shall be made in either cash or shares of Common Stock or a combination thereof at the holder's sole option on the same terms hereunder. To the extent the Corporation elects or is required to satisfy all or part of such redemption price in shares of Common Stock, the number of such shares to be issued on such Automatic Redemption Date shall be the number determined by dividing (x) the dollar amount of the redemption price being satisfied in shares of Common Stock, by (y) 95% of the average of daily VWAPs during the Second Pricing Period. Such shares shall be issued and delivered within three (3) Trading Days following the end of such Second Pricing Period and shall be duly authorized, validly issued, fully paid, non-assessable and free and clear of all encumbrances, restrictions and legends. If any holder of Preferred Shares does not receive the requisite number of shares of Common Stock in the form required above within such three Trading Day period, such holder shall have the option of either (a) requiring the Corporation to issue and deliver all or a portion of such shares or (b) canceling such election (whether by the Corporation or such holder), in whole or in part, to pay all or part of the redemption price in Common Stock, in which case the Corporation shall immediately pay in cash the full redemption price due hereunder or such portion as the holder specifies is to be paid in cash instead of Common Stock. To the extent the Corporation makes any election pursuant to this subsection, all holders of Preferred Shares must be treated equally with respect to such redemption payment. Notwithstanding anything to the contrary herein, the Corporation shall be prohibited from exercising its right to satisfy the redemption price hereunder in shares of Common Stock (and must deliver cash in respect thereof) on the Automatic Redemption Date (x) if at any time from the Notice Date until the time at which the holder(s) receive such shares2 there fails to exist Effective Registration (as defined in the Exchange Agreement) or any of the other conditions set forth in subsection 5(i)(5) below fail to exist, and (y) to the extent any such issuance would cause a violation of, or exceed the limitations contained in, subsection 5(i)(4) below. If any or all of such redemption price is being paid in cash, then such cash payment shall be made on such Automatic Redemption Date or, if not a Trading Day, on the first Trading Day thereafter. If such cash payment, or any cash payment due following the Second Pricing Period, is not paid in full within three (3) Trading Days following such Automatic Redemption Date or Second Pricing Period, as the case may be, then at any holder's option the Corporation shall redeem all outstanding Preferred Shares held by such holder for cash at the Premium Redemption Price (as defined in the Registration Rights Agreement). In addition, any such cash payments shall accrue interest at a rate equal to the lesser of 20% per annum or the highest rate permitted by law, until paid. Any redemption in shares of Common Stock under this subsection shall be deemed a conversion of such Preferred Shares so redeemed at the conversion price set forth in this subsection.

(2) Forced Conversion.

(A) Subject to Subsections 5(i)(4) and 5(i)(5) below, after the Registration Statement (as defined in the Registration Rights Agreement) is declared effective and prior to February 16, 2006, in the event that the closing bid price per share of Common Stock on the Principal Market is equal to or greater than $6.3212 (as such figure shall be appropriately and equitably adjusted pursuant to any stock splits, stock dividends and similar events) during any period of at least twenty (20) out of thirty (30) consecutive Trading Days, the Corporation shall have the right to compel holders of Preferred Shares (on a pro rata basis among holders of Preferred Shares) to convert all or a portion of their Preferred Shares at the Conversion Price in effect on the conversion date; provided,

however,that (1) the Corporation shall provide at least twenty-five (25) Trading Days prior written notice to all holders of its election hereunder, specifying the conversion date ("Forced Conversion Date") and the number of shares to be converted, (2) the VWAP shall equal or exceed the Conversion Price at the time of such election notice and on each Trading Day thereafter through and including the Forced Conversion Date, (3) there shall be Effective Registration at the time such 30-Trading Day period commenced and all times thereafter through and including the Forced Conversion Date, and (4) holders of Preferred Shares may continue to convert any or all of their Preferred Shares after receiving the Corporation's election notice under this Section 5(i)(2) (which conversions shall be applied against the number of Preferred Shares required to be converted on the Forced Conversion Date). Such forced conversion shall be subject to and governed by all the provisions relating to voluntary conversion of the Preferred Shares contained herein.

(B) Subject to Subsections 5(i)(4) and 5(i)(5) below, after the Registration Statement (as defined in the Registration Rights Agreement) is declared effective and prior to February 16, 2006, if the closing bid price per share of Common Stock on the Principal Market on any Trading Day is equal to or greater than 120% of the Conversion Price in effect on the immediately following Trading Day ("Trigger Day") (with appropriate and equitable adjustment for any stock splits, stock dividends and similar events), the Corporation shall have the right to compel holders of Preferred Shares (on a pro rata basis among holders of Preferred Shares) to convert all or a portion of their Preferred Shares on the terms contained herein during the ten (10) consecutive Trading Days immediately following such Trigger Day ("Forced Conversion Period") by delivering a written notice on such Trigger Day to each holder of Preferred Shares specifying the aggregate number of Preferred Shares which must be converted by such holder during the Forced Conversion Period; provided, however, that (1) no holder of Preferred Shares shall be obligated to effect such conversion(s) to the extent any Preferred Shares would convert into more than such holder's pro rata share of the Forced Conversion Limit, (2) no holder of Preferred Shares shall be obligated to effect such conversion(s) on any particular day during the Forced Conversion Period so long as the requisite number of Preferred Shares are converted during the Forced Conversion Period, and (3) there shall be Effective Registration at all times during such Forced Conversion Period and the twenty (20) Trading Days immediately preceding such Forced Conversion Period. Such forced conversion shall be subject to and governed by all the provisions relating to voluntary conversion of the Preferred Shares contained herein.

(3) Forced Redemption. Subject to Subsection 5(i)(5) below, after the Registration Statement (as defined in the Registration Rights Agreement) is declared effective and prior to February 16, 2006, the Corporation shall have the right to redeem (to the extent that such redemption shall not violate any applicable provisions of the laws of the State of Delaware, including, without limitation, Section 160 of the DGCL) for cash at any time and from time to time all or a portion of the outstanding Preferred Shares (on a pro rata basis among holders of Preferred Shares) at a redemption price ("Forced Redemption Price") equal to the greater of (A) 120% of the Liquidation Value of the Preferred Shares being redeemed or (B) 120% of the Liquidation Value for the Preferred Shares being redeemed multiplied by the closing sale price of the Common Stock (as reported by NASDAQ) on the Trading Day next preceding the Forced Redemption Date (as defined below) divided by the then applicable Conversion Price, provided that in the event that Preferred Shares have been converted into at least 2,500,000 shares of Common Stock in the aggregate, the Forced Redemption Price for any Preferred Shares redeemed thereafter shall equal the Liquidation Value; provided, however, that for any redemption pursuant to this Section 5(i)(3), (1) the Corporation shall provide at least thirty (30) Trading Days prior written notice ("Forced Redemption Notice") to

all holders of its election hereunder, specifying the redemption date ("Forced Redemption Date") and the number of shares to be redeemed, (2) there shall be Effective Registration at all times at least thirty (30) Trading Days prior to such election notice and all times thereafter through and including the Forced Redemption Date, and (3) holders of Preferred Shares may continue to convert any or all of their Preferred Shares after receiving the Corporation's redemption election notice under this Section 5(i)(3) up until the Forced Redemption Date. If any holder does not receive the Forced Redemption Price on the Forced Redemption Date, then such holder shall have the right at any time and from time to time thereafter, at the holder's option, to either (1) sell to the Corporation any or all of its Preferred Shares then held by such holder at the Forced Redemption Price plus accrued interest thereon from the Forced Redemption Date until such holder's receipt of the Forced Redemption Price at a rate of 20% per annum, or (2) force the Corporation to convert any or all of the Preferred Shares held by such holder into Common Shares pursuant to the provisions of Section 5(a) above.

(4) Ownership Limitation. Notwithstanding anything contained in subsections (1) and (2) above, no holder's Preferred Shares shall be subject to forced conversion or redemption in shares of Common Stock to the extent such conversion or redemption would result in the holder of Preferred Shares exceeding or violating the limitations or provisions contained in Section 5(j) below. In such event, the Preferred Shares of such holder shall be converted or redeemed to the extent such limitations are not exceeded or violated, and (A) the Corporation shall redeem for cash instead of Common Stock those Preferred Shares which cannot be redeemed in Common Stock under subsection (1) above due to this subsection (4), and (B) no holders shall be forced to convert those Preferred Shares under subsection (2) above which cannot be converted due to this subsection (4).

(5) Conditions Precedent. Notwithstanding the preceding subsections (1), (2) and (3), no holder of Preferred Shares shall be obligated to convert any Preferred Shares held by such holder on the Forced Conversion Date or during the Forced Conversion Period or to accept shares of Common Stock in payment of any redemption hereunder, unless and until each of the following conditions has been satisfied or exists, each of which shall be a condition precedent to any such forced conversion or redemption (automatic or forced) in shares of Common Stock (waivable by any holder with respect to such holder's Preferred Shares):

(A) There shall be Effective Registration;

(B) There shall not have occurred a Change in Control Transaction or the public announcement of a pending Change in Control Transaction which has not been abandoned or terminated; and

(C) The total number of Common Shares issuable hereunder (regardless of any limitations contained herein) shall have been duly authorized and reserved for issuance.

(j) Limitations on Holder's Right to Convert and Corporation's Right to Redeem.

(A) Notwithstanding anything to the contrary contained herein, the number of shares of Common Stock that may be issued to the holder upon conversion or redemption pursuant to the terms hereof shall not exceed a number that, when added to the total number of shares of Common Stock deemed beneficially owned by such holder (other than by virtue of the ownership of securities or rights to acquire securities (including the Preferred Shares) that have limitations on the holder's right to convert, exercise or purchase similar to the limitation set forth herein), together with all shares of Common Stock deemed beneficially owned (other than by virtue of the ownership of securities or rights to acquire securities that have limitations on the right to convert, exercise or purchase similar to the limitation set forth herein) by the holder's "affiliates" (as defined in Rule 144 of the Act) ("Aggregation Parties")

that would be aggregated for purposes of determining whether a group under Section 13(d) of the Exchange Act exists, would exceed 9.9% of the total issued and outstanding shares of the Common Stock (the "Restricted Ownership Percentage"). Each holder shall have the right (x) at any time and from time to time to reduce its Restricted Ownership Percentage immediately upon notice to the Corporation in the event and only to the extent that Section 16 of the Exchange Act or the rules promulgated thereunder (or any successor statute or rules) is changed to reduce the beneficial ownership percentage limitation thereunder from 10%, and (y) (subject to waiver) at any time and from time to time, to increase its Restricted Ownership Percentage immediately in the event of the announcement as pending or planned, of a transaction or event referred to in Section 5(m) below or any other transaction in which in excess of 50% of the Corporation's voting control is transferred in one or a series of related transactions (whether by transfer, merger, consolidation or otherwise) or there is a replacement of more than 50% of the members of the Board of Directors of the Corporation with out the prior approval of the incumbent directors.

(B) The holder covenants at all times on each day (each such day being referred to as a "Covenant Day") as follows: During the balance of such Covenant Day and the succeeding sixty-one (61) days (the balance of such Covenant Day and the succeeding 61 days being referred to as the "Covenant Period") such holder will not acquire shares of Common Stock pursuant to any right (including conversion of Preferred Shares) existing at the commencement of the Covenant Period to the extent the number of shares so acquired by such holder and its Aggregation Parties (ignoring all dispositions) would exceed:

(x): the Restricted Ownership Percentage of the total number of shares of Common Stock outstanding at the commencement of the Covenant Period, minus
(y): the number of shares of Common Stock actually owned by such holder and its Aggregation Parties at the commencement of the Covenant Period.

A new and independent covenant will be deemed to be given by the holder as of each moment of each Covenant Day. No covenant will terminate, diminish or modify any other covenant. The holder agrees to comply with each such covenant. This Section 5(j)(B) controls in the case of any conflict with any other provision of the Exchange Agreement or any agreement or document entered into in connection therewith.

(C) 19.9% Limitation. Notwithstanding anything contained herein, in no event shall the Corporation issue shares of Common Stock hereunder to the extent that the total number of shares issued or deemed issued to the Subscriber under the Exchange Agreement would exceed 19.9% of the Corporation's issued and outstanding shares of Common Stock on the date of the Purchase Agreement. Only shares acquired pursuant to the Purchase Agreement, Preferred Shares and Warrant (as defined in the Exchange Agreement) will be included in determining whether the limitations would be exceeded for purposes of this paragraph.

(k) Certificate for Conversion Price Adjustment. The Corporation shall promptly furnish or cause to be furnished to each holder a certificate prepared by the Corporation setting forth any adjustments or readjustments of the Conversion Price pursuant to this Section 5 and setting forth a brief statement of the facts requiring such adjustment or readjustment.

(l) Specific Enforcement. The Corporation agrees that irreparable damage would occur in the event that any of the provisions of this Certificate of Designations were not performed in accordance with their specific terms or were otherwise breached. Each holder of Preferred Shares and each permitted assignee shall have all rights and remedies set forth in this Certificate and all rights and remedies which such holders have been granted at any time under any other agreement or contract and all of the rights which such holders have under any law. Any person having any

rights under any provision of this Certificate shall be entitled to enforce such rights specifically or pursue other injunctive relief or other equitable remedies (without posting a bond or other security), to recover damages by reason of any breach of any provision of this Certificate and to exercise all other rights granted by law. Each holder of Preferred Shares and each permitted assignee without prejudice may withdraw, revoke or suspend its pursuit of any remedy at any time prior to its complete recovery as a result of such remedy.

(m) Change in Control Transaction. In case of any Change in Control Transaction, each holder of Preferred Shares shall have the right thereafter to, at its option, (A) convert such holder's Preferred Shares, in whole or in part, at the then applicable Conversion Price into the shares of stock and other securities, cash and/or property receivable upon or deemed to be held by holders of Common Stock following any such Change in Control Transaction, and such holder shall be entitled upon such event to receive such amount of securities, cash or property as the shares of the Common Stock of the Corporation into which such holder's Preferred Shares could have been converted immediately prior to such Change in Control Transaction would have been entitled if such conversion were permitted, subject to such further applicable adjustments set forth in this Certificate of Designations, or (B) require the Corporation or its successor to redeem any or all of such Preferred Shares at a redemption price equal to the greater of (i) 120% of the Liquidation Value of such Preferred Shares and (ii) 120% of the product of (x) the average of the Fair Market Price for the five (5) Trading Days immediately preceding such holder's election to have its Preferred Shares redeemed and (y) the number of shares of Common Stock into which such Preferred Shares being redeemed are then convertible, provided that such holder shall have notified the Corporation of its intent to have its Preferred Shares converted or redeemed no later than the five Trading Days prior to the closing date for the Change in Control Transaction; provided, however, that in the event such Change in Control Transaction is a merger solely by an exchange of shares of common stock, then clause (B)(ii) above shall not apply, and such holder, in addition to its rights under clause (B)(i) above, shall have the right to convert any or all of its Preferred Shares pursuant to clause (A) above at a Conversion Price equal to the Floating Price. The terms of any such Change in Control Transaction shall include such terms so as to continue to give to the holders of Preferred Shares the right to receive the amount of securities, cash and/or property upon any conversion or redemption following such Change in Control Transaction to which a holder of the number of shares of Common Stock deliverable upon such conversion would have been entitled in such Change in Control Transaction, and dividends payable hereunder shall be in cash or such new securities and/or property, at such holder's option. This provision shall similarly apply to successive reclassifications, consolidations, mergers, sales, transfers, share exchanges or other Change in Control Transactions.

6. Voting Rights. Other than as provided herein and under the Delaware General Corporation Law, the holders of Preferred Shares shall have no rights to vote in connection with any matter voted upon by the holders of Common Stock of the Corporation; provided, however, that the affirmative vote of a majority of the Corporation's outstanding Preferred Shares voting as a single class on an as converted basis shall be necessary for (i) any amendment, modification or repeal of this Certificate of Designations (whether by merger, consolidation or otherwise), or (ii) any amendment to the Certificate of Incorporation or by-laws of the Corporation (whether by merger, consolidation or otherwise) that may amend or change or adversely affect any of the rights, preferences, obligations or privileges of the Preferred Shares, provided, however, that (a) holders of Preferred Shares who are affiliates of the Corporation (and the Corporation itself) shall not participate in such vote and the Preferred Shares of such holders shall be disregarded and deemed not to be outstanding for purposes of such vote, and (b) no vote shall be required in connection with a merger, the sole purpose of which is to effect a change of the Corporation's state of incorporation and/or increase the number of members of the Board of Directors of the Corporation, so long as such merger or change does not in any way amend

or change or adversely affect any of the rights, preferences, obligations or privileges of the Preferred Shares.

7. Notices. The Corporation shall distribute to the holders of Preferred Shares copies of all notices, materials, annual and quarterly reports, proxy statements, information statements and any other documents distributed generally to the holders of shares of Common Stock of the Corporation, at such times and by such method as such documents are distributed to such holders of such Common Stock.

8. Certificates.

(a) The certificate(s) representing the Preferred Shares held by any holder of Preferred Shares may be exchanged by such holder at any time and from time to time for certificates with different denominations representing an equal aggregate number of Preferred Shares, as reasonably requested by such holder, upon surrendering the same. No service charge will be made for such registration or transfer or exchange. In the event that any holder of Preferred Shares notifies the Corporation that its certificate(s) therefor have been lost, stolen or destroyed, the Corporation shall promptly and without charge deliver replacement certificate(s) to such holder, provided that such holder executes and delivers to the Corporation an agreement reasonably satisfactory to the Corporation to indemnify the Corporation from any loss incurred by it in connection with such lost, stolen or destroyed certificate(s).

(b) The certificate(s) representing the Preferred Shares may be imprinted with the legends in substantially the following form:

"THESE SECURITIES HAVE NOT BEEN REGISTERED FOR OFFER OR SALE UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS. THEY MAY NOT BE SOLD OR OFFERED FOR SALE EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER SAID ACT AND ANY APPLICABLE STATE SECURITIES LAW OR AN APPLICABLE EXEMPTION FROM SUCH REGISTRATION REQUIREMENTS."

"THIS CERTIFICATE IS NOT REQUIRED TO BE PHYSICALLY SURRENDERED TO THE CORPORATION IN THE EVENT THAT THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE CONVERTED OR REDEEMED IN PART. AS A RESULT, FOLLOWING ANY CONVERSION OR REDEMPTION OF ANY PORTION OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE, THE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY BE LESS THAN THE NUMBER OF SHARES INDICATED ON THIS CERTIFICATE."

9. Attorneys' Fees. In connection with enforcement by a holder of Preferred Shares of any obligation of the Corporation hereunder, the prevailing party shall be entitled to recovery of reasonable attorneys' fees and expenses incurred.

10. No Reissuance. No Preferred Shares acquired by the Corporation by reason of redemption, purchase, conversion or otherwise shall be reissued.

11. No Senior Securities or Variable Rate Transactions.

(a) So long as any Preferred Shares remain outstanding, the Corporation and its subsidiaries shall not, without the affirmative vote of the holders of at least 75% of the outstanding Preferred Shares, issue any securities ranking senior to or pari passu with the Preferred Shares in any manner (including without limitation with respect to dividends, timing of receipt of liquidation preference or timing of redemption) or incur any indebtedness, except for (a) convertible debentures issued to London Pacific for an aggregate principal amount outstanding, including amounts outstanding on the Exchange Date, of up to $5.5 million, (b) indebtedness under working capital facilities from

commercial bank lines of credit, and (c) Senior Debt, as defined in Section 3.19 of the Exchange Agreement.

(b) So long as any Preferred Shares remain outstanding, the Corporation and its subsidiaries shall not, without the affirmative vote of the holders of at least 75% of the outstanding Preferred Shares, enter into any Variable Rate Transaction or MFN Transaction.

12. Severability of Provisions. If any right, preference or limitation of the Preferred Shares set forth in this Certificate of Designations (as this Certificate of Designations may be amended from time to time) is invalid, unlawful or incapable of being enforced by reason of any rule or law or public policy, all other rights, preferences and limitations set forth in this Certificate of Designations, which can be given effect without the invalid, unlawful or unenforceable right, preference or limitation shall nevertheless remain in full force and effect, and no right, preference or limitation herein set forth be deemed dependent upon any such other right, preference or limitation unless so expressed herein.

13. Limitations. Except as may otherwise be required by law and as are set forth in the Exchange Agreement and the Registration Rights Agreement, the Preferred Shares shall not have any powers, preference or relative participating, optional or other special rights other than those specifically set forth in this Certificate of Designations (as may be amended from time to time) or otherwise in the Certificate of Incorporation of the Corporation.

* * * * *

[Signature Page Follows]

IN WITNESS WHEREOF, this Certificate of Designations of the Corporation has been duly executed this 13th day of August, 2001.

		HYBRID NETWORKS, INC.
		By:		/s/ Michael D. Greenbaum Name: Michael D. Greenbaum Title: President and Chief Executive Officer

EXHIBIT A TO CERTIFICATE OF DESIGNATIONS

(To be Executed by Holder
in order to Convert Preferred Shares)

CONVERSION NOTICE
FOR
SERIES K CUMULATIVE CONVERTIBLE PREFERRED STOCK

The undersigned, as a holder ("Holder") of shares designated as Series K Cumulative Convertible Preferred Stock ("Preferred Shares") of HYBRID NETWORKS, INC., a Delaware corporation (the "Corporation"), hereby irrevocably elects to convert Preferred Shares for shares ("Common Shares") of common stock, par value $0.001 per share (the "Common Stock"), of the Corporation according to the terms and conditions of the Certificate of Designations for the Preferred Shares ("Certificate") as of the date written below. The undersigned hereby requests that share certificates for the Common Shares to be issued to the undersigned pursuant to this Conversion Notice be issued in the name of, and delivered to, the undersigned or its designee as indicated below. No fee will be charged to the Holder of Preferred Shares for any conversion. Capitalized terms used herein and not otherwise defined shall have the meanings ascribed thereto in the Certificate. The undersigned represents as of the date hereof that, after giving effect to such conversion of Preferred Shares pursuant to this Conversion Notice, the undersigned will not exceed the "Restricted Ownership Percentage" contained in Section 5(j)(A) of the Certificate and will remain in compliance with Section 5(j)(B) of the Certificate.

Conversion Date:

Conversion Information:

NAME OF HOLDER:

By:
Print Name:
Print Title:

Print Address of Holder:

Issue Common Stock to:
at:

If Common Shares are to be issued to a person other than Holder, Holder's signature must be guaranteed below:

SIGNATURE GUARANTEED BY:

THE COMPUTATION OF NUMBER OF COMMON SHARES TO BE RECEIVED IS SET FORTH ON PAGE 2 OF THE CONVERSION NOTICE.

Page 1 of Conversion Notice

Page 2 to Conversion Notice dated for:
(Conversion Date) (Name of Holder)

COMPUTATION OF NUMBER OF COMMON SHARES TO BE RECEIVED

Number of Preferred Shares being converted:			shares
(1)	Number of Preferred Shares × $1,000:	$
(2)	Accreted Dividends and Accrued But Unpaid Dividends [amount (1) above × (.06/360) x number of days elapsed since cash dividends last paid or original issuance]:	$
(3)	Liquidated Damages not yet paid:	$

Aggregate Liquidation Value [(1) + (2) + (3)]:				$

Conversion Price				$

Total Number of Common Shares = Aggregate Liquidation Value
Conversion Price

NUMBER OF COMMON SHARES ISSUED UPON CONVERSION = shares

The Holder hereby represents that, immediately following such conversion, the balance of the number of Preferred Shares held by such Holder equals .

If the conversion is not being settled by DTC, please issue and deliver certificate(s) for Common Shares in the following amount(s):

If the Holder is receiving certificate(s) for Preferred Shares upon the conversion, please issue and deliver certificate(s) for Preferred Shares in the following amounts:

QuickLinks

Exhibit 3.01

EXHIBIT A TO CERTIFICATE OF DESIGNATIONS
COMPUTATION OF NUMBER OF COMMON SHARES TO BE RECEIVED
EX-4.01 4 a2056568zex-4_01.htm EXHIBIT 4.01 Prepared by MERRILL CORPORATION
QuickLinks -- Click here to rapidly navigate through this document

Exhibit 4.01

REGISTRATION RIGHTS AGREEMENT

THIS REGISTRATION RIGHTS AGREEMENT ("Agreement") is entered into as of August 13, 2001 by and between HYBRID NETWORKS, INC., a Delaware corporation with offices at 6409 Guadalupe Mines Road, San Jose, California 95120 (the "Company"), and HALIFAX FUND, L.P., a Cayman Islands limited partnership (the "Purchaser").

W I T N E S S E T H:

WHEREAS, pursuant to that certain Securities Purchase Agreement dated as of February 16, 2001 between the Company and the Purchaser ("Purchase Agreement"), the Company issued and sold to the Purchaser on February 16, 2001 (i) a 6% Convertible Debenture (the "Debenture") of the Company in the original principal amount of $7.5 million, (ii) a 5-year warrant (the "Warrant") to purchase an aggregate of up to 833,333 shares (the "Warrant Shares") of the Company's common stock, $0.001 par value ("Common Stock"), and (iii) an adjustment warrant (the "Adjustment Warrant") to purchase a number of shares of Common Stock calculated pursuant to a formula set forth therein;

WHEREAS, pursuant to the terms of that certain Registration Rights Agreement dated as of February 16, 2001 between the Company and the Purchaser (the "Prior Registration Rights Agreement"), the shares of Common Stock issuable upon conversion of the Debenture and exercise of the Warrant and the Adjustment Warrant were subject to registration rights of the Purchaser, and pursuant thereto the Company filed with the SEC under the Securities Act a registration statement on Form S-3 on or about April 11, 2001 (Registration No. 333-56896) and a pre-effective amendment to such registration statement on or about May 31, 2001 (the "Pre-Effective Registration Statement");

WHEREAS, pursuant to that certain Exchange Agreement dated as of the date hereof by and between the Company and the Purchaser (the "Exchange Agreement"), the Company and the Purchaser have agreed to exchange the Debenture and the Adjustment Warrant for 7,560 shares (the "Preferred Shares") of the Company's Series K Cumulative Convertible Preferred Stock, par value $.001 per share, which are convertible into shares ("Underlying Shares") of Common Stock; and

WHEREAS, pursuant to the terms of, and in partial consideration for the Purchaser's agreement to enter into, the Exchange Agreement, the Company has agreed to provide the Purchaser with certain registration rights with respect to the Underlying Shares and to continue to provide the Purchaser with certain registration rights with respect to the Warrant Shares, as well as certain other rights and remedies as set forth in this Agreement;

NOW, THEREFORE, in consideration of the mutual promises, representations, warranties, covenants and conditions set forth in the Exchange Agreement and this Agreement, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Company and the Purchaser hereby agree as follows:

1. Certain Definitions. Capitalized terms used herein and not otherwise defined shall have the meaning ascribed thereto in the Exchange Agreement and/or the Warrant. As used in this Agreement, the following terms shall have the following respective meanings:

"Commission" or "SEC" shall mean the Securities and Exchange Commission or any other federal agency at the time administering the Securities Act.

"Effectiveness Deadline" has the meaning specified in Section 2(a) herein.

"Exchange" and "Exchange Date" shall have the meanings ascribed to such terms in the Exchange Agreement.

"Fair Market Value" shall have the meaning ascribed to such term in the Warrant.

"Holder" and "Holders" shall mean the Purchaser and any transferee or transferees of Registrable Securities, Preferred Shares and/or the Warrant which have not been sold to the public to whom the registration rights conferred by this Agreement have been transferred in compliance with this Agreement.

"Interfering Events" shall have the meaning set forth in Section 2(b).

"Monthly Delay Payment" shall have the meaning specified in Section 2(b)(i)(B).

"Premium Redemption Price" shall mean the following:

(a) as to the Preferred Shares, the greater of (x) 120% of the Liquidation Value (as defined in the Certificate) of all such Preferred Shares being sold to the Company, or (y) 105% of the Liquidation Value of the Preferred Shares being sold to the Company multiplied by the highest Common Stock closing price on the Principal Market (or other Approved Market) between and including date of the event triggering the right of redemption and the trading day immediately prior to the actual redemption of such Preferred Shares and divided by the then applicable Conversion Price (as defined in the Certificate) or the lowest daily volume-weighted average sale price of the Common Stock on the Principal Market during the five (5) Trading Days immediately preceding the redemption date, if lower, in each case payable in cash;

(b) as to the Underlying Shares and Warrant Shares, the greater of (x) 105% of the dollar amount which is the product of (i) the number of shares to be redeemed, multiplied by (ii) the highest Common Stock closing price on the Principal Market (or other Approved Market) between and including the date of the event triggering the right of redemption and the trading day immediately prior to the actual redemption of such shares, or (y) 120% of the Liquidation Value of the Preferred Shares which were converted into the Underlying Shares being redeemed or 120% of the aggregate exercise price for the Warrant Shares being redeemed, as the case may be, in each case payable in cash; and

(c) as to the Warrant, 105% of the dollar amount which is the product of (i) the number of Warrant Shares issuable to the Holder upon exercise thereof (assuming full exercise without regard to any beneficial ownership limitations set forth therein) multiplied by (ii) the difference between (A) the highest Common Stock closing price on the Principal Market (or other Approved Market) between and including date of the event triggering the right of redemption and the trading day immediately prior to the actual redemption of such shares, less (B) the exercise price under such Warrant, in each case payable in cash.

"Registrable Securities" shall mean: (i) the Underlying Shares and the Warrant Shares (without regard to any limitations on beneficial ownership contained therein) or other securities issued or issuable to each Holder or its permitted transferee or designee (a) upon conversion of the Preferred Shares and/or upon exercise of the Warrant, or (b) upon any distribution with respect to, any exchange for or any replacement of such Preferred Shares or Warrant, or (c) upon any conversion, exercise or exchange of any securities issued in connection with any such distribution, exchange or replacement, or (d) upon any redemption of the Preferred Shares paid in shares of Common Stock (which shares shall be deemed to be shares issuable upon conversion of Preferred Shares and included in the definition of "Underlying Shares" hereunder and "Common Shares" under the Exchange Agreement); (ii) securities issued or issuable upon any stock split, stock dividend, recapitalization or similar event with respect to the foregoing; and (iii) any other security issued as a dividend or other distribution with respect to, in exchange for or in replacement of the securities referred to in the preceding clauses.

The terms "register", "registered" and "registration" shall refer to a registration effected by preparing and filing a registration statement in compliance with the Securities Act and applicable

rules and regulations thereunder, and the declaration or ordering of the effectiveness of such registration statement.

"Registration Expenses" shall mean all expenses to be incurred by the Company in connection with each Holder's registration rights under this Agreement, including, without limitation, all registration and filing fees, printing expenses, fees and disbursements of counsel for the Company, "blue sky" fees and expenses, reasonable fees and disbursements of counsel to Holders (using a single counsel selected by a majority in interest of the Holders) for a "due diligence" examination of the Company and review of the Registration Statement and related documents (to the extent that the aggregate of such fees and expenses does not exceed the difference between $35,000 and the aggregate fees and disbursements paid to KKWC under Section 3.4 of the Exchange Agreement), and the expense of any special audits incident to or required by any such registration (but excluding the compensation of regular employees of the Company, which shall be paid in any event by the Company).

"Registration Statement" shall have the meaning set forth in Section 2(a) herein.

"Registration Period" shall have the meaning specified in Section 5 herein.

"Regulation D" shall mean Regulation D as promulgated pursuant to the Securities Act, and as subsequently amended.

"Securities" means the Registrable Securities, the Preferred Shares and the Warrant.

"Securities Act" or "Act" shall mean the Securities Act of 1933, as amended.

"Selling Expenses" shall mean all underwriting discounts and selling commissions applicable to the sale of Registrable Securities, and all fees and disbursements of counsel for Holders not included within "Registration Expenses".

"Trading Day" shall mean (x) if the Common Stock is listed on the New York Stock Exchange or the American Stock Exchange, a day on which there is trading on such stock exchange, or (y) if the Common Stock is not listed on either of such stock exchanges but sale prices of the Common Stock are reported on an automated quotation system, a day on which trading is reported on the principal automated quotation system on which sales of the Common Stock are reported, or (z) if the foregoing provisions are inapplicable, a day on which quotations are reported by National Quotation Bureau Incorporated.

2. Registration Requirements. The Company shall use its best efforts to effect the registration of the Registrable Securities (including without limitation the execution of an undertaking to file post-effective amendments, appropriate qualification under applicable "blue sky" or other state securities laws and appropriate compliance with applicable regulations issued under the Securities Act) as would permit or facilitate the resale of all the Registrable Securities in the manner (including manner of sale) reasonably requested by the Holder and in all U.S. jurisdictions. Such best efforts by the Company shall include the following:

(a) The Company shall, as expeditiously as reasonably possible after the Exchange Date:

(i) But in any event within 30 days thereafter, prepare and file with the Commission on Form S-3 (or in the event that the Company is ineligible to use either such form, such other form as the Company is eligible to use under the Securities Act) under the Securities Act either (I) a new registration statement covering the resale by the Purchaser of the Registrable Securities and a withdrawal of the Pre-Effective Registration Statement or (II) if permitted under the Securities Act and the rules and regulations thereunder, an amendment to the Pre-Effective Registration Statement covering the resale by the Purchaser of the Registrable Securities (and deleting coverage of the shares of Common Stock issuable upon conversion of

the Debenture and exercise of the Adjustment Warrant). Any such new registration statement or amended Pre-Effective Registration Statement, including any amendments or supplements thereto and prospectuses contained therein, is referred to herein as the "Registration Statement". The Registration Statement, to the extent allowable under the Securities Act and the rules promulgated thereunder (including Rule 416), shall state that such Registration Statement also covers such number of additional shares of Common Stock as may become issuable to prevent dilution resulting from stock splits, stock dividends or similar events. Subject to compliance with the rules of the SEC, the number of shares of Common Stock initially included in such Registration Statement shall be no less than 200% of the aggregate number of shares of Common Stock issuable upon full conversion of the Preferred Shares (without regard to any beneficial ownership limitations set forth therein), plus 100% of the number of shares of Common Stock estimated in good faith to be issuable upon exercise of the Warrant in full (without regard to any beneficial ownership limitations set forth therein) as of the most recent filing date. Thereafter, the Company shall use its best efforts to cause such Registration Statement to be declared effective as soon as reasonably practicable, provided that, notwithstanding the foregoing, the Company shall cause such Registration Statement to be declared effective on or prior to October 16, 2001 (the "Effectiveness Deadline"). The Company shall provide Holders and their legal counsel reasonable opportunity to review any such Registration Statement or amendment or supplement thereto prior to filing. Without limiting the foregoing, the Company will promptly respond to all SEC comments, inquiries and requests, and shall request acceleration of effectiveness at the earliest possible date. If the Company is not initially eligible to use Form S-3, it will, at the request of a majority-in-interest of the holders of Registrable Securities, amend its Form S-1 to a Form S-3 at such time that it becomes eligible to do so. The Company shall notify the Holders in writing (A) within one day following each of the SEC's clearance to request acceleration of effectiveness of the Registration Statement and the Company's request for such acceleration of effectiveness and (B) immediately upon the SEC's declaration of such effectiveness.

(ii) Prepare and file with the SEC such amendments and supplements to such Registration Statement and the prospectus used in connection with such Registration Statement, or prepare and file such additional registration statements, as may be necessary to comply with the provisions of the Act with respect to the disposition of all securities covered by such Registration Statement in accordance with the intended methods of disposition by the seller thereof as set forth in the Registration Statement (and the disposition of all Registrable Securities as necessary to comply with this Agreement) and notify the Holders of the filing and effectiveness of such Registration Statement and any amendments or supplements.

(iii) After the registration, furnish to each Holder such numbers of copies of a current prospectus conforming with the requirements of the Act, copies of the Registration Statement, any amendment or supplement thereto and any documents incorporated by reference therein and such other documents as such Holder may reasonably require in order to facilitate the disposition of Registrable Securities owned by such Holder.

(iv) Use its best efforts to register and qualify the securities covered by such Registration Statement under such other securities or "blue sky" laws of all U.S. jurisdictions (except in any such jurisdiction where the registration and qualification of the securities covered by such Registration Statement is exempt under the laws and regulations of such jurisdiction); provided that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions.

(v) Notify each Holder immediately of the happening of any event (but not the substance or details of any such event unless specifically requested by a Holder who agrees in

writing to maintain the confidentiality of such information) as a result of which the prospectus (including any supplements thereto or thereof and any information incorporated or deemed to be incorporated by reference therein) included in such Registration Statement, as then in effect, includes an untrue statement of material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing, and, pursuant to Section 2(f) (and subject to the grace periods in Section 2(b)(iii)), use its best efforts to promptly update and/or correct such prospectus.

(vi) Notify each Holder immediately of the issuance by the Commission or any state securities commission or agency of any stop order suspending the effectiveness of the Registration Statement or the initiation of any proceedings for that purpose. The Company shall use its best efforts to prevent the issuance of any stop order and, if any stop order is issued, to obtain the lifting thereof at the earliest possible time.

(vii) Permit a single firm of counsel, designated as Holders' counsel by the Holders of a majority of the Registrable Securities included in the Registration Statement, to review the Registration Statement and all amendments and supplements thereto within a reasonable period of time prior to each filing, and shall not file any document in a form to which such counsel reasonably objects.

(viii) Use its best efforts to list the Registrable Securities covered by such Registration Statement with all securities exchange(s) and/or markets on which the Common Stock is then listed and/or quoted and prepare and file any required filings with the National Association of Securities Dealers, Inc. or any exchange or market where the Common Stock is then traded.

(ix) If applicable, cooperate with the Holders to avail themselves of the prospectus delivery mechanism set forth in Rule 153 (or successor thereto) under the Act.

(b) Set forth below in this Section 2(b) are (I) events that may arise that the Purchaser considers will interfere with the full enjoyment of their rights under the Exchange Agreement and this Agreement (the "Interfering Events"), and (II) certain remedies applicable in each of these events.

Paragraphs (i) through (v) of this Section 2(b) describe the Interfering Events, provide a remedy to the Purchaser if an Interfering Event occurs and provide that the Purchaser may require that the Company redeem outstanding Securities at a specified price if certain Interfering Events are not timely cured. The occurrence of any Interfering Event shall constitute a default hereunder and a breach of this Agreement.

Paragraph (vi) provides, inter alia, that if payments required as the remedy in the case of certain of the Interfering Events are not paid when due, the Company may be required by the Purchaser to redeem outstanding Securities at a specified price.

The preceding paragraphs in this Section 2(b) are meant to serve only as an introduction to this Section 2(b), are for convenience only, and are not to be considered in applying, construing or interpreting this Section 2(b).

(i) Delay in Effectiveness of Registration Statement.

(A) In the event that the Registration Statement has not been declared effective by the Effectiveness Deadline, then the Company shall pay to each Holder a Monthly Delay Payment (as defined below) on the day after the Effectiveness Deadline. In addition, the Company shall pay the Holder a Monthly Delay Payment for each 30 day period (or portion thereof) thereafter during which the Registration Statement has not been declared effective, which Monthly Delay Payments shall not in the aggregate exceed the maximum percentage permitted by law. For clarification purposes and without limiting

any other provision hereof, such failure to have such Registration Statement declared effective by the Effectiveness Deadline shall constitute a default as of the Effectiveness Deadline without any cure period whatsoever.

(B) As used in this Agreement, a "Monthly Delay Payment" shall be a cash payment equal to $150,000 (in the aggregate to all Holders), payable on the date on which the specified condition in this Section 2(b) has not been fulfilled or the specified deficiency has not been remedied, and $150,000 (in the aggregate to all Holders), payable for each 30-day period thereafter (or portion thereof) that the specified condition in this Section 2(b) has not been fulfilled or the specified deficiency has not been remedied. Payment of the Monthly Delay Payments, and any Premium Redemption Price payment due pursuant to the other provisions of this Section 2(b), shall be due and payable from the Company to such Holder within 5 business days of demand therefor. Without limiting the foregoing, if payment in immediately available funds of the Premium Redemption Price is not made within such 5 business day period, the Holder may revoke and withdraw in whole or in part its election to cause the Company to make such mandatory purchase at any time prior to its receipt of such cash, without prejudice to its ability to elect to receive that particular or other Premium Redemption Price payments in the future.

(ii) No Listing; Premium Price Redemption for Delisting of Class of Shares.

(A) In the event that the Company fails, refuses or is unable to cause the Registrable Securities covered by the Registration Statement to be listed and/or quoted, as the case may be, with an Approved Market and each other securities exchange and market on which the Common Stock is then traded at all times during the Registration Period, then the Company shall make to each Holder a Monthly Delay Payment for each 30 day period (or portion thereof) during the Registration Period from and after such failure, refusal or inability to so list the Registrable Securities until the Registrable Securities are so listed and/or quoted.

(B) In the event that shares of Common Stock of the Company are delisted from or not quoted on, or trading in the Common Stock is otherwise suspended on, or such delisting or suspension has been threatened from, an Approved Market at any time following the Exchange Date and remains so delisted, not quoted or suspended for 5 consecutive Trading Days without being listed and/or quoted on another Approved Market, then at the option of each Holder and to the extent such Holder so elects, the Company shall on 2 business days notice either (1) make to such Holder a Monthly Delay Payment for each 30 day period (or portion thereof) that the shares are delisted, not quoted or suspended or (2) redeem the Securities held by such Holder, in whole or in part, at a redemption price equal to the Premium Redemption Price; provided, however, that such Holder may revoke such request at any time prior to receipt of such Monthly Delay Payments or Premium Redemption Price, as the case may be.

(iii) Blackout Periods. In the event any Holder is unable to sell Registrable Securities under the Registration Statement for more than (A) 15 consecutive Trading Days or (B) an aggregate of 30 Trading Days in any 12 month period ("Suspension Grace Period"), including without limitation by reason of the Company's failure to deliver unlegended shares, any suspension or stop order with respect to the Registration Statement or the fact that an event has occurred as a result of which the prospectus (including any supplements thereto) included in such Registration Statement then in effect includes an untrue statement of material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing, or the number of shares of Common Stock covered by the Registration Statement is insufficient at such time to

make such sales (any of the foregoing, a "Blackout"), then the Company shall make to each Holder a Monthly Delay Payment for each 30 day period (or portion thereof) from and after the expiration of the Suspension Grace Period. In lieu of receiving the Monthly Delay Payment as provided above, a Holder shall have the right but not the obligation to elect to have the Company redeem its Securities at a price equal to the Premium Redemption Price. In the event that any Holder is unable to sell Registrable Securities under the Registration Statement after the Registration Statement is declared effective due to the obligation of the Company to file any post-effective amendment or prospectus supplement thereto solely as a result of any change in the plan of distribution of the Common Stock covered thereby requested by the selling stockholders or of the identity of the selling stockholders thereunder, then such period shall not be counted against the number of days constituting a Blackout provided that the Company acts in good faith to effect any such amendment or supplement as soon as reasonably possible.

(iv) Redemption for Exercise Deficiency. In the event that the Company does not have a sufficient number of shares of Common Stock available to satisfy the Company's obligations to any Holder upon conversion of a Preferred Share or receipt of a notice of exercise of the Warrant from such Holder (other than solely due to the lack of consent by the Company's stockholders pursuant to Section 3.14 of the Exchange Agreement), or the Company is otherwise unable or unwilling for any reason to issue unlegended Common Stock as required by (and within the time frames required by), and in accordance with the provisions of, the Preferred Shares, the Warrant, this Agreement or the Exchange Agreement (each, an "Exercise Deficiency"), then at any time 5 days after the commencement of the running of the first 30 day period following an Exercise Deficiency, at the request of any Holder, the Company promptly shall purchase from such Holder, on the terms set forth in Section 2(b)(i)(B) above, the Preferred Shares that are unconvertible, the portion of the Warrant that is unexercisable and/or the shares of Common Stock required to be issued that have not been issued, in each case as a result of the Exercise Deficiency, at their Premium Redemption Price.

(v) Additional Interfering Events. In the event there is: (i) a default in payment of any amounts due under the Certificate on or after the date such payment is due, which default continues for 5 business days after written notice of such non-payment has been received by the Company; (ii) a default in the timely issuance of Common Shares upon and in accordance with terms of the Certificate, which default continues for five business days after the Company has received written notice informing the Company that it has failed to issue shares or deliver stock certificates within the fifth day following the Conversion Date (as defined in the Certificate) or a redemption date; (iii) failure by the Company on or prior to the earlier of the applicable cure period, if any, or the thirtieth (30^th) day after written notice has been received by the Company, to comply with any material provision of the Certificate, the Exchange Agreement, the Registration Rights Agreement or the Warrant (including without limitation the failure to issue the requisite number of shares of Common Stock upon conversion or redemption of Preferred Shares and the failure to redeem Preferred Shares upon the Holder's request following a Change in Control Transaction) (the foregoing shall not include those provisions which already constitute an Interfering Event pursuant to another clause under this Section 2(b) and shall not limit any other right or remedy of the Purchaser under the Transaction Documents); (iv) a material breach by the Company of its representations or warranties in this Agreement, the Exchange Agreement, Purchase Agreement or Warrants; (v) any default after any cure period under, or acceleration prior to maturity of, any mortgage, indenture or instrument under which there may be issued or by which there may be secured or evidenced any indebtedness for money borrowed by the Company for in excess of $1 million or for money borrowed the repayment of which is

guaranteed by the Company for in excess of $1 million, whether such indebtedness or guarantee now exists or shall be created hereafter; or (vi) if the Company is subject to any Bankruptcy Event, then each Holder shall, at its option, have the right to cause the Company to redeem its Securities in whole or in part at the Premium Redemption Price at any time.

(vi) Premium Redemption Price for Defaults.

(A) The Company acknowledges that any failure, refusal or inability by the Company to perform the obligations described in the foregoing paragraphs (i) through (v) will cause the Holders to suffer damages in an amount that will be difficult to ascertain, including without limitation damages resulting from the loss of liquidity in the Registrable Securities and the additional investment risk in holding the Registrable Securities. Accordingly, the parties agree, after consulting with counsel, that it is appropriate to include in this Agreement the foregoing provisions for Monthly Delay Payments and mandatory redemptions in order to compensate the Holders for such damages. The parties acknowledge and agree that the Monthly Delay Payments and mandatory redemptions set forth above represent the parties' good faith effort to quantify such damages and, as such, agree that the form and amount of such payments and mandatory redemptions are reasonable and will not constitute a penalty.

(B) In the event that the Company fails to make any Monthly Delay Payment within 10 calendar days of demand therefor, each Holder shall have the right to sell to the Company any or all of its Securities at the Premium Redemption Price on the terms set forth in Section 2(b)(i)(B) above.

(vii) Cumulative Remedies. Each Monthly Delay Payment triggered by an Interfering Event provided for in the foregoing paragraphs (i) through (v) shall be in addition to each other Monthly Delay Payment triggered by another Interfering Event; provided, however, that in no event shall the Company be obligated to make to any Holder Monthly Delay Payments in an aggregate amount greater than $225,000 for any 30 day period (or portion thereof). The Monthly Delay Payments and mandatory redemptions provided for above are in addition to and not in lieu or limitation of any other rights the Holders may have at law, in equity or under the terms of the Transaction Documents including without limitation the right to specific performance. Each Holder shall be entitled to specific performance of any and all obligations of the Company in connection with the registration rights of the Holders hereunder.

(c) If the Holder(s) intend to distribute the Registrable Securities by means of an underwriting, the Holder(s) shall so advise the Company. Any such underwriting may only be administered by investment bankers reasonably satisfactory to the Company.

(d) The Company shall enter into such customary agreements for secondary offerings (including a customary underwriting agreement with the underwriter or underwriters, if any) and take all such other reasonable actions reasonably requested by the Holders in connection therewith in order to expedite or facilitate the disposition of such Registrable Securities and in such connection, whether or not an underwriting agreement is entered into and whether or not the Registrable Securities are to be sold in an underwritten offering, the Company shall:

(i) make such representations and warranties to the Holders and the underwriter or underwriters, if any, in form, substance and scope as are customarily made by issuers to underwriters in secondary offerings;

(ii) cause to be delivered, if requested, to the sellers of Registrable Securities and the underwriter or underwriters, if any, opinions of independent counsel to the Company, on and dated as of the effective day (or in the case of an underwritten offering or deemed

underwritten offering, dated the date of delivery of any Registrable Securities sold pursuant thereto) of the Registration Statement, and within 90 days following the end of each fiscal year thereafter, which counsel and opinions (in form, scope and substance) shall be reasonably satisfactory to the Holders and the underwriter(s), if any, and their counsel and covering, without limitation, such matters as the due authorization and issuance of the securities being registered and compliance with securities laws by the Company in connection with the authorization, issuance and registration thereof and other matters that are customarily given to underwriters in underwritten offerings, addressed to the Holders and each underwriter, if any;

(iii) cause to be delivered, immediately prior to the effectiveness of the Registration Statement (and, in the case of an underwritten offering or deemed underwritten offering, at the time of delivery of any Registrable Securities sold pursuant thereto), and at the beginning of each fiscal year following a year during which the Company's independent certified public accountants shall have reviewed any of the Company's books or records, a "comfort" letter from the Company's independent certified public accountants addressed to the Holders and each underwriter, if any, stating that such accountants are independent public accountants within the meaning of the Securities Act and the applicable published rules and regulations thereunder, and otherwise in customary form and covering such financial and accounting matters as are customarily covered by letters of the independent certified public accountants delivered in connection with secondary offerings; such accountants shall have undertaken in each such letter to update the same during each such fiscal year in which such books or records are being reviewed so that each such letter shall remain current, correct and complete throughout such fiscal year; and each such letter and update thereof, if any, shall be reasonably satisfactory to the Holders;

(iv) if an underwriting agreement is entered into, the same shall include customary indemnification and contribution provisions to and from the underwriters and procedures for secondary underwritten offerings;

(v) deliver such documents and certificates as may be reasonably requested by the Holders of the Registrable Securities being sold or the managing underwriter or underwriters, if any, to evidence compliance with clause (i) above and with any customary conditions contained in the underwriting agreement, if any; and

(vi) deliver to the Holders on the effective day (or in the case of an underwritten offering, dated the date of delivery of any Registrable Securities sold pursuant thereto) of the Registration Statement, and at the beginning of each fiscal quarter thereafter, a certificate in form and substance as shall be reasonably satisfactory to the Holders, executed by an executive officer of the Company and to the effect that all the representations and warranties of the Company contained in the Exchange Agreement are still true and correct except as disclosed in such certificate; the Company shall, as to each such certificate delivered at the beginning of each fiscal quarter, update or cause to be updated each such certificate during such quarter so that it shall remain current, complete and correct throughout such quarter; and such updates received by the Holders during such quarter, if any, shall have been reasonably satisfactory to the Holders.

(e) The Company shall make available for inspection by the Holders, representative(s) of all the Holders together, any underwriter participating in any disposition pursuant to a Registration Statement, and any attorney or accountant retained by any Holder or underwriter, all financial and other records customary for purposes of the Holders' due diligence examination of the Company and review of any Registration Statement, all SEC Documents (as defined in the Exchange Agreement) filed subsequent to the Exchange, pertinent corporate documents and properties of

the Company, and cause the Company's officers, directors and employees to supply all information reasonably requested by any such representative, underwriter, attorney or accountant in connection with such Registration Statement, provided that such parties agree to keep such information confidential.

(f) The Company shall file a Registration Statement with respect to any newly authorized and/or reserved shares representing Registrable Securities that are not covered by an existing Registration Statement within twenty (20) business days of any shareholders meeting authorizing or reserving same and shall use its best efforts to cause such Registration Statement to become effective within ninety (90) days of such shareholders meeting. If the Holders become entitled, pursuant to an event described in clause (iii) of the definition of Registrable Securities, to receive any securities in respect of Registrable Securities that were already included in a Registration Statement, subsequent to the date such Registration Statement is declared effective, and the Company is unable under the securities laws to add such securities to the then effective Registration Statement, the Company shall promptly file, in accordance with the procedures set forth herein, an additional Registration Statement with respect to such newly Registrable Securities. The Company shall use its best efforts to (i) cause any such additional Registration Statement, when filed, to become effective under the Securities Act, and (ii) keep such additional Registration Statement effective during the period described in Section 5 below. All of the registration rights and remedies under this Agreement shall apply to the registration of such newly reserved shares and such new Registrable Securities, including without limitation the provisions providing for Monthly Delay Payments contained herein.

(g) The Company shall promptly forward to the Holders and the Holders' counsel a copy of any correspondence or other written communications to or from or concerning (i) the SEC or other regulatory authority, relating to the Registration Statement or the Registrable Securities, and (ii) the NASD or the NASDAQ Stock Market relating to the listing or delisting, or potential delisting, of the Company's Common Stock, to the extent same does not constitute material nonpublic information.

3. Expenses of Registration. All Registration Expenses incurred in connection with any registration, qualification or compliance with registration pursuant to this Agreement shall be borne by the Company, and all Selling Expenses of a Holder shall be borne by such Holder.

4. Registration on Form S-3; Other Forms. The Company shall use its best efforts to qualify for registration on Form S-3 or any comparable or successor form or forms, or in the event that the Company is ineligible to use such form, such form as the Company is eligible to use under the Securities Act.

5. Registration Period. In the case of the registration effected by the Company pursuant to this Agreement, the Company will use its best efforts to keep such registration effective at all times during the period ("Registration Period") commencing on the earlier of the effective date of the Registration Statement or the Effectiveness Deadline and continuing thereafter until the later to occur of (a) the date on which sales are permitted of all Registrable Securities without registration under Rule 144(k) (provided that the Company's transfer agent has accepted an instruction from the Company to such effect and assuming there is no cashless exercise of the Warrant) or (b) the earlier of the date on which (i) there are no longer any Preferred Shares or Warrant outstanding or issuable and (ii) the fifth (5^th) anniversary of the Exchange Date.

6. Indemnification.

(a) The Company Indemnity. The Company will indemnify each Holder, each of its officers, directors and partners, and each person controlling each Holder, within the meaning of Section 15 of the Securities Act and the rules and regulations thereunder with respect to which registration, qualification or compliance has been effected pursuant to this Agreement, and each underwriter, if any, and each person who controls, within the meaning of Section 15 of the Securities Act and the rules and regulations thereunder, any underwriter, against all claims, losses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any prospectus, offering circular or other document (including any related registration statement, notification or the like) incident to any such registration, qualification or compliance, or based on any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, or any violation by the Company of the Securities Act or any state securities law or in either case, any rule or regulation thereunder applicable to the Company and relating to action or inaction required of the Company in connection with any such registration, qualification or compliance, and will reimburse each Holder, each of its officers, directors and partners, and each person controlling such Holder, each such underwriter and each person who controls any such underwriter, for any legal and any other expenses reasonably incurred in connection with investigating and defending any such claim, loss, damage, liability or action, provided that the Company will not be liable in any such case to a Holder to the extent that any such claim, loss, damage, liability or expense arises out of or is based on any untrue statement or omission based upon written information furnished to the Company by such Holder or the underwriter (if any) therefor and stated to be specifically for use therein. The indemnity agreement contained in this Section 6(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of the Company (which consent will not be unreasonably withheld).

(b) Holder Indemnity. Each Holder will, severally and not jointly, if Registrable Securities held by it are included in the securities as to which such registration, qualification or compliance is being effected, indemnify the Company, each of its directors, officers, partners, and each underwriter, if any, of the Company's securities covered by such a registration statement, each person who controls the Company or such underwriter within the meaning of Section 15 of the Securities Act and the rules and regulations thereunder, each other Holder (if any), and each of their officers, directors and partners, and each person controlling such other Holder(s), against all claims, losses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any such registration statement, prospectus, offering circular or other document, or any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statement therein not misleading, and will reimburse the Company and such other Holder(s) and their directors, officers and partners, underwriters or control persons for any legal or any other expenses reasonably incurred in connection with investigating and defending any such claim, loss,

damage, liability or action, in each case to the extent, but only to the extent, that such untrue statement (or alleged untrue statement) or omission (or alleged omission) is made in such registration statement, prospectus, offering circular or other document in reliance upon and in conformity with written information furnished to the Company by such Holder and stated to be specifically for use therein, and provided that the maximum amount for which such Holder shall be liable under this indemnity shall not exceed the net proceeds received by such Holder from the sale of the Registrable Securities. The indemnity agreement contained in this Section 6(b) shall not apply to amounts paid in settlement of any such claims, losses, damages or liabilities if such settlement is effected without the consent of such Holder (which consent shall not be unreasonably withheld).

(c) Procedure. Each party entitled to indemnification under this Section 6 (the "Indemnified Party") shall give notice to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has actual knowledge of any claim as to which indemnity may be sought, and shall permit the Indemnifying Party to assume the defense of any such claim in any litigation resulting therefrom, provided that counsel for the Indemnifying Party, who shall conduct the defense of such claim or any litigation resulting therefrom, shall be approved by the Indemnified Party (whose approval shall not be unreasonably withheld), and the Indemnified Party may participate in such defense at such party's expense, and provided further that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations under this Article except to the extent that the Indemnifying Party is materially and adversely affected by such failure to provide notice. No Indemnifying Party, in the defense of any such claim or litigation, shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect to such claim or litigation. Each Indemnified Party shall furnish such information regarding itself or the claim in question as an Indemnifying Party may reasonably request in writing and as shall be reasonably required in connection with the defense of such claim and litigation resulting therefrom.

7. Contribution. If the indemnification provided for in Section 6 herein is unavailable to the Indemnified Parties in respect of any losses, claims, damages or liabilities referred to herein (other than by reason of the exceptions provided therein), then each such Indemnifying Party, in lieu of indemnifying each of such Indemnified Parties, shall contribute to the amount paid or payable by each such Indemnified Party as a result of such losses, claims, damages or liabilities as between the Company on the one hand and any Holder on the other, in such proportion as is appropriate to reflect the relative fault of the Company and of such Holder in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities, as well as any other relevant equitable considerations. The relative fault of the Company on the one hand and of any Holder on the other shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact relates to information supplied by the Company or by such Holder.

In no event shall the obligation of any Indemnifying Party to contribute under this Section 7 exceed the amount that such Indemnifying Party would have been obligated to pay by way of indemnification if the indemnification provided for under Section 6(a) or 6(b) hereof had been available under the circumstances.

The Company and the Holders agree that it would not be just and equitable if contribution pursuant to this Section 7 were determined by pro rata allocation (even if the Holders or the underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraphs. The amount paid or payable by an Indemnified Party as a result of the losses, claims,

damages and liabilities referred to in the immediately preceding paragraphs shall be deemed to include, subject to the limitations set forth above, any legal or other expenses reasonably incurred by such Indemnified Party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this section, no Holder or underwriter shall be required to contribute any amount in excess of the amount by which (i) in the case of any Holder, the net proceeds received by such Holder from the sale of Registrable Securities or (ii) in the case of an underwriter, the total price at which the Registrable Securities purchased by it and distributed to the public were offered to the public exceeds, in any such case, the amount of any damages that such Holder or underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation.

8. Survival. The indemnity and contribution agreements contained in Sections 6 and 7 and the representations and warranties of the Company referred to in Section 2(d)(i) shall remain operative and in full force and effect regardless of (i) any termination of this Agreement or the Exchange Agreement or any underwriting agreement, (ii) any investigation made by or on behalf of any Indemnified Party or by or on behalf of the Company, and (iii) the consummation of the sale or successive resales of the Registrable Securities.

9. Information by Holders. Each Holder shall reasonably promptly furnish to the Company in writing such information regarding such Holder and the distribution and/or sale proposed by such Holder as the Company may reasonably request in writing and as shall be reasonably required in connection with any registration, qualification or compliance referred to in this Agreement. The intended method or methods of disposition and/or sale (Plan of Distribution) of such securities as so provided by such Holder shall be included without alteration in the Registration Statement covering the Registrable Securities and shall not be changed without written consent of such Holder (which shall not be unreasonably withheld), except that such Holder may not require an intended method of disposition which violates applicable securities law or a description of the method of disposition to which the SEC objects.

10. NASDAQ Limit on Stock Issuances. Section 3.14 of the Exchange Agreement shall govern limits imposed by NASDAQ rules on the issuance of Common Stock.

11. Replacement Certificates. The certificate(s) representing the Registrable Securities held by the Purchaser (or then Holder) may be exchanged by the Purchaser (or such Holder) at any time and from time to time for certificates with different denominations representing an equal aggregate number of Registrable Securities, as reasonably requested by the Purchaser (or such Holder) upon surrendering the same. No service charge will be made for such registration or transfer or exchange.

12. Transfer or Assignment. Except as otherwise provided herein, this Agreement shall be binding upon and inure to the benefit of the parties and their successors and permitted assigns. The rights granted to the Purchaser by the Company under this Agreement to cause the Company to register Registrable Securities may be transferred or assigned (in whole or in part) to a transferee or assignee of Registrable Securities, Preferred Shares or Warrant that are or that are convertible into or exercisable for, an aggregate of not less than 20,000 shares of Common Stock for transfers or assignments in part, and all other rights granted to the Purchaser by the Company hereunder may be transferred or assigned to any transferee or assignee of any Registrable Securities, Preferred Shares or Warrant; provided in each case that the Company must be given written notice by the such Purchaser at the time of or within a reasonable time after said transfer or assignment, stating the name and address of said transferee or assignee and identifying the securities with respect to which such registration rights are being transferred or assigned; and provided further that the transferee or assignee of such rights agrees in writing to be bound by the provisions of this Agreement.

13. Miscellaneous.

(a) Remedies. The Company and the Purchaser acknowledge and agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent or cure breaches of the provisions of this Agreement and to enforce specifically the terms and provisions hereof, this being in addition to any other remedy to which any of them may be entitled by law or equity.

(b) Jurisdiction. EACH OF THE COMPANY AND THE PURCHASER (I) HEREBY IRREVOCABLY SUBMITS TO THE EXCLUSIVE JURISDICTION OF THE UNITED STATES DISTRICT COURT, THE STATE COURTS AND OTHER COURTS OF THE UNITED STATES SITTING IN NEW YORK COUNTY, NEW YORK, OR SAN JOSE, CALIFORNIA FOR THE PURPOSES OF ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT AND (II) HEREBY WAIVES, AND AGREES NOT TO ASSERT IN ANY SUCH SUIT ACTION OR PROCEEDING, ANY CLAIM THAT IT IS NOT PERSONALLY SUBJECT TO THE JURISDICTION OF SUCH COURTS, THAT THE SUIT, ACTION OR PROCEEDING IS BROUGHT IN AN INCONVENIENT FORUM OR THAT THE VENUE OF THE SUIT, ACTION OR PROCEEDING IS IMPROPER. EACH OF THE COMPANY AND THE PURCHASER CONSENTS TO PROCESS BEING SERVED IN ANY SUCH SUIT, ACTION OR PROCEEDING BY MAILING A COPY THEREOF TO SUCH PARTY AT THE ADDRESS IN EFFECT FOR NOTICES TO IT UNDER THIS AGREEMENT AND AGREES THAT SUCH SERVICE SHALL CONSTITUTE GOOD AND SUFFICIENT SERVICE OF PROCESS AND NOTICE THEREOF. NOTHING IN THIS PARAGRAPH SHALL AFFECT OR LIMIT ANY RIGHT TO SERVE PROCESS IN ANY OTHER MANNER PERMITTED BY LAW.

(c) Notices. Any notice or other communication required or permitted to be given hereunder shall be in writing by facsimile, mail or personal delivery and shall be effective upon actual receipt of such notice. The addresses for such communications shall be:

to the Company:

Hybrid Networks, Inc.
6409 Guadalupe Mines Road
San Jose, California 95120
Telephone: 408-323-6500
Facsimile:
Attention:

with a copy to:

Fenwick and West LLP
2 Palo Alto Square
Palo Alto, California 94306
Telephone: 650-494-0600
Facsimile: 650-494-1417
Attention: Dan Winnike, Esq.

to the Purchaser:

Halifax Fund, L.P.
c/o The Palladin Group, L.P.
195 Maplewood Avenue
Maplewood, New Jersey 07040
Attention: Maurice Hryshko
Telephone: (973) 313-6470
Fax: (973) 313-6495

with copies to:

Kleinberg, Kaplan, Wolff & Cohen, P.C.
551 Fifth Avenue
New York, New York 10176
Telephone: (212) 986-6000
Facsimile: (212) 986-8866
Attention: Peter J. Weisman, Esq.

Any party hereto may from time to time change its address for notices by giving at least 10 days' written notice of such changed address to the other parties hereto.

(d) Indemnity. Each party shall indemnify each other party against any loss, cost or damages (including reasonable attorney's fees) incurred as a result of such parties' breach of any representation, warranty, covenant or agreement in this Agreement.

(e) Waivers. No waiver by any party of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of any party to exercise any right hereunder in any manner impair the exercise of any such right accruing to it thereafter. The representations and warranties and the agreements and covenants of the Company and the Purchaser contained herein shall survive the Exchange.

(f) Execution. This Agreement may be executed in two or more counterparts, all of which shall be considered one and the same agreement, it being understood that all parties need not sign the same counterpart.

(g) Publicity. The Company agrees that it will not disclose, and will not include in any public announcement, the name of the Purchaser without its express written approval, unless and until such disclosure is required by law or applicable regulation, and then only to the extent of such requirement. The Company agrees to deliver a copy of any public announcement regarding the matters covered by this Agreement or any agreement or document executed herewith, and any public announcement including the name of the Purchaser, to the Purchaser, prior to the publication of such announcements.

(h) Entire Agreement. This Agreement, together with the Exchange Agreement, the Warrant, the Purchase Agreement and the agreements and documents contemplated hereby and thereby, contains the entire understanding and agreement of the parties, and may not be modified or terminated except by a written agreement signed by both parties.

(i) Governing Law. THIS AGREEMENT AND THE VALIDITY AND PERFORMANCE OF THE TERMS HEREOF SHALL BE GOVERNED BY AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE STATE OF NEW YORK APPLICABLE TO CONTRACTS EXECUTED AND TO BE PERFORMED ENTIRELY IN SUCH STATE.

(j) Severability. The parties acknowledge and agree that the Holders are not agents, affiliates or partners of each other, that all representations, warranties, covenants and agreements of the Holders hereunder are several and not joint, that no Holder shall have any responsibility or liability for the representations, warrants, agreements, acts or omissions of any other Holder, and that any rights granted to "Holders" hereunder shall be enforceable by each Holder hereunder.

(k) Jury Trial. EACH PARTY HERETO WAIVES THE RIGHT TO A TRIAL BY JURY.

(l) Titles. The titles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement.

* * * Signature page follows * * *

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above written.

		COMPANY:
		HYBRID NETWORKS, INC.,

		By:	/s/ Michael D. Greenbaum Name: Michael D. Greenbaum Title: President and Chief Executive Officer

		PURCHASER:
		HALIFAX FUND, L.P.

		By:	/s/ Maurice Hryshko Name: Maurice Hryshko Title: Counsel The Palladin Group, L.P. Investment Adviser

Signature page to Registration Rights Agreement

QuickLinks

Exhibit 4.01

EX-4.02 5 a2056568zex-4_02.htm EXHIBIT 4.02 Prepared by MERRILL CORPORATION
QuickLinks -- Click here to rapidly navigate through this document

Exhibit 4.02

EXCHANGE AGREEMENT

EXCHANGE AGREEMENT ("Agreement") dated as of August 13, 2001 by and between HYBRID NETWORKS, INC., a Delaware corporation (the "Company"), and HALIFAX FUND, L.P., a Cayman Islands limited partnership (the "Purchaser").

W I T N E S S E T H:

WHEREAS, the Company and the Purchaser wish to exchange the Debenture and the Adjustment Warrant for 7,560 shares (the "Preferred Shares") of the Company's Series K Cumulative Convertible Preferred Stock, par value $.001 per share, which are convertible into shares ("Common Shares") of Common Stock, in accordance with the terms of that certain Certificate of Designations (the "Certificate") attached hereto as Annex A, all on the terms and conditions described below;

WHEREAS, the Common Shares and the Warrant Shares (collectively, the "Registrable Securities") will carry registration rights pursuant to the terms of that certain Registration Rights Agreement to be entered into between the Company and the Purchaser substantially in the form annexed hereto as Annex B (the "Registration Rights Agreement") and the parties desire to completely terminate the Prior Registration Rights Agreement;

NOW, THEREFORE, in consideration of the foregoing premises and the covenants contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows:

ARTICLE I
Exchange of Debenture and Adjustment Warrant for Preferred Shares

Section 1.1 Issuance of Preferred Shares. Upon the following terms and conditions, the Company shall issue to the Purchaser, and the Purchaser shall acquire from the Company, 7,560 Preferred Shares in exchange for the surrender and cancellation of the Debenture and Adjustment Warrant.

Section 1.2 The Exchange.

(a) The exchange of the Debenture and Adjustment Warrant (the "Exchange") shall take place on or about the date hereof (the "Exchange Date"). On the Exchange Date the parties shall deliver all the items described in Section 4.3 below. In connection therewith, (1) the Company shall deliver original executed certificates evidencing the Preferred Shares to Kleinberg, Kaplan, Wolff & Cohen, P.C. ("KKWC") on or before the Exchange Date to hold for the Exchange, (2) the Company and the Purchaser shall exchange signature pages to this Agreement and the Registration Rights Agreement by facsimile on the date hereof (with four originals to be forwarded to KKWC by overnight courier), and (3) the stamped copy of the Certificate, the officer's certificate, the Sprint Consent and the opinion of counsel referenced in Section 4.2 below, respectively, shall be

delivered to KKWC on or before the Exchange Date to hold for the Exchange (which officer's certificate, Sprint Consent and opinion may be by facsimile with originals to follow).

(b) On the Exchange Date, the Purchaser shall receive all the original executed certificates evidencing the Preferred Shares, registered in the name of the Purchaser or its nominee, and the Purchaser shall surrender to the Company the Debenture and Adjustment Warrant for cancellation (which may be delivered to KKWC on the Exchange Date to be forwarded to the Company promptly following the Exchange Date). In addition, each party shall deliver all documents, instruments and writings required to be delivered by such party pursuant to this Agreement at or prior to the Exchange. Additionally, on the Exchange Date the Company shall pay to KKWC its legal fees and disbursements as set forth in Section 3.4.

(c) For clarification purposes, the Warrant shall remain outstanding following the Exchange (as amended pursuant to Section 1.5 below) and carry the registration rights set forth in the Registration Rights Agreement.

Section 1.3 Waivers. Effective upon, and only upon, the consummation of the Exchange, each party hereto forever waives any and all defaults of the other party hereto arising, or which may have arisen, under the Purchase Agreement, the Debenture or Prior Registration Rights Agreement, including without limitation any defaults under Section 2(b) of the Prior Registration Rights Agreement but excluding any misrepresentations under Article II of the Purchase Agreement (which misrepresentations are not waived and shall continue to constitute a default), with the effect that any such default did not occur. Without limiting the foregoing, the $150,000 payment received by the Purchaser from the Company on or about June 29, 2001 in satisfaction of the liquidated damages payment due under the Prior Registration Rights Agreement, which shall be waived pursuant to the preceding sentence, shall be deemed applied against interest which was previously due under the Debenture and thus is factored into the exchange rate hereunder.

Section 1.4 Rule 144. The Company and the Purchaser hereby agree that for purposes of determining the holding period under Rule 144 promulgated under the Securities Act (as defined herein) for the Preferred Shares and Common Shares, the holding period for the Preferred Shares and Common Shares shall be deemed to have commenced as of February 16, 2001, the date that the Debenture was issued, and the Company shall not take any position inconsistent with such holding period. For as long as any Preferred Shares or Common Shares remain outstanding, the Company covenants to comply with the information requirements set forth in Rule 144(c) of the Securities Act on a timely basis and to take such other steps as may be required, including without limitation instructions to its transfer agents, to enable the Purchaser or holder of Common Shares or Preferred Shares to effect resales of such securities under such Rule 144.

Section 1.5 Warrant Amendment.

(a) Amendments. The Warrant is hereby amended as follows:

(i) The following language shall be added to the end of clause (1) of Section 4(f)(ii) of the Warrant: "and the Common Stock shall be listed, quoted and traded, and not subject to any suspension of trading, on the NASDAQ National Market System, the American Stock Exchange, the New York Stock Exchange or the NASDAQ Small Cap Market, and no such market or exchange shall have notified the Company (in writing or orally) that the Company or its Common Stock is subject to delisting or suspension which notice is still in effect or which facts precipitating such potential delisting or suspension still exist;" and

(ii) The following new clause (5) shall be added after clause (4) in Section 4(f)(ii) of the Warrant: "and (5) There shall no longer be outstanding any Preferred Shares (as defined in that certain Exchange Agreement between the Company and the initial Holder hereof dated on or about August 3, 2001)."

(b) Replacement Warrant; Tacking. The Company agrees that, promptly following the Exchange Date, the Company shall issue and deliver to the Purchaser a replacement Warrant in exchange for the currently outstanding Warrant, which replacement Warrant shall be identical to the Warrant in all respects except for the amendments set forth in Section 1.5(a) above, at which time the Purchaser shall promptly return the currently outstanding Warrant to the Company for cancellation. The Company and the Purchaser hereby agree that for purposes of determining the holding period under Rule 144 of the Securities Act for the Warrant Shares in the event of a cashless exercise of the Warrant, the holding period for the Warrant Shares shall be deemed to have commenced as of February 16, 2001, the date that the Warrant was originally issued, and the Company shall not take any position inconsistent with such holding period.

Section 1.6 Termination of Prior Registration Rights Agreement. Effective upon, and only upon, the consummation of the Exchange, each of the parties hereto agrees that (a) the Prior Registration Rights Agreement will be terminated in its entirety and that all of the terms and provisions thereof will no longer be in effect, (b) each of the parties will release the other parties hereto from all obligations arising out of the Prior Registration Rights Agreement and neither party shall have any further rights arising out of the Prior Registration Rights Agreement, and (c) there will be no amounts due and owing under the Prior Registration Rights Agreement.

ARTICLE II
Representations and Warranties

Section 2.1 Representations and Warranties of the Company. The Company hereby makes the following representations and warranties to the Purchaser as of the date hereof and the Exchange Date except as may be set forth in a Schedule attached hereto bearing the subsection number of the subsection modified by such Schedule (it being agreed that the disclosure set forth in any Schedule shall only apply to the specified subsection of this Section 2.1 referred to in the caption of such Schedule):

(a) Organization and Qualification; Material Adverse Effect. The Company is a corporation duly incorporated and existing in good standing under the laws of the State of Delaware and has the requisite corporate power to own its properties and to carry on its business as now being conducted. The Company does not have any direct or indirect subsidiaries (defined as any entity of which the Company owns, directly or indirectly, 50% or more of the equity or voting power). Except where specifically indicated to the contrary, all references in this Agreement to subsidiaries shall be deemed to refer to all direct and indirect subsidiaries of the Company. Except where specifically indicated to the contrary, all references in this Article II to the Company shall be deemed to refer to the Company and its consolidated subsidiaries. Each of the Company and its subsidiaries is duly qualified as a foreign corporation to do business and is in good standing in every jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary other than those in which the failure so to qualify would not have a Material Adverse Effect. "Material Adverse Effect" means any adverse effect on the business, operations, prospects, properties or condition (financial or otherwise) of the entity with respect to which such term is used and which is (either alone or together with all other adverse effects) material to such entity and other entities controlling or controlled by such entity taken as a whole, and any material adverse effect on the transactions contemplated under this Agreement, the Registration Rights Agreement or any other agreement or document contemplated hereby or thereby.

(b) Authorization; Enforcement. (i) The Company has all requisite corporate power and authority to enter into and perform its obligations under this Agreement, the Certificate, the Warrant and the Registration Rights Agreement (the "Transaction Documents") and to issue the Preferred Shares, the Warrant and the Registrable Securities (collectively, the "Securities") in

accordance with the terms hereof and thereof and in accordance with the Purchase Agreement, (ii) the execution and delivery of the Transaction Documents by the Company and the consummation by it of the transactions contemplated hereby and thereby, including the issuance of the Registrable Securities and the prior issuance of the Warrant under the Purchase Agreement, have been duly authorized by all necessary corporate action, and no further consent or authorization of the Company or its Board of Directors (or any committee or subcommittee thereof) or stockholders is required, (iii) the Transaction Documents have been duly executed and delivered by the Company and (iv) the Transaction Documents constitute valid and binding obligations of the Company enforceable against the Company in accordance with their terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of creditors' rights and remedies or by other equitable principles of general application.

(c) Capitalization. The authorized capital stock of the Company consists of 100,000,000 shares of Common Stock and 5,000,000 shares of preferred stock, of which there are 22,379,780 shares of Common Stock and no shares of preferred stock issued and outstanding (excluding the Preferred Shares). Except as set forth in Schedule 2.1(c) hereto, no shares of Common Stock and no shares of preferred stock were reserved for issuance to persons other than the Purchaser. All of the outstanding shares of the Company's Common Stock and, if issued, preferred stock have been validly issued and are fully paid and non-assessable. No shares of capital stock are entitled to preemptive rights and, there are no outstanding options or outstanding warrants for shares of Common Stock (excluding the Warrant and Adjustment Warrant). There are no other scrip, rights to subscribe to, calls or commitments of any character whatsoever relating to, or securities or rights exchangeable for or convertible into, any shares of capital stock of the Company, or contracts, commitments, understandings, or arrangements by which the Company is or may become bound to issue additional shares of capital stock of the Company or options, warrants, scrip, rights to subscribe to, or commitments to purchase or acquire, any shares, or securities or rights convertible or exchangeable into shares, of capital stock of the Company. The Company has furnished the Purchaser with a true and correct copy of the Company's Amended and Restated Certificate of Incorporation (the "Charter"), as in effect on the date hereof, and a true and correct copy of the Company's By-Laws, as in effect on the date hereof (the "By-Laws").

(d) Issuance of Registrable Securities. The Common Shares and Warrant Shares are duly authorized and reserved for issuance, and, when issued upon conversion and/or exercise of the Preferred Shares or the Warrant, respectively, in accordance therewith, the Registrable Securities will be validly issued, fully paid and non-assessable, free and clear of any and all liens, claims and encumbrances, and, subject to the registration of such shares in accordance with the applicable provisions of the Securities Act of 1933, as amended (the "Securities Act" or the "Act") and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), will be entitled to be quoted and/or listed (as the case may be) on the NASDAQ National Market System, the American Stock Exchange, the New York Stock Exchange, NASDAQ Small Cap Market or the OTC Bulletin Board (each an "Approved Market"), and the holders of such Registrable Securities shall be entitled to all rights and preferences then accorded to a holder of Common Stock. The outstanding shares of freely tradable Common Stock are currently quoted on the NASDAQ National Market System.

(e) No Conflicts. The execution, delivery and performance of the Transaction Documents by the Company and the consummation by the Company of the transactions contemplated hereby and thereby and the issuance of the Securities do not and will not (i) result in a violation of the Company's Charter or By-Laws or (ii) conflict with, or constitute a default (or an event which with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation of, any agreement, indenture, patent, patent

license or instrument to which the Company is a party and the loss of which could reasonably be expected to have a Material Adverse Effect on the Company (collectively, "Company Agreements"), or (iii) result in a violation of any federal, state, local or foreign law, rule, regulation, order, judgment or decree (including federal and state securities laws and regulations) applicable to the Company or any of its subsidiaries or by which any property or asset of the Company or any of its subsidiaries is bound or affected, except (other than in the case of clause (i) above) where such violation would not reasonably be expected to have a Material Adverse Effect. The business of the Company and its direct and indirect subsidiaries is being conducted in material compliance with (i) its Charter and By-Laws, (ii) all Company Agreements and (iii) all applicable laws, ordinances or regulations of any governmental entity, except (other than in the case of clause (i) above) where such violation would not reasonably be expected to have a Material Adverse Effect. Except for filings, consents and approvals required under applicable state and federal securities laws, rules or regulations, or the rules and regulations of the Approved Markets and covered by the Registration Rights Agreement, the Company is not required under federal, state, local or foreign law, rule or regulation, or under any agreement, to obtain any consent, authorization or order of, or make any filing or registration with, any court or governmental agency or third party in order for it to execute, deliver or perform any of its obligations under the Transaction Documents, or to issue and sell the Securities, except for the registration provisions provided in the Registration Rights Agreement, the written consent ("Sprint Consent") of Sprint to the Transaction Documents and the transactions contemplated thereby, and compliance with the "piggy-back" registration rights provisions of the Company's outstanding registration rights agreements described in Schedule 2.1(f) hereto (and disclosing the names of the potential selling stockholders and the maximum number of shares that they could require to be registered).

(f) SEC Documents; No Non-Public Information; Financial Statements. The Common Stock is registered pursuant to Section 12(g) of the Exchange Act and since June 30, 1999 the Company and its subsidiaries have filed all reports, schedules, forms, statements and other documents required to be filed by it with the SEC pursuant to the reporting requirements of the Exchange Act, including all such proxy information, solicitation statement and registration statements, and any amendments thereto required to have been filed as of the Exchange Date (all of the foregoing including filings incorporated by reference therein being referred to herein as the "SEC Documents"). The Company has not directly or indirectly provided, and will not directly or indirectly provide, to the Purchaser any material non-public information or any information which, according to applicable law, rule or regulation, should have been disclosed publicly by the Company but which has not been so disclosed. As of their respective dates, the SEC Documents complied in all material respects with the requirements of the Exchange Act and the Securities Act, as the case may be, and the rules and regulations of the SEC promulgated thereunder and other federal, state and local laws, rules and regulations applicable to such SEC Documents, and none of the SEC Documents contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. No event or circumstance has occurred prior to the date hereof or will have occurred as of or on the Exchange Date which would require the Company to disclose such event or circumstance in order to make the statements in the SEC Documents not misleading but which has not, or will have not, been so disclosed.

(g) Financial Statements. The financial statements of the Company and its subsidiaries included in the SEC Documents comply as to form and substance in all material respects with applicable accounting requirements and the published rules and regulations of the SEC or other applicable rules and regulations with respect thereto. Such financial statements have been prepared in accordance with United States generally accepted accounting principles applied on a consistent basis during the periods involved (except (i) as may be otherwise indicated in such financial

statements or the notes thereto or (ii) in the case of unaudited interim statements, to the extent they may not include footnotes or may be condensed or summary statements) and fairly present in all material respects the financial position of the Company and its subsidiaries as of the dates thereof and the results of operations and cash flows for the periods then ended (subject, in the case of unaudited statements, to normal year-end audit adjustments). The occurrence of any potential event described in Schedule 2.1(g) will not cause a default, breach or violation of any material agreement of the Company, including, without limitation, any loan agreement or any agreement with a customer or supplier (or constitute an event which with notice or lapse of time or both would become a default, breach or violation). The Company is not subject to any Bankruptcy Event (as defined below).

(h) Principal Exchange/Market. The principal market on which the Common Stock is currently quoted is the NASDAQ National Market System.

(i) No Material Adverse Change. Except as disclosed in the Pre-Agreement SEC Documents (as defined below), since December 31, 1999, no Material Adverse Effect has occurred or exists, and no event or circumstance has occurred that with notice or the passage of time or both is reasonably likely to result in a Material Adverse Effect with respect to the Company or its subsidiaries on a consolidated basis.

(j) No Undisclosed Liabilities. The Company and its subsidiaries have no liabilities or obligations not disclosed in the Pre-Agreement SEC Documents (as defined below), other than those liabilities incurred in the ordinary course of the Company's or its subsidiaries' respective businesses since December 31, 1999, which liabilities, individually or in the aggregate, do not have a Material Adverse Effect on the Company or its direct or indirect subsidiaries.

(k) No Undisclosed Events or Circumstances. To the best knowledge of the Company, no material event or circumstance has occurred or exists with respect to the Company or its direct or indirect subsidiaries or their respective businesses, properties, prospects, operations or financial condition, which, under applicable law, rule or regulation, requires public disclosure or announcement by the Company but which has not been so publicly announced or disclosed.

(l) No General Solicitation. Neither the Company, nor any of its affiliates, or, to its knowledge, any person acting on its or their behalf has engaged in any form of general solicitation or general advertising (within the meaning of Regulation D under the Securities Act) in connection with the offer or sale of the Securities.

(m) No Integrated Offering. Other than pursuant to the Purchase Agreement, neither the Company, nor any of its affiliates, nor to its knowledge any person acting on its or their behalf, has directly or indirectly (i) issued any securities of any kind, other than upon the exercise of outstanding stock options, during the six month period immediately prior to the date hereof, or (ii) made any other offers or sales of any security or solicited any offers to buy any security under circumstances that would require registration of the Securities.

The issuance of the Securities to the Purchaser will not be integrated with any other issuance of the Company's securities (past, current or future) which requires stockholder approval under the rules of the NASDAQ National Market System.

(n) Form S-3. The Company is eligible to file the Registration Statement (as defined in the Registration Rights Agreement) on Form S-3 under the Act and rules promulgated thereunder, and Form S-3 is permitted to be used for the transactions contemplated hereby under the Act and rules promulgated thereunder.

(o) Intellectual Property. The Company and its subsidiaries own or possess adequate rights or licenses to use all trademarks, trade names, service marks, service mark registrations, service

names, patents, patent rights, patent applications, copyrights, inventions, licenses, approvals, governmental authorizations, trade secrets and confidential business information, computer software, and all other proprietary or intellectual property rights, and all goodwill associated with the foregoing (collectively, "Intellectual Property") necessary or desirable to conduct their respective businesses as now conducted or currently contemplated to be conducted in the future. Except for such expirations and terminations that would not individually or in the aggregate have a Material Adverse Effect on the Company, none of the Company's Intellectual Property rights have expired or terminated, or are expected to expire or terminate within three (3) years from the date of this Agreement. Except as would not individually or in the aggregate have a Material Adverse Effect, the Company and its subsidiaries do not have any knowledge of any infringement, interference or misappropriation by the Company or its subsidiaries of or with Intellectual Property or other similar rights of others, or of any such development of similar or identical trade secrets or technical information by others, and there is no claim, action or proceeding being made or brought against, or to the Company's knowledge, being threatened against, the Company or its subsidiaries regarding Intellectual Property or other infringement, interference or misappropriation. The Company and its subsidiaries have taken reasonable security measures to protect the secrecy, confidentiality and value of all of their Intellectual Property.

(p) Poison Pill Provisions. Neither the Company nor any of its subsidiaries have a stockholder rights plan. None of the acquisition of the Securities nor the deemed beneficial ownership of shares of Registrable Securities prior to, or the acquisition of Registrable Securities pursuant to, the conversion or exercise of the Preferred Shares or the Warrant, respectively, will in any event under any circumstance, but without giving effect to the ownership of any other securities of the Company, trigger the poison pill provisions of any other or subsequently adopted plan or agreement, or a substantially similar occurrence under any successor or similar plan.

(q) No Litigation. Except as set forth in the reports or documents filed at least 5 Trading Days prior to the Exchange Date by the Company pursuant to Section 13(a) or 15(d) of the Exchange Act (the "Pre-Agreement SEC Documents"), no litigation or claim (including those for unpaid taxes) against the Company or any of its subsidiaries is pending or, to the Company's knowledge, threatened, and no other event has occurred, which if determined adversely could reasonably be expected to have a Material Adverse Effect on the Company or could reasonably be expected to materially and adversely affect the transactions contemplated hereby. There is no legal proceeding described in the Pre-Agreement SEC Documents that could reasonably be expected to have a Material Adverse Effect on the Company.

(r) Brokers. The Company has taken no action which would give rise to any claim by any person for brokerage commissions, finder's fees or similar payments by the Company or the Purchaser relating to this Agreement or the transactions contemplated hereby. The Company shall be responsible for any and all such payments which may arise.

(s) Other Securities. There are no outstanding securities issued by the Company that are entitled to registration rights under the Act. There are no outstanding securities issued by the Company that are directly or indirectly convertible into, exercisable into, or exchangeable for, shares of Common Stock of the Company, or that have anti-dilution or similar rights that would be affected by the issuance of any of the Securities.

(t) Certain Transactions. Except as disclosed in the Pre-Agreement SEC Documents, none of the officers, directors, or key employees of the Company is presently a party to any transaction with the Company or any of its subsidiaries (other than for services as employees, officers and directors), including any contract, agreement or other arrangement providing for the furnishing of services to or by, providing for rental of real or personal property to or from, or otherwise requiring payments to or from any officer, director or such employee or, to the knowledge of the

Company, any corporation, partnership, trust or other entity in which any officer, director, or any such employee has a substantial interest or is an officer, director, trustee or partner.

(u) Insurance. The Company and each of its subsidiaries are insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as reasonably prudent and customary in the businesses in which the Company and its direct and indirect subsidiaries are engaged. Neither the Company nor any such subsidiary has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business without a significant increase in cost.

(v) No Reliance on Purchaser. The Company acknowledges and agrees that the Purchaser is acting solely in the capacity of an arm's length purchaser with respect to the Transaction Documents and the transactions contemplated hereby and thereby. The Company further acknowledges that the Purchaser is not acting as a financial advisor or fiduciary of the Company (or in any similar capacity) with respect to the Transaction Documents and the performance hereunder and thereunder and the transactions contemplated hereby and thereby. The Company further represents to the Purchaser that the Company's decision to enter into the Transaction Documents and the performance hereunder and thereunder has been based solely on the independent evaluation by the Company and its representatives.

(w) Foreign Corrupt Practices Act. Neither the Company, nor any director, officer, agent, employee or other person acting on behalf of the Company or any subsidiary has, in the course of acting for, or on behalf of, the Company, directly or indirectly used any corporate funds for any unlawful contribution, gift, entertainment or other unlawful expenses relating to political activity; directly or indirectly made any direct or indirect unlawful payment to any foreign or domestic government or party official or employee from corporate funds; violated or is in violation of any provision of the U.S. Foreign Corrupt Practices Act of 1977, as amended, or any similar treaties of the United States; or directly or indirectly made any bribe, rebate, payoff, influence payment, kickback or other unlawful payment to any foreign or domestic government or party official or employee.

(x) Application of Takeover Protections. The Company and its board of directors have taken all necessary action, if any, in order to render inapplicable any anti-takeover provision contained in the Company's Charter or By-Laws or Delaware law which is or could become applicable to the Purchaser as a result of the transactions contemplated by the Transaction Documents, including, without limitation, the Company's issuance of the Common Stock and the Purchaser's ownership of Common Stock.

(y) Acknowledgement of Dilution. The number of shares of Common Stock issuable upon conversion of the Preferred Shares and exercise of the Warrant may increase substantially in certain circumstances. The Company acknowledges that its obligation to issue shares of Common Stock in accordance with the Transaction Documents is absolute and unconditional, regardless of the dilution that such issuance may have on other stockholders of the Company.

Section 2.2 Representations and Warranties of the Purchaser. The Purchaser hereby makes the following representations and warranties to the Company as of the date hereof and the Exchange Date:

(a) Organization. Such Purchaser is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization.

(b) Authorization; Enforcement. (i) Such Purchaser has the requisite power and authority to enter into and perform its obligations under the Transaction Documents and to acquire the Securities being issued to it hereunder, (ii) the execution and delivery of the Transaction Documents by such Purchaser and the consummation by it of the transactions contemplated thereby have been duly authorized by all necessary corporate or partnership action, and (iii) the Transaction Documents constitute valid and binding obligations of such Purchaser enforceable against such Purchaser in accordance with their terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of creditors' rights and remedies or by other equitable principles of general application.

(c) No Conflicts. The execution, delivery and performance of the Transaction Documents and the consummation by such Purchaser of the transactions contemplated thereby do not and will not (i) result in a violation of such Purchaser's organizational documents, or (ii) conflict with any agreement, indenture or instrument to which such Purchaser is a party, or (iii) result in a material violation of any law, rule, or regulation, or any order, judgment or decree of any court or governmental agency applicable to such Purchaser.

(d) Securities Purchase Representations.

(i) Access to Other Information. Such Purchaser acknowledges that the Company has made available to such Purchaser the opportunity to examine the SEC Documents and such additional documents from the Company and to ask questions of, and receive full answers from, the Company concerning, among other things, the Company, its financial condition, its management, its prior activities and any other information which such Purchaser considers relevant or appropriate in connection with entering into this Agreement.

(ii) Risks of Purchase. Such Purchaser acknowledges that the Securities have not been registered under the Act. Such Purchaser is capable of assessing the risks of acquiring the Securities and is fully aware of the economic risks thereof.

(iii) Purchase Representation. Such Purchaser is acquiring the Preferred Shares, and may purchase the Registrable Securities, for its own account and not with a view to distribution in violation of any securities laws; provided, however, that by making the representations herein, such Purchaser does not agree to hold the Securities for any minimum or other specific term and reserves the right to dispose of the Securities at any time in accordance with federal and state securities laws applicable to such disposition.

(iv) Restricted Securities. Such Purchaser acknowledges and understands that the terms of issuance have not been reviewed by the SEC or by any state securities authorities and that the Securities have been issued in reliance on the certain exemptions for non-public offerings under the Act, which exemptions depend upon, among other things, the representations made and information furnished by such Purchaser.

(v) Ability to Bear Economic Risk. Such Purchaser is an "accredited investor" as defined in Rule 501 of Regulation D, as amended, under the Act, and that it (i) is able to bear the economic risk of purchasing the Securities, (ii) is able to hold the Securities for an indefinite period of time, and (iii) can afford a complete loss of its purchase of the Securities.

(e) Brokers. The Purchaser has taken no action which would give rise to any claim by any person for brokerage commissions, finder's fees or similar payments by the Company relating to the Transaction Documents or the transactions contemplated thereby. All fees and amounts payable to the brokers listed in Section 2.1(r) shall be solely the responsibility of the Company.

ARTICLE III
Covenants

Section 3.1 Registration and Listing; Effective Registration. Until the earlier of (i) five (5) years from the Exchange Date and (ii) the date on which the Purchaser neither holds any Registrable Securities nor has the right to acquire any Registrable Securities, the Company will cause the Common Stock to continue at all times to be registered under Section 12(b) or Section 12(g) of the Exchange Act, will comply in all respects with its reporting and filing obligations under the Exchange Act, and will not take any action or file any document (whether or not permitted by the Exchange Act or the rules thereunder) to terminate or suspend such reporting and filing obligations. Until the earlier of (i) five (5) years from the Exchange Date and (ii) the date on which the Purchaser neither holds any Registrable Securities nor has the right to acquire any Registrable Securities, the Company shall continue the listing and/or quoting of the Registrable Securities on the NASDAQ National Market System or one of the other Approved Markets and comply in all respects with the Company's reporting, filing and other obligations under the bylaws or rules of the Approved Market on which the Registrable Securities are listed and/or quoted, as the case may be. The Company shall cause the Registrable Securities to be quoted on the NASDAQ National Market System or one of the other Approved Markets no later than the registration of the Registrable Securities under the Act, and at all times shall continue such listing(s) and/or quoting on one of the Approved Markets. As used herein and in the other Transaction Documents, the term "Effective Registration" shall mean: (i) the Company has complied with its material obligations under all the Transaction Documents in all material respects and has not made any material misrepresentations under any of the Transaction Documents or under any other agreements between the Company and the Purchaser, except for those breaches or defaults which are capable of being cured and have been so cured within a reasonable time following notice of such breach or default (not to exceed 5 business days); (ii) the resale of all Registrable Securities (as defined in the Registration Rights Agreement) is covered by an effective registration statement in accordance with the terms of the Registration Rights Agreement and such registration statement is not subject to any suspension or stop orders; (iii) the resale of such Registrable Securities may be effected pursuant to a current and deliverable prospectus that is not subject to any blackout or similar circumstance (including a prospectus supplement filed with the SEC in accordance with the terms of the Warrant following any Issuer Notice (as defined therein)); (iv) such Registrable Securities are listed, or approved for listing prior to issuance, on an Approved Market and are not subject to any trading suspension (nor shall trading generally have been suspended on such exchange or market), and the Company shall not have been notified of any pending or threatened proceeding or other action to delist or suspend the Common Stock on the Approved Market on which the Common Stock is then traded or listed; (v) the requisite number of shares of Common Stock shall have been duly authorized and reserved for issuance as required by the terms of the Transaction Documents; (vi) no Interfering Event (as described in the Registration Rights Agreement) then exists; and (vii) none of the Company or any direct or indirect subsidiary of the Company is subject to any Bankruptcy Event. For purposes hereof, "Bankruptcy Event" means any of the following events: (a) the Company or any subsidiary commences a case or other proceeding under any bankruptcy, reorganization, arrangement, adjustment of debt, relief of debtors, dissolution, insolvency or liquidation or similar law of any jurisdiction relating to the Company or any subsidiary thereof; (b) there is commenced against the Company or any subsidiary any such case or proceeding that is not dismissed within 60 days after commencement; (c) the Company or any subsidiary is adjudicated insolvent or bankrupt or any order of relief or other order approving any such case or proceeding is entered; (d) the Company or any subsidiary suffers any appointment of any custodian or the like for it or any substantial part of its property that is not discharged or stayed within 60 days; (e) the Company or any subsidiary makes a general assignment for the benefit of creditors; (f) the Company or any subsidiary fails to pay, or states that it is unable to pay or is unable to pay, its debts generally as they become due; (g) the Company or any subsidiary calls a meeting of its creditors with a view to arranging a

composition, adjustment or restructuring of its debts; or (h) the Company or any subsidiary, by any act or failure to act, expressly indicates its consent to, approval of or acquiescence in any of the foregoing or takes any corporate or other action for the purpose of effecting any of the foregoing.

Section 3.2 Warrant on Exercise. Upon any partial exercise by the Purchaser (or then holder) of the Warrant, the Company shall issue and deliver to such Purchaser (or holder) within five Trading Days of the date on which the Warrant is exercised, a new Warrant or Warrants representing the adjusted number of shares of Common Stock issuable upon exercise of the Warrant.

Section 3.3 Replacement Certificates. The certificate(s) or instrument(s) representing the Securities held by the Purchaser (or then holder) may be exchanged by such Purchaser (or such holder) at any time and from time to time for certificates or instruments with different denominations representing an equal aggregate number of Securities as requested by such Purchaser (or such holder) upon surrendering the same. The Company will deliver such substitute certificates or instruments within 3 Trading Days. No service charge will be made for such registration or transfer or exchange.

Section 3.4 Expenses. The Company shall pay to KKWC in immediately available funds, at the Exchange and promptly upon receipt of any further invoices relating to the same, all reasonable legal fees and expenses incurred by the Purchaser in connection with the transactions contemplated by this Agreement, the Registration Rights Agreement and the Certificate, provided that any such amounts in excess of $30,000 shall be paid by Purchaser. At the Exchange, the Company shall pay the amount due for such fees and expenses (which may include fees and expenses estimated to be incurred for the completion of the transaction, including post-closing matters), provided that any such amounts in excess of $30,000 shall be paid by Purchaser. In the event any amount paid by or on behalf of the Company is ultimately less than actual fees and expenses, the Company shall (subject to the $30,000 cap) promptly pay such deficiency to KKWC upon receipt of an invoice therefor. In lieu thereof, the Purchaser may pay such amounts due to KKWC, and the Company shall promptly reimburse the Purchaser for such amounts.

Section 3.5 Securities Compliance. The Company shall notify the SEC, the NASDAQ Stock Market and the NASD, in accordance with their requirements, of the transactions contemplated by Transaction Documents, and shall take all other necessary action and proceedings as may be required and permitted by applicable law, rule and regulation, for the legal and valid issuance of the Securities. Without limiting the foregoing, the Company shall, within two days following the Exchange Date file a Form 8-K with the SEC and/or issue a press release describing in detail the transactions contemplated in the Transaction Documents. Within one (1) Trading Day following any delivery of an Issuer Notice (as defined in and pursuant to the Warrant), the Company shall file with the SEC a prospectus supplement to the prospectus included in the Registration Statement (as defined in the Registration Rights Agreement) as required by the terms of the Warrant and Registration Rights Agreement. Such Form 8-K and any other Form 8-K and/or press release, and/or prospectus supplement, or other publicity concerning the Transaction Documents, shall contain such information as is reasonably requested by the Purchaser and be approved by the Purchaser in writing prior to issuance. No Form 8-K and/or press release shall name the Purchaser except as shall be required by law or consented to in writing by the Purchaser, which consent will not be unreasonably withheld. If the Company fails to so file a Form 8-K, press release or prospectus supplement as required herein within the requisite time period, the Purchaser at any time may issue a press release covering the transactions contemplated by the Transaction Documents or such Issuer Notice, as the case may be (provided that the Company shall not be relieved of its obligations to so file a prospectus supplement).

Section 3.6 Dividends or Distributions; Purchases of Equity Securities. For so long as any Preferred Shares remain outstanding, the Company agrees that it shall not (a) declare or pay any dividends or make any distributions to any holder or holders of Common Stock (other than dividends payable in Common Stock) in their capacity as stockholders, or (b) purchase, redeem or otherwise

acquire for value, directly or indirectly, any shares of Common Stock or other equity security of the Company, other than the debentures currently outstanding issued to London Pacific.

Section 3.7 Notices. The Company agrees to provide all holders of the Preferred Shares and the Warrant with copies of all notices and information, including without limitation notices and proxy statements in connection with any meetings, that are provided to the holders of shares of Common Stock, contemporaneously with the delivery of such notices or information to such Common Stock holders.

Section 3.8 Use of Proceeds. The Company agrees that the proceeds received by the Company from the sale of the Debenture and Warrant under the Purchase Agreement and the sale of the shares of Common Stock issuable upon exercise of the Warrant shall be used only for legally permitted general corporate purposes and shall not be used to repay or prepay any indebtedness of the Company except for trade payables incurred in the ordinary course of business.

Section 3.9 Notification of Additional Financings; Adjustments. The Company agrees that until the first anniversary of the Exchange Date, the Purchaser shall have a right of first offer with respect to all non-public capital raising transactions as set forth in this Section 3.9. The Company shall give advance written notice to the Purchaser of its intention to complete any such financing so that the Purchaser may, to the extent it in its sole discretion determines to do so, propose to provide such financing, in which case the Purchaser must propose such financing within three Trading Days following such notice by the Company. After any such proposal by the Purchaser is made, the Company shall negotiate in good faith with such Purchaser in order to attempt to agree on a financing transaction; provided, however, that if no such agreement in principle is reached within three Trading Days following the proposal, the Company shall not be precluded from seeking such financing from any other sources or from accepting such financing from any other sources. This right of first offer shall continue even if the Purchaser elects not to participate in one or more such financings. Notwithstanding anything herein to the contrary, this right of first offer shall not apply to issuances of the Company's securities pursuant to (i) the Company's current or future employee, director or bona fide consultant options plans and/or compensation arrangements, (ii) strategic corporate alliances not undertaken principally for financing purposes, and (iii) revolving or term loans provided to the Company by federal or state chartered banks or thrifts.

Section 3.10 Reservation of Stock Issuable Upon Exercise of the Warrant. The Company shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of Preferred Shares and exercise of the Warrant, such number of its shares of Common Stock as shall from time to time be sufficient to effect the full conversion of all Preferred Shares and the full exercise of the Warrant, and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the full conversion of all Preferred Shares and the full exercise of the Warrant, the Company will take such corporate action as may be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes, including without limitation engaging in best efforts to obtain the requisite shareholder approval. Without in any way limiting the foregoing, the Company agrees to reserve and at all times keep available solely for purposes of the conversion of Preferred Shares and exercise of the Warrant such number of authorized but unissued shares of Common Stock that is at least equal to 200% of the aggregate shares issuable upon full conversion of the Preferred Shares plus 100% of the number of shares of Common Stock issuable upon exercise of the Warrant in full, which numbers shall be appropriately adjusted for any stock split, reverse split, stock dividend or reclassification of the Common Stock. If the Company falls below the reserves specified in the immediately preceding sentence and does not cure such non-compliance within 30 days of its start, then the Purchaser will be entitled to the compensatory payments specified in Section 2(b)(i) of the Registration Rights Agreement. If at any time the number of authorized but unissued shares of Common Stock is not sufficient to effect the full conversion of the Preferred Shares

and the full exercise of the Warrant, the Purchaser shall be entitled to, inter alia, the premium price redemption rights provided in the Registration Rights Agreement. All calculations pursuant to this paragraph shall be performed without regard to any restrictions or limitations on beneficial ownership of Common Stock contained in the Preferred Shares or the Warrant.

Section 3.11 Best Efforts. The parties shall use their best efforts to satisfy timely each of the conditions described in Article 4 of this Agreement.

Section 3.12 Limitations on Transfers. The Company shall not contribute or transfer its assets to any of its subsidiaries, other than a subsidiary that has delivered its guarantee to the Purchaser in form and substance satisfactory to the Purchaser.

Section 3.13 Form D; Blue Sky Laws. The Company agrees to file a Form D with respect to the Securities, as required under Regulation D of the Act and to provide a copy thereof to the Purchaser promptly after such filing. The Company shall, on or before the Exchange Date, take such action as the Company shall have reasonably determined is necessary to qualify the applicable Securities for sale to the Purchaser at the Exchange pursuant to this Agreement under applicable securities or "blue sky" laws of the states of the United States (or to obtain an exemption from such qualification), and shall provide evidence of any such action so taken to the Purchaser on or prior to the Exchange Date.

Section 3.14 NASDAQ Rule. Notwithstanding anything contained herein, the Preferred Shares and Warrant shall not be convertible and exercisable to the extent that in excess of 4,372,600 shares of Common Stock (19.9% of the Common Stock issued and outstanding on the date of the Purchase Agreement, which number shall be subject to readjustment for any stock split, stock dividend or reclassification of the Common Stock) (the "20% Cap") would be issued thereon, unless the Company receives stockholder approval for such issuance. The Purchaser shall have the right to receive cash payments from the Company for all shares of Common Stock that this Section 3.14 renders the Company incapable of issuing to such Purchaser ("Deficiency Shares") at a price equal to (a) for the Preferred Shares, the Liquidation Value (as defined in the Certificate) of the Preferred Shares which would otherwise be converted into Deficiency Shares and (b) for the Warrants, the value determined by the Black-Scholes pricing model for such portion of the Warrants which would otherwise be exercisable for Deficiency Shares. If applicable, the restrictions and redemption obligations set forth in this Section 3.14 shall cease to apply if (1) the Company obtains written shareholder approval to issue Common Shares in excess of the 20% Cap pursuant to the rules and regulations of the Approved Market on which the Common Stock is traded, or (2) the Company provides the Purchaser with irrevocable written notice, based upon the written advice of its counsel, that any such issuance of Common Shares is not subject to the 20% Cap pursuant to the rules and regulations of such Approved Market. The Company will use its best efforts promptly to obtain either the shareholder approval or the irrevocable notice described in the preceding sentence and to provide the Purchaser with a copy of same. Without limiting the foregoing, in the event at any time the number of Registrable Securities then issued or issuable upon full conversion and exercise of the Preferred Shares and Warrant is 85% of the 20% Cap (assuming full conversion and exercise without regard to any beneficial ownership limitations set forth therein), then the Company shall within 60 days hold a stockholders meeting and shall solicit the aforementioned shareholder approval by soliciting proxies in favor of issuing Common Shares in excess of the 20% Cap and will use its best efforts to have all affiliates of the Company which own or control shares of Common Stock to vote their shares in favor of such resolution.

Section 3.15 Transactions With Affiliates. The Company agrees that any transaction or arrangement between it or any of its subsidiaries and any affiliate or employee of the Company shall be effected on an arms' length basis in accordance with customary commercial practice and, except with respect to grants of options and stock to service providers, including employees and directors, shall be approved by a majority of the Company's outside directors.

Section 3.16 Press Release. The Purchaser shall have the opportunity to review any press release in connection with the transactions contemplated hereby prior to its issuance.

Section 3.17 Reporting Lack of Effective Registration. The Company shall promptly notify the Purchaser in writing if there shall ever be a lack of Effective Registration, as well as when Effective Registration is re-established.

Section 3.18 Rule 144. With a view to making available to the Purchaser the benefits of Rule 144 promulgated under the Securities Act or any other similar rule or regulation of the SEC that may at any time permit the Purchaser to sell securities of the Company to the public without registration ("Rule 144"), the Company agrees, until such time as all of the Securities may be freely sold to the public under Rule 144(k) (or any successor thereto), to:

(a) make and keep public information available, as those terms are understood and defined in Rule 144;

(b) file with the SEC in a timely manner all reports and other documents required of the Company under the Securities Act and the Exchange Act so long as the Company remains subject to such requirements (it being understood that nothing herein shall limit any of the Company's other obligations under this Agreement and the filing of such reports and other documents is required for the applicable provisions of Rule 144); and

(c) furnish to the Purchaser so long as such Purchaser owns Registrable Securities, promptly upon request, (i) a written statement by the Company that it has complied with the reporting requirements of Rule 144, the Act and the Exchange Act, (ii) a copy of the most recent annual or quarterly report of the Company and such other reports and documents so filed by the Company, and (iii) such other information as may be reasonably requested to permit the Purchaser to sell such securities pursuant to Rule 144 without registration.

Section 3.19 Subordination. So long as any Preferred Shares remain outstanding, the Company shall not, and shall cause each of its subsidiaries not to, without the prior written consent of the Purchaser which may be withheld for any reason in the Purchaser's sole discretion, (1) permit, create, incur, assume, guarantee or otherwise become directly or indirectly liable for, any additional indebtedness, or (2) issue any shares of preferred stock or other capital stock which is senior to or pari passu with the Preferred Shares, other than (a) the convertible debentures issued to London Pacific for up to $5.5 million in aggregate principal amount outstanding, (b) indebtedness under commercial bank lines of credit, and (c) indebtedness outstanding under senior debt (collectively, "Senior Debt") issued by the Company which (1) is not directly or indirectly convertible into, exercisable for or exchangeable into any capital stock or other equity of the Company and (2) does not directly or indirectly provide for or contemplate the issuance of capital stock or equity of the Company or any securities convertible into, exercisable for or exchangeable into such capital stock or equity. So long as any Preferred Shares remain outstanding, the Company shall not, and shall cause each of its subsidiaries not to, repay any indebtedness of the Company except for trade payables incurred in the ordinary course of business.

Section 3.20 Reporting Events Described in Schedule 2.1(f) of the Purchase Agreement. The Company represents and warrants that any discounts, expenses or liabilities which may have needed to have been recorded as and to the extent described in Schedule 2.1(f) of the Purchase Agreement have been so recorded on or prior to the end of the Company's first fiscal quarter for 2001, and any deferral of revenues as and to the extent described in Schedule 2.1(f) of the Purchase Agreement were only deferred until a date which was on or prior to March 31, 2001.

ARTICLE IV
Conditions to Exchange

Section 4.1 Conditions Precedent to the Obligation of the Company to Issue Preferred Shares. The obligation hereunder of the Company to issue the Preferred Shares to the Purchaser at the Exchange is subject to the satisfaction at or before the Exchange of each of the applicable conditions set forth below. These conditions are for the Company's sole benefit and may be waived by the Company at any time in its sole discretion.

(a) Accuracy of the Purchaser's Representations and Warranties. The representations and warranties of the Purchaser will be true and correct as of the date when made and as of the Exchange Date.

(b) Performance by the Purchaser. The Purchaser shall have performed all agreements and satisfied all conditions required to be performed or satisfied by the Purchaser at or prior to the Exchange, including surrender of the Debenture and Adjustment Warrant.

(c) No Injunction. No statute, rule, regulation, executive order, decree, ruling or injunction shall have been enacted, entered, promulgated or endorsed by any court or governmental authority of competent jurisdiction which prohibits the consummation of any of the transactions contemplated by the Transaction Documents.

Section 4.2 Conditions Precedent to the Obligation of the Purchaser to Exchange. The obligation hereunder of the Purchaser to acquire and exchange for the Preferred Shares at the Exchange is subject to the satisfaction, at or before the Exchange, of each of the applicable conditions set forth below. These conditions are for the Purchaser's benefit and may be waived by the Purchaser at any time in its sole discretion.

(a) Accuracy of the Company's Representations and Warranties. The representations and warranties of the Company shall be true and correct as of the date when made and as of the Exchange Date as though made at that time (except for representations and warranties expressly as of an earlier date, which shall be true and correct in all material respects as of such date).

(b) Performance by the Company. The Company shall have performed all agreements and satisfied all conditions required to be performed or satisfied by the Company at or prior to the Exchange, including, without limitation, delivery of the Preferred Shares and stock certificates therefore.

(c) Trading and/or Quotation. Trading in and/or quotation of the Company's Common Stock shall not have been suspended by the SEC and trading in securities generally as reported by the NASDAQ National Market System (or other Approved Market) shall not have been suspended or limited, and the Common Stock shall be listed on an Approved Market.

(d) No Injunction. No statute, rule, regulation, executive order, decree, ruling or injunction shall have been enacted, entered, promulgated or endorsed by any court or governmental authority of competent jurisdiction which prohibits the consummation of any of the transactions contemplated by Transaction Documents. The NASD shall not have objected or indicated that it may object to the consummation of any of the transactions contemplated by this Agreement. The Company shall have delivered a copy of the Sprint Consent to the Purchaser.

(e) Opinion of Counsel. The Purchaser shall have received an opinion of counsel to the Company in the applicable form attached hereto as Exhibit 4.2(e) and such other opinions, certificates and documents as the Purchaser or its counsel shall reasonably require incident to the closing.

(f) Registration Rights Agreement. The Company and the Purchaser shall have executed and delivered the Registration Rights Agreement in the form and substance of Annex B attached hereto.

(g) Officer's Certificate. The Company shall have delivered to the Purchaser a certificate in form and substance satisfactory to the Purchaser and the Purchaser's counsel, executed by an officer of the Company, certifying as to satisfaction of applicable closing conditions, incumbency of signing officers, and the true, correct and complete nature of the Certificate of Incorporation, By-laws, good standing and authorizing resolutions of the Company.

(h) Miscellaneous. The Company shall have delivered to the Purchaser such other documents relating to the transactions contemplated by this Agreement as the Purchaser or its counsel may reasonable request.

Section 4.3 Exchange Date Deliveries.

(a) On the Exchange Date, the Company shall deliver to the Purchaser:

(i) Stock certificates evidencing the Preferred Shares;

(ii) A copy of the Certificate filed with Secretary of State of the State of Delaware and stamped by such Secretary of State;

(iii) The certificate referred to in Section 4.2(g) above;

(iv) The executed Registration Rights Agreement;

(v) The opinion of counsel referred to in Section 4.2(e) above; and

(vi) A copy of the duly executed Sprint Consent.

(b) On the Exchange Date, the Purchaser shall deliver to the Company (or to KKWC for delivery to the Company):

(i) The Debenture and the Adjustment Warrant; and

(ii) The executed Registration Rights Agreement.

ARTICLE V
Legend and Stock

The certificates representing the Preferred Shares issued hereunder and the Warrant shall be stamped or otherwise imprinted with a legend substantially in the following form:

THESE SECURITIES HAVE NOT BEEN REGISTERED FOR OFFER OR SALE UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS. THEY MAY NOT BE SOLD OR OFFERED FOR SALE EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER SAID ACT AND ANY APPLICABLE STATE SECURITIES LAW OR AN APPLICABLE EXEMPTION FROM SUCH REGISTRATION REQUIREMENTS.

Each certificate representing the shares of Common Stock issued upon conversion or exercise of Preferred Shares or the Warrant, prior to such shares being registered under the Act for resale or available for resale under Rule 144(k) under the Act, shall be stamped or otherwise imprinted with a legend in substantially the above form.

The Company agrees to reissue shares of Common Stock issued upon conversion or exercise of Preferred Shares or the Warrant without the legend set forth above at such time as (i) the holder thereof is permitted to dispose of such shares issuable upon conversion of the Preferred Shares or exercise of the Warrant pursuant to Rule 144(k) under the Act or has disposed of such securities pursuant to Rule 144 under the Act, or (ii) such shares are sold to a purchaser or purchasers who (in the opinion of counsel to the seller or such purchaser(s), in form and substance reasonably satisfactory to the Company and its counsel) are able to dispose of such shares publicly without registration under the Act, or (iii) such securities have been registered under the Act.

Prior to the Registration Statement (as defined in the Registration Rights Agreement) being declared effective, any shares of Common Stock issued upon conversion or exercise of Preferred Shares or Warrant shall bear a legend in the same form as the legend indicated above; provided that such legend shall be removed from such shares and the Company shall issue new certificates without such legend if (i) the holder has sold or disposed of such shares pursuant to Rule 144 under the Act, or the holder is permitted to dispose of such shares pursuant to Rule 144(k) under the Act, (ii) such shares are registered for resale under the Act, or (iii) such shares are sold to a purchaser or purchasers who (in the opinion of counsel to the seller or such purchaser(s), in form and substance reasonably satisfactory to the Company and it counsel) are able to dispose of such shares publicly without registration under the Act. Upon such Registration Statement becoming effective, the Company agrees to promptly, but no later than three (3) business days after the Purchaser's written request therefor (and surrender of legended stock certificates), issue new certificates representing such shares without such legend. Any shares issued after the Registration Statement has become effective shall be free and clear of any legends, transfer restrictions and stop orders. The Purchaser agrees to sell the Common Stock issued upon conversion of Preferred Shares or exercise of the Warrant in accordance with the applicable prospectus delivery requirements or in accordance with an exemption from the registration requirements of the Act (including without limitation Rule 144). The Purchaser acknowledges, and will cause any transferee of such Common Stock to whom such Common Stock was transferred other than as registered shares under the Registration Statement or pursuant to Rule 144 to acknowledge, that the Common Stock issued on conversion and exercise of the Preferred Shares and the Warrant has been issued pursuant to the exemption from registration provided by Regulation D under the Act and that the availability of such exemption is dependent upon the Purchaser's not disposing of such shares in an unregistered distribution in violation of securities laws, and Purchaser agrees, and will cause any such transferee to agree, not to dispose of any such Common Stock in an unregistered distribution in violation of securities laws.

Nothing herein shall limit the right of any holder to pledge these securities pursuant to a bona fide margin account or lending arrangement entered into in compliance with law, including applicable securities laws.

ARTICLE VI
Indemnification

In consideration of the Purchaser's execution and delivery of this Agreement and the Registration Rights Agreement and in addition to all of the Company's other obligations under the Transaction Documents, the Company shall defend, protect, indemnify and hold harmless the Purchaser and all of its partners, officers, directors, employees, members and direct or indirect investors and any of the foregoing persons' agents or other representatives (including, without limitation, those retained in connection with the transactions contemplated by this Agreement) (collectively, the "Indemnitees") from and against any and all actions, causes of action, suits, claims, losses, costs, penalties, fees, liabilities and damages, and expenses in connection therewith (irrespective of whether any such Indemnitee is a party to the action for which indemnification hereunder is sought), and including reasonable attorneys' fees and disbursements (the "Indemnified Liabilities"), incurred by any Indemnitee as a result of, or arising out of, or relating to (a) any misrepresentation or breach of any representation or warranty made by the Company in the Transaction Documents or any other certificate or document contemplated hereby or thereby, (b) any breach of any covenant, agreement or obligation of the Company contained in the Transaction Documents or any other certificate or document contemplated hereby or thereby, (c) any cause of action, suit or claim brought or made against such Indemnitee by a third party and arising out of or resulting from (i) the execution, delivery, performance, breach by the Company or enforcement of the Transaction Documents or any other certificate, instrument or document contemplated hereby or thereby, (ii) any transaction financed or to be financed in whole or in part, directly or indirectly, with the proceeds of the issuance of the

Securities or (iii) the status of the Purchaser or holder of the Securities or Warrant as a stockholder of the Company, and (d) the enforcement of this Section.

ARTICLE VII
Governing Law; Miscellaneous.

Section 7.1 Governing Law. THIS AGREEMENT SHALL BE GOVERNED BY AND INTERPRETED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK APPLICABLE TO CONTRACTS TO BE EXECUTED AND PERFORMED EXCLUSIVELY IN NEW YORK. EACH PARTY HEREBY IRREVOCABLY SUBMITS TO THE EXCLUSIVE JURISDICTION OF THE STATE AND FEDERAL COURTS SITTING IN THE CITY OF NEW YORK, BOROUGH OF MANHATTAN, OR SAN JOSE, CALIFORNIA, FOR THE ADJUDICATION OF ANY DISPUTE HEREUNDER OR IN CONNECTION HEREWITH OR WITH ANY TRANSACTION CONTEMPLATED HEREBY OR DISCUSSED HEREIN, AND HEREBY IRREVOCABLY WAIVES, AND AGREES NOT TO ASSERT IN ANY SUIT, ACTION OR PROCEEDING, ANY CLAIM THAT IT IS NOT PERSONALLY SUBJECT TO THE JURISDICTION OF ANY SUCH COURT, THAT SUCH SUIT, ACTION OR PROCEEDING IS BROUGHT IN AN INCONVENIENT FORUM OR THAT THE VENUE OF SUCH SUIT, ACTION OR PROCEEDING IS IMPROPER. EACH PARTY HEREBY IRREVOCABLY WAIVES PERSONAL SERVICE OF PROCESS AND CONSENTS TO PROCESS BEING SERVED IN ANY SUCH SUIT, ACTION OR PROCEEDING BY MAILING A COPY THEREOF TO SUCH PARTY AT THE ADDRESS FOR SUCH NOTICES TO IT UNDER THIS AGREEMENT AND AGREES THAT SUCH SERVICE SHALL CONSTITUTE GOOD AND SUFFICIENT SERVICE OF PROCESS AND NOTICE THEREOF. NOTHING CONTAINED HEREIN SHALL BE DEEMED TO LIMIT IN ANY WAY ANY RIGHT TO SERVE PROCESS IN ANY MANNER PERMITTED BY LAW. EACH PARTY HEREBY WAIVES ALL RIGHTS TO TRIAL BY JURY.

Section 7.2 Counterparts. This Agreement may be executed in two or more identical counterparts, all of which shall be considered one and the same agreement and shall become effective when counterparts have been signed by each party and delivered to the other party; provided that a facsimile signature shall be considered due execution and shall be binding upon the signatory thereto with the same force and effect as if the signature were an original, not a facsimile signature.

Section 7.3 Headings. The headings of this Agreement are for convenience of reference and shall not form part of, or affect the interpretation of, this Agreement.

Section 7.4 Severability. If any provision of this Agreement shall be invalid or unenforceable in any jurisdiction, such invalidity or unenforceability shall not affect the validity or enforceability of the remainder of this Agreement in that jurisdiction or the validity or enforceability of any provision of this Agreement in any other jurisdiction.

Section 7.5 Entire Agreement; Amendments; Waivers.

(a) This Agreement supersedes all other prior oral or written agreements between the Purchaser, the Company, their affiliates and persons acting on their behalf with respect to the matters discussed herein, and this Agreement and the instruments referenced herein (including the other Transaction Documents and the Purchase Agreement and Prior Registration Rights Agreement) contain the entire understanding of the parties with respect to the matters covered herein and therein. No provision of this Agreement may be amended other than by an instrument in writing signed by the Company and the Purchaser, and no provision hereof may be waived other than by an instrument in writing signed by the party against whom enforcement is sought.

(b) The Purchaser may at any time elect, by notice to the Company, to waive (whether permanently or temporarily, and subject to such conditions, if any, as the Purchaser may specify in

such notice) any of its respective rights (but not obligations) under any of the Transaction Documents to acquire shares of Common Stock from the Company, in which event such waiver shall be binding against the Purchaser in accordance with its terms.

Section 7.6 Notices. Any notices, consents, waivers or other communications required or permitted to be given under the terms of this Agreement must be in writing, must be delivered by (i) courier, mail or hand delivery or (ii) facsimile, and will be deemed to have been delivered upon receipt. The addresses and facsimile numbers for such communications shall be:

If to the Company:

		Hybrid Networks, Inc. 6409 Guadalupe Mines Road San Jose, California 95120
		Telephone:		408-323-6500
		Facsimile:		408-323-6470
		Attention:		President and CEO

with a copy to:

		Fenwick and West LLP 2 Palo Alto Square Palo Alto, California 94306
		Telephone:		650-494-0600
		Facsimile:		650-494-1417
		Attention:		Dan Winnike, Esq.

If to the Purchaser:

		Halifax Fund, L.P. c/o The Palladin Group, L.P. 195 Maplewood Avenue Maplewood, New Jersey 07040
		Attention:		Maurice Hryshko
		Telephone:		(973) 313-6470
		Fax:		(973) 313-6495

with a copy to:

		Kleinberg, Kaplan, Wolff & Cohen, P.C. 551 Fifth Avenue New York, New York 10176
		Telephone:		212-986-6000
		Facsimile:		212-986-8866
		Attention:		Peter J. Weisman, Esq.

Each party shall provide five (5) days prior written notice to the other party of any change in address, telephone number or facsimile number. Written confirmation of receipt (A) given by the recipient of such notice, consent, waiver or other communication, (B) mechanically or electronically generated by the sender's facsimile machine containing the time, date and recipient facsimile number or (C) provided by a nationally recognized overnight delivery service, shall be rebuttable evidence of personal service, receipt by facsimile or receipt from a nationally recognized overnight delivery service in accordance with clause (i), (ii) or (iii) above, respectively.

Section 7.7 Successors and Assigns. Except as otherwise provided herein, this Agreement shall be binding upon and inure to the benefit of the parties and their respective successors and assigns. The Purchaser may assign some or all of its rights hereunder without the consent of the Company in connection with any sale or transfer of all or any portion of the Securities held by the Purchaser. The

Company shall not assign this Agreement or any rights or obligations hereunder without the prior written consent of the Purchaser, including by merger or consolidation.

Section 7.8 No Third Party Beneficiaries. This Agreement is intended for the benefit of the parties hereto and their respective permitted successors and assigns, and is not for the benefit of, nor may any provision hereof be enforced by, any other person.

Section 7.9 Survival. The representations, warranties and agreements of the Company and the Purchaser contained in the Agreement shall survive the Exchange.

Section 7.10 Further Assurances. Each party shall do and perform, or cause to be done and performed, all such further acts and things, and shall execute and deliver all such other agreements, certificates, instruments and documents, as the other party may reasonably request in order to carry out the intent and accomplish the purposes of this Agreement and the consummation of the transactions contemplated hereby.

Section 7.11 Remedies. The Purchaser and each permitted assignee shall have all rights and remedies set forth in this Agreement, the Certificate, the Warrant and the Registration Rights Agreement and all rights and remedies which such holders have been granted at any time under any other agreement or contract and all of the rights which such holders have under any law. Any person having any rights under any provision of this Agreement shall be entitled to enforce such rights specifically (without posting a bond or other security), to recover damages by reason of any breach of any provision of this Agreement and to exercise all other rights granted by law. The Purchaser and each permitted assignee without prejudice may withdraw, revoke or suspend its pursuit of any remedy at any time prior to its complete recovery as a result of such remedy.

Section 7.12 Days. Unless the context refers to "business days" or "Trading Days," all references herein to "days" shall mean calendar days. "Trading Day" shall mean (x) if the Common Stock is listed on the New York Stock Exchange or the American Stock Exchange, a day on which there is trading on such stock exchange, or (y) if the Common Stock is not listed on either of such stock exchange but sale prices of the Common Stock are reported on an automated quotation system, a day on which trading is reported on the principal automated quotation system on which sales of the Common Stock are reported, or (z) if the foregoing provisions are inapplicable, a day on which quotations are reported by National Quotation Bureau Incorporated.

Section 7.13 Rescission and Withdrawal Right. Notwithstanding anything to the contrary contained in (and without limiting any similar provisions of) the Transaction Documents, wherever the Purchaser exercise a right, election, demand or option under a Transaction Document and the Company does not timely perform its related obligations within the periods therein provided, then the Purchaser may rescind or withdraw, in its sole discretion from time to time upon written notice to the Company, any such notice, demand or election in whole or in part without prejudice to its future actions and rights.

Section 7.14 Obligations Absolute. The Company's obligations under the Transaction Documents are unconditional and absolute and not subject to any right of set off, counterclaim, delay or reduction.

Section 7.15 Publicity. The Company agrees that it will not disclose, and will not include in any public announcement, the name of the Purchaser without the express written agreement of the Purchaser, which consent will not be unreasonably withheld, unless and until such disclosure is required by law or applicable regulation, and then only to the extent of such requirement. The Company agrees that it will deliver a copy of any public announcement regarding the matters covered by this Agreement or any agreement and document executed herewith to the Purchaser and any public announcement including the name of the Purchaser to the Purchaser, reasonably in advance of the release of such announcements.

Section 7.16 Like Treatment of Purchaser and Holders. Neither the Company nor any of its affiliates shall, directly or indirectly, pay or cause to be paid any consideration (immediate or contingent), whether by way of interest, fee, payment for the redemption, conversion of Preferred Shares or exercise of the Securities, or otherwise, to any holder of Securities, for or as an inducement to, or in connection with the solicitation of, any consent, waiver or amendment of any terms or provisions of the Transaction Documents, unless such consideration is required to be paid to all holders of Securities bound by such consent, waiver or amendment. The Company shall not, directly or indirectly, redeem any Securities unless such offer of redemption is made pro rata to all holders of Securities, as the case may be, on identical terms.

Section 7.17 Actions of Holders. Notwithstanding anything herein to the contrary, the actions and obligations of the holders of Securities under the Transaction Documents shall at all times be considered several and not joint, and the holders of Securities are not, under any circumstances, agreeing to act jointly with respect to the Securities or any of their actions or obligations under the Transaction Documents.

* * * * *

[Signature Page Follows]

IN WITNESS WHEREOF, the parties hereto have caused this Exchange Agreement to be duly executed as of the date and year first above written.

		COMPANY:
		HYBRID NETWORKS, INC.
		By:		/s/ Michael D. Greenbaum Name: Michael D. Greenbaum Title: President and Chief Executive Officer
		PURCHASER:
		HALIFAX FUND, L.P.
		By:		/s/ Maurice Hryshko Name: Maurice Hryshko Title: Counsel The Palladin Group L.P. Investment Adviser

Signature page to Exchange Agreement

*List of Schedules*
Schedule 2.1(c)		Reservation of Common Shares and Preemptive Rights
Schedule 2.1(c)(i)		Convertible Securities
Schedule 2.1(e)		Outstanding Securities; Nasdaq Approval; 6% Convertible Debenture
Schedule 2.1(m)		No Integrated Offering
Schedule 2.1(o)		Intellectual Property
Schedule 2.1(s)(i)		Outstanding securities entitled to registration rights
Schedule 2.1(s)(ii)		Outstanding securities affected by the issuance of Securities
Schedule 2.1(t)		Certain Transactions
*List of Exhibits*
Exhibit 4.2(e)		Opinion of Counsel
*Annexes*
Annex A		Certificate of Designations
Annex B		Registration Rights Agreement

QuickLinks

Exhibit 4.02

-----END PRIVACY-ENHANCED MESSAGE-----