VirTra Inc (VTSI)

[ByloCellhi]

The Final Nail!!!!!

Note 4. Convertible Debentures

In August 2005 the Company issued $500,000 in convertible debentures to Dutchess Private Equities Fund I, LLC. The debentures bear interest at 8% per year payable in cash or registered common stock at the Company’s option. The debentures mature in August 2008 and are convertible, at the option of the holder, to shares of the company’s common stock at a conversion price per share equal to the lower of (i) 80% of the lowest closing bid price for the common stock for the fifteen days prior to the conversion date; or (ii) 125% of the volume weighted average price on the closing date.

In addition the Company issued to the holders of the convertible debentures warrants to purchase 500,000 shares of the Company’s common stock.

In 2006, we were penalized $601,239 by Dutchess for failure to file a registration statement registering their shares. We disagree with Dutchess on the amount of the penalty, but in 2006 we recorded the full amount of the penalties which are included in amounts due Dutchess as of December 31, 2007.

As of November 30, 2007, we stopped servicing this debt with new issuances of common stock, pending a reconciliation with Dutchess over amounts still owed on the arrangement.

On February 19, 2008, we received notice from the American Arbitration Association that a preliminary meeting would be held March 10, 2008 to determine rights and obligations of the parties. Management elected not to attend the hearing.

On March 15, 2008 our corporate counsel advised us that the total amount of liability to Dutchess is estimated at $1,421,264 and that it is likely the arbitrator will rule in favor of Dutchess. Further, subsequent to the ruling, Dutchess will have the right to use the court system to pursue legal collection procedures. We have included the total amount of this liability calculated by counsel and we continue to accrue interest on this debenture balance and have included $4,675 in interest expense for the three months ended March 31, 2008.

Derivative Liability

Based on the guidance in SFAS 133 and EITF 00-19, the Company concluded that these convertible debentures were required to be accounted for as derivatives. SFAS 133 and EITF 00-19 require the Company to bifurcate and separately account for the conversion features of the convertible debentures and warrants issued as embedded derivatives.

Pursuant to SFAS 133, the Company bifurcated the conversion feature from the debentures because the conversion price is not fixed and the debentures are not convertible into a fixed number of shares. Accordingly, the embedded derivative must be bifurcated and accounted for separately.

Furthermore, the Company concluded that the exercise price and the number of shares to be issued under the warrants are not fixed. Therefore, exercise of these warrants and these debentures might result in issuing an indeterminate number of shares, and it cannot be concluded that the Company has a sufficient number of authorized shares to settle these warrants. As such, the warrants were accounted for as derivative instrument liabilities. The Company is required to record the fair value of the conversion features and the warrants on its balance sheet at fair value with changes in the values of these derivatives reflected in the statement of operations as "Gain (loss) on embedded derivative liability."

At March 31, 2008, the Company has valued this derivative liability at $380,616 and has recognized a loss resulting from the change in value of this derivative liability of $42,481.