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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2006
OR
/ / 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 0-26059
CIRTRAN CORPORATION
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(Exact name of registrant as specified in its charter)
Nevada 68-0121636
------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No)
incorporation or organization)
4125 South 6000 West
West Valley City, Utah 84128
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(Address of Principal Executive Offices) (Zip Code)
(801) 963-5112
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the proceeding 12 months and (2) has been subject to such filing requirements
for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act. Yes X No
--- ---
The number of shares outstanding of the registrant's common stock as of May 18,
2006: 618,068,117.
Transitional Small Business Disclosure Format (check one): Yes No X
--- ---
1
Table of Contents
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Page
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Balance Sheets as of March 31, 2006, (unaudited) and 3
December 31, 2005
Statements of Operations for the Three Months ended 4
March 31, 2006, (unaudited) and 2005 (unaudited)
Statements of Cash Flows for the Three Months ended 5
March 31, 2006, (unaudited) and 2005 (unaudited)
Notes to Condensed Consolidated Financial Statements 7
(unaudited)
Item 2. Management's Discussion and Analysis of or Plan of Operation 17
Item 3. Evaluation of Controls and Procedures 31
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 35
Item 5. Other Information 35
Item 6 Exhibits 37
Signatures 38
2
CIRTRAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
March 31, December 31,
2006 2005
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ASSETS
Current Assets
Cash and cash equivalents $ 443,637 $ 1,427,865
Trade accounts receivable, net of allowance
for doubtful accounts of $158,374 and
$158,374, respectively 3,019,960 3,358,981
Inventory, Net of reserve of $751,296 and
$751,296, respectively 2,203,537 2,271,604
Prepaid Deposits - 142,188
Other 108,976 252,941
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Total Current Assets 5,776,110 7,453,579
Property and Equipment, Net 2,778,692 2,686,737
Investment in Securities, at Cost 300,000 300,000
Other Assets, Net 691,417 361,581
Deposits 129,283 100,000
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Total Assets $ 9,675,502 $ 10,901,897
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LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities
Accounts payable $ 528,963 $ 1,239,519
Accrued liabilities 551,049 1,222,018
Deferred revenue 33,625 119,945
Derivative liability 3,136,160 4,910,303
Convertible Debenture - 996,252
Current maturities of long-term notes payable 1,225,785 12,610
Notes payable to stockholders - 95,806
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Total Current Liabilities 5,475,582 8,596,453
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Long-Term Notes Payable, Less Current Maturities 1,033,989 1,037,390
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Commitments and Contingencies
Stockholders' Equity (Deficit)
Common stock, par value $0.001; authorized
750,000,000 shares; issued and outstanding
shares: 616,562,117 and 583,368,569 at March
31, 2006 and December 31, 2005, respectively 616,558 583,364
Additional paid-in capital 22,154,684 20,012,000
Accumulated deficit (19,605,311) (19,327,310)
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Total Stockholders' Equity (Deficit) 3,165,931 1,268,054
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Total Liabilities and Stockholders'
Equity (Deficit) $ 9,675,502 $ 10,901,897
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The accompanying notes are an integral part of these financial statements.
3
CIRTRAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended March 31, 2006 2005
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Net Sales $ 1,737,824 $ 2,920,465
Cost of Sales (990,370) (1,949,773)
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Gross Profit 747,454 970,692
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Operating Expenses
Selling, general and administrative expenses 837,520 959,891
Non-cash employee compensation expense - 69,000
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Total Operating Expenses 837,520 1,028,891
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Loss From Operations (90,066) (58,199)
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Other Income (Expense)
Interest (1,086,253) (143,770)
Other, net - 241
Gain on forgiveness of debt 4,670 -
Gain on derivative valuation 893,651 -
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Total Other Expense, Net (187,932) (143,529)
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Net Loss $ (277,998) $ (201,728)
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Basic and diluted loss per common share $ (0.00) $ (0.00)
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Basic and diluted weighted-average
common shares outstanding 558,748,729 488,490,792
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The accompanying notes are an integral part of these financial statements.
4
CIRTRAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Three Months Ended March 31, 2006 2005
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Cash flows from operating activities
Net loss $ (277,998) $ (201,728)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 114,939 73,660
Accretion expense 965,512 -
Provision for doubtful accounts - 417
Amortization of loan premium to
interest expense - 11,057
Non-cash compensation expense - 69,000
Loan costs and fees in lieu of interest
on notes payable - 61,500
Options issued to attorneys and consultants
for services - 21,526
Gain on derivative valuation (893,651)
Accrued Interest Expense 61,586 -
Changes in assets and liabilities:
Trade accounts receivable 366,021 (119,299)
Prepaid Deposits 142,188 -
Inventories 68,067 (148,087)
Prepaid expenses and other assets (255,318) (1,836)
Accounts payable (710,556) (108,800)
Accrued liabilities (214,368) (43,111)
Deferred revenue (86,320) -
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Total adjustments (441,900) (183,973)
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Net cash used in operating activities (719,898) (385,701)
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Cash flows from investing activities
Cash aquired with PFE acquisition - 39,331
Purchase of property and equipment (166,730) (230,771)
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Net cash used in investing activities (166,730) (191,440)
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Cash flows from financing activities
Proceeds from notes payable to stockholders - 4,414
Payments on notes payable to stockholders (95,806) -
Proceeds from notes payable, net of cash
paid for offering costs - 503,500
Principal payments on notes payable (1,994) -
Proceeds from notes payable to related parties - 95,586
Proceeds from exercise of options and warrants
to purchase common stock - 33,000
Exercise of options issued to attorneys and
consultants for services 200 150
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Net cash provided by financing activities (97,600) 636,650
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Net increase in cash and cash equivalents (984,228) 59,509
Cash and cash equivalents at beginning of year 1,427,865 81,101
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Cash and cash equivalents at end of period $ 443,637 $ 140,610
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The accompanying notes are an integral part of these financial statements.
5
CIRTRAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(CONTINUED)
For the Three Months Ended March 31, 2006 2005
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Supplemental disclosure of cash flow information
Cash paid during the period for interest $ 22,765 $ -
Noncash investing and financing activities
Acquisition of PFE Properties, LLC for
stock and assumption of note payable $ - $ 1,868,974
Common stock issued for settlement of
note payable and accrued interest - 2,148,913
Deposit applied to purchase of property
and equipment - 100,000
Common stock issued for accrued liabilities 464,187 411,402
Stock options exercised for settlement of
accrued interest and accrued compensation 81,000 59,000
Stock options exercised for settlement of
notes payable to stockholders - 23,000
Common stock issued for partial conversion
of convertible debenture and derivative liability 1,630,491 -
The accompanying notes are an integral part of these financial statements.
6
CIRTRAN CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Condensed Financial Statements -- The accompanying unaudited condensed
consolidated financial statements include the accounts of CirTran Corporation
and its subsidiaries (the "Company"). These financial statements are condensed
and, therefore, do not include all disclosures normally required by accounting
principles generally accepted in the United States of America. These statements
should be read in conjunction with the Company's annual financial statements
included in the Company's Annual Report on Form 10-KSB. In particular, the
Company's significant accounting principles were presented as Note 1 to the
consolidated financial statements in that Annual Report. In the opinion of
management, all adjustments necessary for a fair presentation have been included
in the accompanying condensed consolidated financial statements and consist of
only normal recurring adjustments. The results of operations presented in the
accompanying condensed consolidated financial statements for the three months
ended March 31, 2006, are not necessarily indicative of the results that may be
expected for the full year ending December 31, 2006.
Principles of Consolidation -- The consolidated financial statements include the
accounts of CirTran Corporation, and it's wholly owned subsidiaries, Racore
Technology Corporation, CirTran-Asia Inc, CirTran Products, Inc., Diverse Media
Group Corporation and PFE Properties, LLC. All significant intercompany
transactions have been eliminated in consolidation.
Stock-Based Compensation -- Effective January 1, 2006, the Company adopted the
provisions of Statement of Accounting Standards No. 123R, Share Based Payment
("FAS 123R") for its one stock-based compensation plan. The Company previously
accounted for this plan under the recognition and measurement principles of
Accounting Standards No. 25, Accounting for Stock Issued to Employees, ("APB
25") and related interpretations and disclosure requirements established by SFAS
No. 123, Accounting for Stock-Based Compensation ("SFAS 123") as amended by SFAS
No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure.
Under APB 25, no compensation expense was recorded in earnings for the Company's
stock-based options granted under its compensation plans. The pro forma effects
on net income and earnings per share for the options and awards granted under
the plans were instead disclosed in a note to the consolidated financial
statements. Under SFAS 123R, all stock-based compensation is measured at the
grant date, based on the fair value of the option or award, and is recognized as
an expense in earnings over the requisite service period, which is typically
through the date the options vest.
The Company adopted SFAS 123R using the modified prospective method. Under this
method, for all stock-based options and awards, granted prior to January 1, 2006
that remain outstanding as of that date, compensation cost is recognized for the
unvested portion over the remaining requisite service period, using the
grant-date fair value measured under the original provisions of SFAS 123 for pro
forma and disclosure purposes. No such options were outstanding as of January 1,
2006.
The Company utilized the Black-Scholes model for calculating the fair value pro
forma disclosures under SFAS 123 and will continue to use this model, which is
an acceptable valuation approach under SFAS 123R. The following table summarizes
7
the Black-Scholes option-pricing model assumptions used to compute the
weighted-average fair value of stock options granted during the periods below:
Three Months Ended
March 31,
2006 2005
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Expected dividend yield N/A* -
Risk free interest rate N/A* 3.76%
Expected volatility N/A* 282%
Expected life N/A* $ 0.16
Weighted average fair value per share N/A* $ 0.02
* Not applicable as there were no options granted during the period
No options were granted for the three months ended March 31, 2006 and all
previously issued options were fully vested prior to January 1, 2006. Therefore,
there were no compensation costs relating to stock-based compensation for the
three months ended March 31, 2006, including the effects from adoption of SFAS
123R, which would have previously been presented in a pro forma disclosure, as
discussed above.
The following table illustrates the effect on net income and earnings per share
as if the Company had applied the fair-value recognition provisions of SFAS 123
to all of its stock-based compensation awards for periods prior to adoption of
SFAS 123R:
Three Months Ended March 31, 2005
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Net loss, as reported $(201,728)
Add: Stock-based employee compensation expense
included in net loss 69,000
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards (138,248)
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Pro forma net loss $(270,976)
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Basic and diluted loss per common share as reported $ (0.00)
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Basic and diluted loss per common share pro forma $ (0.00)
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Patents -- Legal fees and other direct costs incurred in obtaining patents in
the United States and other countries are capitalized. Patents costs are
amortized over the estimated useful life of the patent. During the year ended
December 31, 2005, the Company capitalized $35,799 in patent related legal
costs. Amortization expense was $1,279 during the three months ended March 31,
2006.
The realization of patents and other long-lived assets is evaluated periodically
when events or circumstances indicate a possible inability to recover the
carrying amount. An impairment loss is recognized for the excess of the carrying
amount over the fair value of the asset or the group of assets. Fair value is
determined based on expected discounted net future cash flows. The analysis
necessarily involves significant management judgment to evaluate the capacity of
an asset to perform within projections. As required, an evaluation of impairment
was made on the patents as of March 31, 2006. No indicators of impairment were
noted.
8
NOTE 2 - REALIZATION OF ASSETS
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, which contemplate continuation of the Company as a going concern. The
Company had net loss of $277,998 for the three months ended March 31, 2006,
compared to a net loss of $527,708 for the year ended December 31, 2005. As of
March 31, 2006, and December 31, 2005, the Company had an accumulated deficit of
$19,605,311 and $19,327,310, respectively, and a total stockholders' equity of
$3,165,931 and $1,268,054, respectively. The Company also had a working capital
(deficit) of $300,528 and $(1,142,874) as of March 31, 2006, and December 31,
2005, respectively. In addition, the Company used, rather than provided, cash in
its operations in the amounts of $719,698 and $1,751,744 for the three months
ended March 31, 2006, and the year ended December 31, 2005, respectively. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern.
In view of the matters described in the preceding paragraphs, recoverability of
a major portion of the recorded asset amounts shown in the accompanying
consolidated balance sheets is dependent upon continued operations of the
Company, which in turn is dependent upon the Company's ability to meet its
financing requirements on a continuing basis, to maintain or replace present
financing, to acquire additional capital from investors, and to succeed in its
future operations. The financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
amounts and classification of liabilities that might be necessary should the
Company be unable to continue in existence.
NOTE 3 - RELATED PARTY TRANSACTIONS
Notes Payable to Stockholders -- During December 2005 a stockholder loaned the
Company $95,806 which was recorded as a notes payable to stockholders. The
proceeds of this loan were used to fund on going operations of the Company. In
January 2006, the Company made a payment to the stockholder which repaid the
entire balance ($95,806) of the loan.
NOTE 4 - COMMITMENTS AND CONTINGENCIES
Settlement of Litigation -- During January 2002, the Company settled a lawsuit
that had alleged a breach of facilities sublease agreement involving facilities
located in Colorado. The Company's liability in this action was originally
estimated to range up to $2.5 million. The Company had filed a counter suit in
the same court for an amount exceeding $500,000 for missing equipment.
Effective January 18, 2002, the Company entered into a settlement agreement
which required the Company to pay the plaintiff the sum of $250,000. Of this
amount, $25,000 was paid upon execution of the settlement, and the balance,
together with interest at 8% per annum, was payable by July 18, 2002. As
security for payment of the balance, the Company executed and delivered to the
plaintiff a Confession of Judgment and also issued 3,000,000 shares of common
stock, which were held in escrow and were treated as treasury stock recorded at
no cost. The fair value of the 3,000,000 shares was less than the carrying
amount of the note payable. Because 75 percent of the balance had not been paid
by May 18, 2002, the Company was required to prepare and file with the
Securities & Exchange Commission, at its own expense, a registration statement
with respect to the escrowed shares.
As of December 31, 2005, the Company was in default of its obligations under the
settlement agreement and the total payment due thereunder had not been made. A
registration statement with respect to the escrowed shares was not filed and the
Company did not replace the escrowed shares with registered, free-trading shares
as per the terms of the agreement. The plaintiff filed a Confession of Judgment
and proceeded with execution thereon. The shares in escrow were released and
issued as partial settlement of $92,969 on the note payable outstanding.
9
In connection with a separate sublease agreement of these facilities, the
Company received a settlement from the sublessee during May 2002, in the amount
of $152,500, which was recorded as other income. The Company did not receive
cash from this settlement, but certain obligations of the Company were paid
directly. $109,125 of the principal balance of the note related to the
settlement mentioned above was paid. Also, $7,000 was paid to the Company's
legal counsel as a retainer for future services. The remaining $36,375 was paid
to the above mentioned plaintiff as a settlement of rent expense.
During September 2002, the plaintiff filed a claim that the $109,125 portion of
the payment was to be applied as additional rent expense rather than a principal
payment on the note payable. The Company estimated that the probability of the
$109,125 being considered additional rent expense was remote and disputed the
claim.
On January 26, 2006, a settlement was reached related to the leased facilities
in Colorado. The Company settled the remaining claim for $200,000 cash.
During 2003 and 2004, an investment firm filed suits in the U.S. District Court
for the District of Utah seeking payment of a commission consisting of common
stock valued at 1,750,000 for allegedly introducing the Company to the Equity
Line Investor (See Note 10). The case was previously dismissed in a New York
court.
On February 24, 2006, the Company entered into a settlement agreement with the
investment firm. The Company issued 4,000,000 shares of restricted stock with a
fair value of $0.044 per share. Warrants were also issued to purchase 7,000,000
shares of the Company's common stock with an exercise price of $0.05 cents per
share and a life of 5 years. The warrants were valued using the Black-Scholes
pricing model at $288,186. Total consideration for the settlement was valued at
$464,186.
Litigation - Various vendors have notified the Company that they believe they
have claims against the Company totaling $18,810. None of these vendors have
filed lawsuits in relation to these claims. The Company has accrued for these
claims, and they are included in accounts payable.
In addition, various vendors have notified the Company that they believe they
have claims against the Company totaling $164,802. The Company has determined
the probability of realizing any loss on these claims is remote. The Company has
made no accrual for these claims and is currently in the process of negotiating
the dismissal of these claims with the various vendors.
Registration Rights - In May 2005, in connection with the Company's issuance of
a convertible debenture (discussed below), the Company granted to the debenture
holder registration rights, pursuant to which the Company agreed to file, within
120 days of the closing of the purchase of the debenture, a registration
statement to register the resale of shares of the Company's common stock
issuable upon conversion of the debenture. The company also agreed to use its
best efforts to have the registration statement declared effective within 270
days after filing the registration statement. The Company agreed to register the
resale of up to 100,000,000 shares, and to keep such registration statement
effective until all of the shares issuable upon conversion of the debenture have
been sold. The Company filed the registration statement on September 23, 2005.
As of March 31, 2006, the registration statement had not been declared
effective.
In December 2005, in connection with the Company's issuance of a convertible
debenture (discussed below), the Company granted to the debenture holder
registration rights, pursuant to which the Company agreed to file, within 120
days of the closing of the purchase of the debenture, a registration statement
10
to register the resale of shares of the Company's common stock issuable upon
conversion of the debenture. The company also agreed to use its best efforts to
have the registration statement declared effective within 270 days after filing
the registration statement. The Company agreed to register the resale of up to
32,608,696 shares and 10,000,000 warrants, and to keep such registration
statement effective until all of the shares issuable upon conversion of the
debenture have been sold.
In connection with the settlement agreement with the investment firm discussed
above in this Note, the Company agreed to register the resale by the investment
firm of shares issued or issuable to it in connection with the settlement.
Accrued Payroll Tax Liabilities -- The Utah State Tax Commission entered into an
agreement to allow the Company to pay the tax liability owing to the State of
Utah in equal monthly installments of $4,000. Through December 2005, the Company
had made the required payments.
In January 2006, the Utah State Tax Commission reduced the remaining accrued
payroll taxes, penalties and interest due on prior period payroll taxes to the
amount of $98,316. The balance was paid in full.
Manufacturing Agreement -- On June 10, 2004, the Company entered into an
exclusive manufacturing agreement with certain Developers. Under the terms of
the agreement, the Company, through its wholly-owned subsidiary CirTran-Asia,
has the exclusive right to manufacture certain products developed by the
Developers or any of their affiliates. The Developers will continue to provide
marketing and consulting services related to the products under the agreement.
Should the Developers terminate the agreement early, they must pay the Company
$150,000. Revenue is recognized when products are shipped. Title passes to the
customer or independent sales representative at the time of shipment.
In connection with this agreement the Company agreed to issue options to
purchase 1,500,000 shares common stock to the Developers upon the sale, shipment
and payment for 200,000 units of a fitness product. In addition, the Company
agreed to issue options to purchase 300,000 shares of common stock to the
Developers for each multiple of 100,000 units of the fitness product sold in
excess of the initial 200,000 units within twenty-four months of the agreement
(June 2004). The options will be exercisable at $0.06 per share, vest on the
grant date and expire one year after issuance. As of March 31, 2006, the Company
had sold, shipped and received payment for, 257,577 units of the fitness
product. In January 2005, the Company issued 1,500,000 options under the terms
of the agreement. During the three months ended March 31, 2006 the options
expired.
In connection with the above manufacturing agreement, the Company agreed to
issue various options to purchase shares of common stock to the Developers upon
the sale, shipment, and payment of certain quantities of the additional
products. In addition, the Company agreed to issue additional options to
purchase common stock to the developers for each multiple of units sold in
excess of the initial units within the first twenty-four months of the
agreements. The schedule of units and potential options that will be issued
follows:
11
Options Each Multiple of Options for Each
Initial for Initial Units above Multiple
Product Units Units Sold Initial Units of Units
--------------------------------------------------------------------------------
1 500,000 500,000 200,000 200,000
2 25,000 500,000 15,000 100,000
3 100,000 500,000 50,000 100,000
4 300,000 1,000,000 100,000 200,000
5 200,000 250,000 100,000 100,000
6 200,000 500,000 100,000 100,000
As of March 31, 2006, the Company had not sold, shipped and received payment for
enough units to require the issuance of options related to the additional
products under these agreements. Because the Developers must provide future
services for the options to vest, the options are treated as unissued for
accounting purposes. The cost of these options will be recognized when the
options are earned.
NOTE 5 - MORTGAGE NOTE PAYABLE
In conjunction with the acquisition of PFE, the Company assumed a mortgage note
payable for $1,050,000, which is secured by the land and the building that was
acquired as part of the PFE acquisition. The note bears interest at 12.5% per
annum and is collateralized by the land and building. Interest only payments
were made through January 2006. Starting in February 2006, principal and
interest payments were required based on a twenty-year amortization of the note.
The entire balance of principal and unpaid interest will be due in December
2008.
NOTE 6 - CONVERTIBLE DEBENTURES
Highgate - On May 26, 2005, the Company entered into an agreement with Highgate
to issue to Highgate a $3,750,000, 5% Secured Convertible Debenture (the
"Debenture"). The Debenture is due December 2007 and is secured by all of the
Company's property.
Accrued interest is payable at the time of maturity or conversion. The Company
may, at its option, elect to pay accrued interest in cash or shares of the
Company's common stock. If paid in stock, the conversion price shall be the
closing bid price of the common stock on either the date the interest payment is
due or the date on which the interest payment is made. The balance of accrued
interest owed at March 31, 2006, and December 31, 2005, was $152,349 and
$111,986, respectively.
At any time, Highgate may elect to convert principal amounts owing on the
Debenture into shares of the Company's common stock at a conversion price equal
to the lesser of $0.10 per share, or an amount equal to the lowest closing bid
price of the Company's common stock for the twenty trading days immediately
preceding the conversion date. The Company has the right to redeem a portion or
the entire Debenture then outstanding by paying 105% of the principal amount
redeemed plus accrued interest thereon.
Highgate's right to convert principal amounts into shares of the Company's
common stock is limited as follows:
(i) Highgate may convert up to $250,000 worth of the principal
amount plus accrued interest of the Debenture in any
consecutive 30-day period when the market price of the
12
Company's stock is $0.10 per share or less at the time of
conversion;
(ii) Highgate may convert up to $500,000 worth of the principal
amount plus accrued interest of the Debenture in any
consecutive 30-day period when the price of the Company's
stock is greater than $0.10 per share at the time of
conversion; provided, however, that Highgate may convert in
excess of the foregoing amounts if the Company and Highgate
mutually agree; and
(iii) Upon the occurrence of an event of default, Highgate may, in
its sole discretion, accelerate full repayment of all
debentures outstanding and accrued interest thereon or may
convert the Debentures and accrued interest thereon into
shares of the Company's common stock.
Except in the event of default, Highgate may not convert the Debenture for a
number of shares that would result in Highgate owning more than 4.99% of the
Company's outstanding common stock.
In connection with the issuance of the Highgate Debenture, the Company granted
Highgate registration rights related to the issuance of the debenture. (See Note
4.)
The Company determined that the features of the Debenture fell under derivative
accounting treatment. As of March 31, 2006 the carrying value of the Debenture
was $1,068,604. The carrying value will be accreted each quarter over the life
of the Debenture until the carrying value equals the unconverted face value of
$3,000,000 (see below). The fair value of the derivative liability as of March
31, 2006 was $1,767,254.
In connection with the issuance of the Debenture, $2,265,000 of the proceeds
were paid to Cornell to repay promissory notes. Fees of $256,433 were withheld
from the proceeds, were capitalized, and are being amortized over the life of
the note. As such, of the total Debenture of $3,750,000, the net proceeds to the
Company were $1,228,567. The proceeds were used for general corporate and
working capital purposes, at the Company's discretion.
In January 2006, Highgate converted $750,000 of its convertible debenture into
24,193,548 shares of the Company's common stock at a conversion rate of $0.031
per share, which was the lower of $0.10 or 100% of the lowest closing bid price
of the Company's commons stock over the 20 trading days preceding the
conversion.
Cornell - On December 30, 2005, the Company entered into an agreement with
Cornell Capital Partners, L.P. ("Cornell") to issue to Cornell a $1,500,000, 5%
Secured Convertible Debenture (the "Cornell Debenture"). The Cornell Debenture
is due July 30, 2008, and is secured by all the Company's property, junior to
the Highgate security interest.
Accrued interest is payable at the time of maturity or conversion. The Company
may, at its option, elect to pay accrued interest in cash or shares of the
Company's common stock. If paid in stock, the conversion price shall be the
closing bid price of the common stock on either the date the interest payment is
due or the date on which the interest payment is made. The balance of accrued
interest owed at March 31, 2006 and December 31, 2005 was $18,082 and zero,
respectively.
At any time, Cornell may elect to convert principal amounts owing on the Cornell
Debenture into shares of the Company's common stock at a conversion price equal
to an amount equal to the lowest closing bid price of the Company's common stock
for the twenty trading days immediately preceding the conversion date. The
Company has the right to redeem a portion or the entire Cornell Debenture then
13
outstanding by paying 105% of the principal amount redeemed plus accrued
interest thereon.
Cornell's right to convert principal amounts into shares of the Company's common
stock is limited as follows:
(i) Cornell may convert up to $250,000 worth of the principal
amount plus accrued interest of the Cornell Debenture in any
consecutive 30-day period when the market price of the
Company's stock is $0.10 per share or less at the time of
conversion;
(ii) Cornell may convert up to $500,000 worth of the principal
amount plus accrued interest of the Cornell Debenture in any
consecutive 30-day period when the price of the Company's
stock is greater than $0.10 per share at the time of
conversion; provided, however, that Cornell may convert in
excess of the foregoing amounts if the Company and Cornell
mutually agree; and
(iii) Upon the occurrence of an event of default, Cornell Capital
Partners, LP may, in its sole discretion, accelerate full
repayment of the debenture outstanding and accrued interest
thereon or may convert the Debenture and accrued interest
thereon into shares of the Company's common stock.
Except in the event of default, Cornell may not convert the Cornell Debenture
for a number of shares that would result in Cornell owning more than 4.99% of
the Company's outstanding common stock.
The Cornell Debenture was issued with 10,000,000 warrants with an exercise price
of $0.09 per share that vest immediately and have a three year life.
In connection with the issuance of the Cornell Debenture, the Company granted
Cornell registration rights related to the issuance of the Cornell Debenture and
warrants. (See Note 4.)
The Company determined that the features on the Cornell Debenture and the
associated warrants fell under derivative accounting treatment. As of March 31,
2006 the carrying value of the Cornell Debenture was $143,160. The carrying
value will be accreted each quarter over the life of the Cornell Debenture until
the carrying value equals the face value of $1,500,000. The fair value of the
derivative liability as of March 31, 2006 was $1,368,906.
In connection with the issuance of the Cornell Debenture, fees of $130,000 were
withheld from the proceeds, capitalized, and will be amortized over the life of
the Cornell Debenture. As such, of the total Cornell Debenture of $1,500,000,
the net proceeds to the Company were $1,370,000. The proceeds will be used for
general corporate and working capital purposes, at the Company's discretion.
As of March 31, 2006, Cornell had not converted any of the Cornell Debenture
into shares of the Company's common stock.
NOTE 7 - STOCKHOLDERS' EQUITY
Common Stock Issuances -- During the three months ended March 31, 2006, the
Company issued 4,000,000 shares of common stock as a settlement of litigation
with an investment firm. (See Note 4.)
14
During the three months ended March 31, 2006, the Company issued to Highgate
24,193,548 shares of restricted common stock in connection with a conversion by
Highgate of $750,000 principal amount of the convertible debenture. (See Note
6.)
NOTE 8 - STOCK OPTIONS AND WARRANTS
Non-Employee Options - During the three months ended March 31, 2006, 2,000,000
of previously issued options were exercised by counsel for proceeds of $200.
Employee Options - During the three month period ended March 31, 2006, 3,000,000
options were exercised for accrued compensation and employee advances of $54,000
and $27,000 respectively.
Developer Options - During 2005, the Company granted options to purchase
1,500,000 shares of common stock to developers at exercise prices of $0.06 per
share. The options were all one-year options and vested on the dates granted.
Two of the developers were employees and together were issued 1,000,000 of the
options. The exercise price equaled the fair value of the common shares at the
time these options were granted; therefore, the options had no intrinsic value.
The fair value of these options of $42,052 was estimated using the Black-Scholes
option pricing model with the following assumptions: risk free interest rate
ranging of 4.00%, dividend yield of 0.0%, volatility of 302%, and expected
average life of .5 years. These options expired during the three months ended
March 31, 2006.
The remaining 500,000 developer options were issued to a non-employee under the
terms described above. Because the developer was a non-employee, cost of goods
sold of $21,526 was recorded for the fair value of options issued during the
year ended December 31, 2005. These options were valued using the Black-Scholes
option pricing model with the following assumptions: risk free interest rate
ranging of 4.00%, dividend yield of 0.0%, volatility of 302%, and expected
average life of .5 years. None of these options were exercised during 2005.
These options expired during the three months ended March 31, 2006.
A summary of the stock option activity for the three months ended March 31,
2006, is as follows:
Weighted Average
Shares Exercise Price
---------- ----------------
Outstanding at December 31, 2005 16,750,500 $ 0.02
Granted - $ -
Exercised (5,000,000) $ 0.02
Cancelled (1,500,000) $ 0.06
----------
Outstanding at March 31, 2006 10,250,500 $ 0.03
==========
Excercisable at March 31, 2006 10,250,500 $ 0.03
==========
NOTE 9 -SEGMENT INFORMATION
Segment information has been prepared in accordance with SFAS No. 131,
"Disclosure About Segments of an Enterprise and Related Information." The
Company has three reportable segments: electronics assembly, Ethernet
technology, and contract manufacturing. The electronics assembly segment
manufactures and assembles circuit boards and electronic component cables. The
Ethernet technology segment designs and manufactures Ethernet cards. The
contract manufacturing segment manufactures, either directly or through foreign
subcontractors, certain products under an exclusive manufacturing agreement. The
accounting policies of the segments are consistent with those described in the
summary of significant accounting policies. The Company evaluates performance of
15
each segment based on earnings or loss from operations. Selected segment
information is as follows:
Electronics Ethernet Contract
Assembly Technology Manufacturing Total
-------------------------------------------------------------------------------------
March 31, 2006
Sales to external customers $ 774,359 $ 22,226 $ 941,239 $ 1,737,824
Intersegment sales - - - -
Segment income (loss) (30,057) (58,108) (189,833) (277,998)
Segment assets 4,529,176 192,756 4,953,570 9,675,502
Depreciation and amortization 82,912 210 31,817 114,939
March 31, 2005
Sales to external customers $ 773,013 $ 22,608 $ 2,124,844 $ 2,920,465
Intersegment sales - - - -
Segment loss (372,197) (66,739) 237,208 (201,728)
Segment assets 4,591,074 216,838 1,800,585 6,608,497
Depreciation and amortization 50,399 594 22,667 73,660
March 31,
---------------------------
Sales 2006 2005
--------------------------------------------------------------------------------
Total sales for reportable segments $1,737,824 $2,920,465
Elimination of intersegment sales - -
--------------------------------------------------------------------------------
Consolidated net sales $1,737,824 $2,920,465
--------------------------------------------------------------------------------
March 31,
---------------------------
Total Assets 2006 2005
--------------------------------------------------------------------------------
Total assets for reportable segments $9,675,502 $6,608,497
Adjustment for intersegment amounts - -
Consolidated total assets $9,675,502 $6,608,497
--------------------------------------------------------------------------------
NOTE 10 - SUBSEQUENT EVENTS
Stock Options - During April 2006, counsel for the Company exercised options to
purchase 1,500,000 shares of common stock with an exercise price of $0.0001 per
share.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
This discussion should be read in conjunction with Managements' Discussion and
Analysis of Financial Condition and Results of Operations included in our Annual
Report on Form 10-KSB for the year ended December 31, 2005.
Overview
We provide a mixture of high and medium size volume turnkey manufacturing
services using surface mount technology, ball-grid array assembly,
pin-through-hole and custom injection molded cabling for leading electronics
OEMs in the communications, networking, peripherals, gaming, law enforcement,
consumer products, telecommunications, automotive, medical, and semiconductor
industries. Our services include pre-manufacturing, manufacturing and
post-manufacturing services. Through our subsidiary, Racore Technology
Corporation, we design and manufacture Ethernet technology products. Our goal is
to offer customers the significant competitive advantages that can be obtained
from manufacture outsourcing, such as access to advanced manufacturing
technologies, shortened product time-to-market, reduced cost of production, more
effective asset utilization, improved inventory management, and increased
purchasing power.
During 2004, we established a new division, CirTran-Asia, Inc, which has
contributed to a large portion of the increase in revenue since that time. This
division is an Asian-based, wholly owned subsidiary of CirTran Corporation and
provides a myriad of manufacturing services to the direct response and retail
consumer markets. Our experience and expertise in manufacturing enables
CirTran-Asia to enter a project at any phase: engineering and design, product
development and prototyping, tooling, and high-volume manufacturing. We
anticipate that CirTran-Asia will pursue manufacturing relationships beyond
printed circuit board assemblies, cables, harnesses and injection molding
systems by establishing complete "box-build" or "turn-key" relationships in the
electronics, retail, and direct consumer markets. This strategic move into the
Asian market has helped to elevate CirTran to an international contract
manufacturer status for multiple products in a wide variety of industries, and
has, in short order, allow us to target large-scale contracts.
CirTran has established a dedicated satellite office for CirTran-Asia, and has
retained Mr. Charles Ho to lead the new division. Having proven the value and
reliability of its core products, CirTran Corporation has chosen to expand into
previously untapped product lines.
On December 2, 2005, we announced that we had formed a new division, CirTran
Products, which will offer products for sale at retail. The new division will be
run from our new Los Angeles office, with Trevor Saliba, our executive vice
president for worldwide business development, working to develop sales. We
anticipate that consumer products built by our CirTran Asia subsidiary, as well
as other products which we plan to acquire, will be available for retail sale in
2006.
On March 21, 2006, we announced that we had formed a new subsidiary to provide
end-to-end services to the direct response and entertainment industries. The new
division will provide product marketing, production, media funding and
merchandise manufacturing services. Forming this new division was a necessary
step to maximize product manufacturing opportunities for CirTran's proprietary
products and to provide marketing services for individual entrepreneurs and
inventors. The new division will be headquartered in CirTran's Los Angeles
(Century City) offices and be headed by Mr. Saliba. We are presently in
development of proprietary programs to be launched in the product marketing
division, production services and media funding divisions. We are also in final
17
discussions on two projects for our merchandising division. We continue to
pursue opportunities in the direct response and entertainment division to
maximize manufacturing and business opportunities
Fitness Products
In early June 2004, the Company entered into an exclusive manufacturing
agreement with certain Developers, including Charles Ho, the President of
CirTran-Asia. Under the terms of the agreement, CirTran, through its
wholly-owned subsidiary CirTran-Asia, has the exclusive right to manufacture
certain products developed by the Developers or any of their affiliates.
Pursuant to the agreement, we could enter into addendum agreements with the
developers with respect to particular products to be produced and manufactured.
The agreement was to be for an initial term of 36 months, and may be continued
after that on a month-to-month basis unless terminated by either party by
providing written notice.
On June 7, 2004, we announced that CirTran-Asia had received an initial purchase
order on May 26, 2004, from International Edge relating to the manufacture of
80,000 abdominal fitness machines. This order was the first order placed with
CirTran-Asia under the exclusive manufacturing agreement. Subsequently, on June
14, 2004, we received another order for 80,000 units of the abdominal fitness
machines, which was announced on June 16, 2004, through a separate press
release. The Company received many orders subsequent to these first orders.
Since these announcements, CirTran-Asia has manufactured, shipped, and received
payments of approximately $5,546,000. On August 13, 2004, we also announced that
on August 11, 2004 we had received new orders for Wal-Mart. The Company shipped
to Wal-Mart the complete order of abdominal fitness machines and received
payments of approximately $400,000 through the date of this Report. The units
were distributed to Wal-Mart stores throughout Canada.
On September 9, 2004, we announced that on September 6, 2004, CirTran-Asia had
been awarded the rights to manufacture the Ab Trainer Club Pro, a new abdominal
fitness machine, for Tristar Products, under an exclusive manufacturing
agreement. This new product is another type of abdominal fitness machine. Since
this announcement, and through the date of this Report, CirTran-Asia had
manufactured and shipped units, and received payments of approximately $42,000.
On September 10, 2004, we announced that on September 7, 2004, CirTran-Asia had
been awarded the rights to manufacture the AbRoller, another type of an
abdominal fitness machine, for Tristar Products, under an exclusive
manufacturing agreement. Since this announcement, and through the date of this
Report, CirTran-Asia had manufactured and shipped units, and received payments
of approximately $1,700,000.
On September 14, 2004, we announced that on September 7, 2004, we had begun
manufacturing the Instant Abs product, another type of abdominal fitness
machine, for Tristar Products, under an exclusive manufacturing agreement. Since
this announcement, and through the date of this Report, CirTran-Asia had
manufactured, and shipped units, and received payments of approximately
$640,000.
On September 30, 2004, we announced that on September 23, 2004, CirTran-Asia had
been awarded the rights to manufacture the Denise Austin Pilates product, a
pilates fitness machine, for Tristar Products, under an exclusive manufacturing
agreement. Since this announcement, and through the date of this Report,
CirTran-Asia had manufactured and shipped units, and received payments of
approximately $85,000.
18
On April 28, 2005, CirTran-Asia announced that it has been awarded a contract
(the "April 2005 Agreement") from Guthy - Renker Corporation ("GRC") to be the
exclusive manufacturer of a new fitness machine (the "Fitness Product") for the
sold-on-TV direct response industry. Pursuant to the April 2005 Agreement, GRC
agreed to purchase all of its requirements of the Fitness Product during the
term of the April 2005 Agreement, which is defined as running from the signing
of the agreement through the time when the Fitness Product is not being sold in
quantity. Since signing the April 2005 Agreement, we have received orders
totaling approximately $1,370,000. Since these announcements, CirTran-Asia has
manufactured and shipped orders and has received $1,033,000 as payment for such
shipments.
New Product
On August 11, 2004, we announced that CirTran-Asia received a purchase order
from Emson in New York, on August 10, 2004 relating to the manufacture of a
household cooking appliance for hot dogs and sausages. Since these
announcements, and through the date of this Report, CirTran-Asia had
manufactured and shipped units, and received payments of approximately
$1,630,000.
On October 1, 2004, we entered into an agreement with Transactional Marketing
Partners, Inc. ("TMP"), for consulting services. Pursuant to the agreement, we
engaged TMP to provide strategic planning and for introduction of new business
to us. Under the agreement, we agreed to pay to TMP a fee of ten percent of the
net proceeds received by us from business brought to us by TMP. The fee is to be
paid within 15 calendar days following the end of the month in which we receive
the net proceeds. Additionally, we agreed to pay $7,500 during each of the first
six months of the term of the agreement, with such payments being viewed as an
advance against the fee to be earned. The advance payments are not refundable,
but will be deducted from fees earned by TMP. The agreement had an initial term
of six months, beginning October 1, 2004, and could automatically extended for
successive six-month periods unless either party gives written notice at least
30 days prior to the expiration of the term of the agreement of its intent not
to renew. Additionally, we may terminate the agreement at any time by giving 30
days' written notice. In March 2006, the parties have agreed to six-month
extensions through September 2006. The parties will evaluate the relationship at
that time and decide if there needs to be another extension. To date the
relationship has proven successful, resulting in multiple new manufacturing
relationships.
On January 19, 2005, CirTran Corporation signed an Exclusive Manufacturing
Agreement with Advanced Beauty Solutions L.L.C. ("ABS"), a company relating to
the manufacture of a hair product in California. In early October 2005, we were
notified that ABS had defaulted on its obligation to its financing company. We
have has stopped shipping under credit and are in the process of exercising our
rights permitted by the agreements.
On July 7, 2005, CirTran Corporation signed another Exclusive Manufacturing
Agreement with ABS, relating to the manufacture of a hair dryer product in
California. We had already begun shipment on previous contracts and were
projecting to begin early in 2006.
In October 2005, following the notice of ABS's default, we terminated the
agreement for both products based on the default. In January 2006, following
efforts to resolve the disputes with ABS, the Company filed a lawsuit against
ABS, claiming breach of contract, interference with contractual relationships,
unjust enrichment, and fraud, and seeking damages from ABS.
With respect to the flat iron products, through October 2005, CirTran had
shipped directly to ABS approximately $4,746,000 worth of the product, and
CirTran had received from ABS or its finance company a total amount of
approximately $788,000. In November 2005, we repossessed from ABS approximately
$2,341,000 worth of the products in the United States, as we were permitted to
19
do pursuant to the agreement. As of May 18, 2006, we had a balance remaining
unpaid from ABS of approximately $2,350,000 for the flat iron product.
Since November 2005, we have been pursuing our rights under the agreement and
have been offering the flat iron product for sale directly to ABS's customers.
In doing so, we sold to ABS's international customers directly approximately
$426,000 worth of the flat iron product. The shipments have all been paid in
full. These products shipped were not part of the repossessed inventory.
On January 24, 2006, ABS filed a voluntary petition for relief under chapter 11
of the United States Bankruptcy Code in the United States Bankruptcy Court for
the Central District of California, San Fernando Valley Division (the
"Bankruptcy Court"), Case No. SV 06-10076 GM. On January 30, 2006, a hearing
("Hearing") was held to consider the Emergency Motion for Order Approving the
Settlement and Compromise of the Disputed Secured Claims of Inventory Capital
Group, Inc. ("ICG"), and Media Funding Corporation ("MFC") (the "Settlement
Motion") filed by ABS. The continued Hearing on the Settlement Motion was held
on February 16, 2006, at which time the settlement was modified. Prior to a
separate hearing held on March 24, 2006, on ABS's Motion for Order: (1)
Approving Sale and Assignment of Substantially All Assets of the Estate Free and
Clear of Liens; (2) Approving Assumption and Assignment of Leases and Executory
Contracts Included in the Sale and Rejection of Leases and Executory Contracts
Not Included in the Sale; and (3) Granting Related Relief (the "Sale Motion"),
the settlement was further modified. The modifications to the proposed
settlement were read into the Bankruptcy Court's record at the Hearing on the
Settlement Motion and the March 24, 2006 hearing on the Sale Motion ("Proposed
Modifications"). Written notice of the Proposed Modifications was provided to
creditors and parties in interests on March 27, 2006, and the Declaration of
James C. Bastian, Jr., attesting that no objections to the Proposed
Modifications have been received by ABS, was filed with the Bankruptcy Court. As
of May 18, 2006, an order approving the settlement and the sale had not been
entered by the bankruptcy court.
Subject to and conditioned upon the approval of the settlement by the Bankruptcy
Court and Bankruptcy Court approval of and consummation of the sale of
substantially all of ABS's assets to the Company pursuant to the Sale Motion,
the Company shall have an allowed claim against the ABS's estate in the amount
of $2,350,000, of which $750,000 shall be credited to the purchase of
substantially all of ABS's assets. Under the settlement, the Company shall be
allowed to participate as a general unsecured creditor of ABS's estate in the
amount of $1,600,000 on a pari passu basis with the $2,100,000 general unsecured
claim of certain insiders of ABS and subject to the prior payment of certain
secured, priority, and non-insider claims in the amount of approximately
$1,507,011. Subject to final negotiation and execution of a definitive purchase
agreement and Bankruptcy Court Approval of the sale, CirTran Corporation agreed
to purchase substantially all of ABS's assets in exchange for (i) a cash payment
in the amount of $1,125,000, (ii) a reduction of CirTran's allowed claim in the
Bankruptcy Case by $750,000, (iii) the assumption of any assumed liabilities,
and (iv) the obligation to pay ABS a royalty equal to $3.00 per True Ceramic Pro
flat iron unit sold by ABS (the "Royalty Obligation"). The Royalty Obligation
shall be capped at $4,135,000. To the extent the amounts paid to ABS on account
of the Royalty Obligation equal less than $435,000 on the 2 year anniversary of
the Closing, then, within 30 days of such anniversary, the Company, agreed to
pay ABS an amount equal to $435,000 less the royalty payments made to date. As
part of the settlement, the Company agreed to exchange general releases with,
among others, ABS, Jason Dodo (the manager of ABS), Inventory Capital Group
("ICG"), and Media Funding Corporation ("MFC"). The settlement also resolves a
related dispute with ICG in which ICG will assign $65,000 of its secured claim
against ABS to the Company.
20
With respect to the hair dryers, as of May 18, 2006, we had not received any
orders or shipped any products, either to ABS or its customers.
On December 28, 2005, we signed an Exclusive Manufacturing Agreement (the
"Agreement") with Arrowhead Industries, Inc. ("Arrowhead"), pursuant to which we
will become the exclusive manufacturer of a tool for assisting with the removal
of door hinges called the "Hinge Helper" (the "Product"). Under the Agreement,
Arrowhead agreed to buy the Product exclusively from us for the period of the
Agreement, which is three years. The Product will be manufactured by us or by
sub-manufacturers selected by us.
The Agreement provides that Arrowhead will own all right, title, and interest in
the Product, and will sell and market the Product under its trademarks, service
marks, or trade names.
On January 9, 2006, we issued a press release which referred, in the title, to
the Agreement as a "$22 Million Exclusive Manufacturing Agreement." The dollar
amount referenced relates to the potential amount of income or revenue which we
may receive over the anticipated life of the Agreement.
CirTran announced on January 9, 2006, that Arrowhead Industries, Inc., of
Windermere, Florida, had awarded us an exclusive contract to manufacture its
patented Hinge Helper (TM) do-it-yourself utility tool for the home. The Hinge
Helper will be manufactured by CirTran-Asia, the Company's China-based
subsidiary. The exclusive manufacturing contract for the product is for three
years. Arrowhead has filmed a Hinge Helper infomercial for TV with an airing
date scheduled for late April.
The Hinge Helper is a unique hand tool designed and developed for use by
household customers as well as tradesmen. Recognized by the U.S. Patent Office
(#6,308,390 B1), its trademark and patent are owned by and registered to
Arrowhead. The specific advantage of the Hinge Helper is its ease-of-use and
simplistic design. It can be applied to any residential hinge on wood, metal or
composite doors, and is being manufactured with highly-durable materials,
enabling it to carry a lifetime guarantee.
The contract is for three years, and Arrowhead agreed to purchase a minimum of
ten million units of the Product (the "Minimum Quantity"), subject to the terms
and conditions of the Agreement. Arrowhead and CirTran have agreed on the
Minimum Quantity in good faith, although the parties acknowledged that in
certain circumstances described in the agreement, the agreement may be
terminated prior to the sale of the entire Minimum Quantity. Arrowhead agreed to
submit purchase orders for the Product from time to time in accordance with the
terms of the agreement. Arrowhead agreed to pay CirTran for the Product
purchased at the prices ranging from $2.95 to $1.90 per unit, depending on the
cumulative number of units of Product which have been purchased by Arrowhead.
Arrowhead will also be entitled to a rebate equal to 10% of the purchase Price
paid for Product in the previous Tier. Rebates will be payable only in the form
of a credit memo against future purchases. Rebate credit memos will not be paid
in cash and may not be applied against outstanding balances. We will calculate
eligibility for the Rebate as soon as practicable following the end of the month
in which a new Tier is entered.
We have produced hand made samples, which have been sent to Arrowhead. These
were approved and we are awaiting final approval for the production samples that
were supplied at the end of March 2006. Once the production samples are
approved, we will start production according to the release schedule that should
be provided by Arrowhead shortly thereafter. As of May 18, 2006, the product
samples have been approved. Arrowhead had released and the Company shipped 1,500
units to test media. We are awaiting final production releases.
21
Electronics Business and Lines of Products
On June 10, 2005, we announced that Racore Technology Inc., ("Racore"), a
subsidiary of CirTran Corporation, received a purchase order from the New York
Fire Department, an established city public department on the east coast for
fiber optic Ethernet network adapters. Since this announcement, the product has
been manufactured and shipped, and a payment of $9,000 has been received. We
continue to market and solicit orders on the Racore product line from various
commercial and public agency clients.
On June 23, 2005, we announced that CirTran Corporation entered the "sold-on-TV"
market by having its CirTran-Asia subsidiary build consumers' electronics
products in China, and is now bringing business to the United States,
refurbishing popular skill-stop slot machines from Japan for home amusement use
in the United States. We continue to receive the imported machines from Rock
Bottom Slots, perform the conversion and refurbishment services and ship
directly to the customer.
On June 24, 2005, we announced that Racore received a purchase order from
Lockheed-Martin, a well-known aerospace manufacturing company for fiber optic
token-ring network adapters. Direct sales of new and repeat business from this
company have totaled more than $30,000. Since this announcement the product has
been manufactured and shipped, and payment has been received. As of the date of
this Report, we have shipped an additional $45,000 worth of product to this
company.
On July 22, 2005, we announced that Racore received a purchase order from the
United States Air Force for OptiCORE network interface cards. Since this
announcement, the product has been manufactured and shipped, and payments of
$15,000 have been received.
On August 1, 2005, we announced that Racore received a purchase order for fiber
optics products from Cherokee City Appraisal District, another city public
department located in the southern United States for fiber optic PCI Ethernet
network interface cards with VF-45 connectors. Since this announcement, the
product has been manufactured and shipped, and a payment of $1,030 has been
received.
On August 4, 2005, we announced that Racore received a purchase order from Walt
Disney World, a well-known amusement park in the southeastern United States, for
more than $21,000 worth of network interface cards. Since this announcement, the
product has been manufactured and shipped, and payment has been received.
On August 9, 2005, we announced that CirTran Corporation completed the first
phase of the redevelopment of the next-generation SafetyNet(TM) RadioBridge(TM).
Since this announcement, the Company has completed working on the second phase
of the contract. On March 14, 2006, we announced that we had received a $250,000
order to build and deliver the first production run of the next generation
SafetyNet(TM) RadioBridge(TM) which we redesigned at the request and on behalf
of Aegis Assessments, Inc., a Scottsdale, Arizona-based homeland security
contractor. We delivered the new, redesigned units and received payment in full
from Aegis in April 2006.
On September 13, 2005, we announced that Racore had been named an "approved
vendor" by the City of New York. Racore began its current business relationship
with the City of New York in April when it received a request for an evaluation
unit of the Racore M8190A Fiber Optic Fast Ethernet Network Adapters with
Volition Patch Cords. Racore subsequently received an order placed through one
of its value-added resellers. Since this announcement, the product has been
manufactured and shipped, and a payment of $4,500 has been received.
22
On October 11, 2005, we announced that CirTran Corporation was opening a
satellite office in Los Angeles in accordance with the Company's internal
expansion program. The new 2,500-square foot office will be located on the 17th
floor at 1875 Century Park East in the Century City Entertainment and Business
District of Los Angeles. Scheduled to open in late November, the office will
serve as headquarters for CirTran's business development and strategic planning
activities for the Company's multiple business divisions including electronics,
consumer products, direct response/retail and "as sold-on-TV" products. Current
plans call for CirTran to open additional satellite offices in New York and
London in 2006. Since this announcement, we have leased office space in Los
Angeles, California.
On December 2, 2005, we announced that we had formed a new division, CirTran
Products, which will offer products for sale at retail. The new division will be
run from our new Los Angeles office, with Trevor Saliba, our executive vice
president for worldwide business development, working to develop sales. We
anticipate that consumer products built by our CirTran Asia subsidiary, as well
as other products which we plan to acquire, will be available for retail sale in
2006
CirTran Products was established to pursue manufacturing relationships on both a
contracted and proprietary basis in the consumer products industry. Proprietary
products will be product lines where the intellectual property (logo, trade name
etc.) are owned by CirTran Products as well as exclusively manufactured by
CirTran Corporation. The marketing efforts may also be managed exclusively by
CirTran, or CirTran may choose to engage third party consultants or partner with
an independent marketing firm. CirTran Products also intends to pursue contract
manufacturing relationships in the consumer products industry which can include
product lines including: home/garden, kitchen, health/beauty, toys, licensed
merchandise and apparel for film, television, sports and other entertainment
properties. Licensed merchandise and apparel can be defined as any item that
bears the image of, likeness, or logo of a product sold or advertised to the
public. Licensed merchandise and apparel are sold and marketed in the
entertainment (film and television) and sports (sports franchises) industries.
As of May 18, 2006, we have concentrated our product development efforts into
three areas, home/kitchen appliances, beauty products and licensed merchandise.
We anticipate that these products will be introduced into the market under one
uniform brand name or under separate trademarked names owned by CirTran
Products.
Recent Developments
On March 21, 2006, the Company issued a press release "CirTran Forms New
Division to Serve Direct Response and Entertainment Industries." The new
division will concentrate its efforts on product marketing, production, media
funding and merchandise manufacturing services working as a complete
vertically-integrated platform that can augment our manufacturing services in
the direct response industry. Our experience in this industry over the past two
years has taught us that there is a need for a single source solution. In
addition, we feel it will help us capture additional business that might
otherwise had been lost at the manufacturing level allowing us to participate in
all additional areas.
On April 18, 2006, we announced that we had joined forces with former
heavyweight champion Evander Holyfield to market and promote "The Real Deal
Grill(TM)," a new electric indoor/outdoor cooking product to be sold via TV
infomercials. We arranged with the former champion's company, Holyfield
Management, Inc., of Georgia, for his services to promote the product and to
film a series of TV infomercials featuring Mr. Holyfield and The Real Deal
Grill, which are scheduled to be filmed in Florida in May 2006. Mr. Holyfield
will receive a talent fee for all units sold.
23
On April 19, 2006, we announced that we had signed an agreement relating to "The
Real Deal Grill(TM) (the "Grill"), which will initially be sold on TV worldwide
and endorsed by Evander Holyfield, the four-time heavyweight boxing champion of
the world. The agreement was signed with Harrington Business Development (HBD)
of St. Petersburg, Florida, giving HBD the rights to market the Grill in the
Americas and Japan (the "Territory"). Under the contract, HBD will initially
market the Grill on TV through infomercials in the U.S., Canada, South America
and Japan, which will be filmed in Florida featuring Mr. Holyfield. Under the
terms of the contract, we have paid one-half of the costs of producing the
initial infomercial, in the amount of $37,500. Under the contract, HBD granted
to us the right to use the raw footage, including audio and video, for the
initial infomercial to produce infomercials or other advertisements for the
Grill for use solely outside of the Territory. The agreement has an initial term
of 3 years and may be renewed. HBD is part of Reliant International Media
Corporation ("Reliant"), a full-service direct response company founded by
industry pioneers and leaders Tim and Kevin Harrington. The Harringtons, who
have been in the direct response industry since the early 1980's, have produced
long and short form infomercials for products in numerous categories, which have
been seen on TV around the world.
As of May 18, 2006, we had not received any purchase orders for the Grill, the
infomercial had not been filmed, and we had not begun manufacturing the Grill.
Once we receive the initial purchase order, we anticipate that we will begin
manufacturing, although there can be no guarantee that HBD or Reliant will place
any orders or that we will receive the maximum amount possible under the
agreement, announced as $30 million, which assumed that HBD would purchase $30
million worth of the Grill.
On May 1, 2006, we announced that CirTran Corporation had received a purchase
order from Hill Air Force Base in Utah, adding to its list of government
contracts and assignments. We anticipate that work will begin during the second
quarter of 2006, both on-site at Hill AFB and at our manufacturing facility. The
purchase order includes creating new custom cables and interfaces, refurbishing
existing underground cables, and upgrading various rack assemblies and
connectors. In its initial phase, the order is worth approximately $15,000 to
CirTran.
On May 11, 2006, we announced that we had appointed Richard T. Ferrone, C.P.A.,
as our chief financial officer. Prior to joining CirTran, Mr. Ferrone had headed
his own accounting firm, Ferrone & Associates, which he established in Salt Lake
City in 1994. Previously, he was vice president and CFO for then-publicly-held
GCI Industries, Inc. /Golf Card International for seven years, and served as CFO
of Huntsman, Christensen Real Estate & Development Co. Mr. Ferrone had also
served as vice president and chief financial officer for BSD Medical Corporation
(AMEX: BSM) after beginning his career with a regional accounting firm in Salt
Lake City. Mr. Ferrone has a B.S. in Accounting from the University of Utah,
where he also studied for a Master of Professional Accountancy with a tax
emphasis.
On April 12, 2006, we announced that we had settled all major litigation in
which we were a defendant. These litigation matters had been described in our
previous SEC filings and were settled for less than the original claims against
us. We were able to settle these cases with a total cash outlay of only $200,000
after originally having exposure of up to $4.25 million. We settled with Howard
Salamon, a financial consultant who originally sued us for $1.75 million through
the issuance of 4 million restricted shares and a warrant to purchase an
additional 7 million shares exercisable at $.05 per share. We also settled our
dispute with Sunborne XII, LLC, a Colorado limited liability company and the
owner of a building in Colorado Springs, Colorado, to which we expanded our
operations in the late 1990s, for $200,000 in cash. Sunborne's claim originally
ranged up to $2.5 million. Both settlements were reached in February 2006. Our
subsidiary, CirTran Asia, will continue to proceed with its action against
International Edge, Inc., Michael Casey Enterprises, Inc., Michael Casey, David
Hayek, and HIPMG, Inc., as discussed below under "Legal Proceedings."
24
Significant Accounting Policies
Financial Reporting Release No. 60, which was recently released by the
Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. Note 1 of the Notes to the Financial Statements contained
in our Annual Report on form 10-KSB includes a summary of the significant
accounting policies and methods used in the preparation of our Financial
Statements. The following is a brief discussion of the more significant
accounting policies and methods used by us.
Our discussion and analysis of our financial condition and results of operations
is based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
These principles require us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances. Estimated amounts may differ under different
assumptions or conditions, and actual results could differ from the estimates.
Revenue Recognition
Revenue is recognized when products are shipped. Title passes to the customer or
independent sales representative at the time of shipment. Returns for defective
items are repaired and sent back to the customer. Historically, expenses
experienced with such returns have not been significant and have been recognized
as incurred.
Inventories
Inventories are stated at the lower of average cost or market value. Costs
include labor, material, and overhead costs. Overhead costs are based on
indirect costs allocated among cost of sales, work-in-process inventory, and
finished goods inventory. Indirect overhead costs have been charged to cost of
sales or capitalized as inventory based on management's estimate of the benefit
of indirect manufacturing costs to the manufacturing process.
When there is evidence that the inventory's value is less than original cost,
the inventory is reduced to market value. The Company determines market value on
current resale amounts and whether technological obsolescence exists. The
Company has agreements with most of its customers that require the customer to
purchase inventory items related to their contracts in the event that the
contracts are cancelled. The market value of related inventory is based upon
those agreements.
The Company typically orders inventory on a customer-by-customer basis. In doing
so the Company enters into binding agreements that the customer will purchase
any excess inventory after all orders are complete. Almost 80% of the total
inventory is secured by these agreements.
Related Party Transactions
Certain transactions involving Abacas Ventures, Inc., the Saliba Private Annuity
Trust and the Saliba Living Trust are regarded as related party transactions
under FAS 57. Disclosure concerning these transactions is set out in this Item 2
under "Liquidity and Capital Resources - Liquidity and Financing Arrangements,"
and in "Item 5 - Other Information."
25
Results of Operations - Comparison of Periods ended March 31, 2006 and 2005
Sales and Cost of Sales
Net sales decreased to $1,737,824 for the three months period ended March 31,
2006, as compared to $2,920,465 during the same period in 2005, for a decrease
of 40.5%. This decrease was attributed to the loss of sales in the CirTran Asia
division due to legal issues with the Ab King Pro and ABS (See comments in legal
section). Cost of sales decreased by 48.2%, to $990,370 during the three months
period ended March 31, 2006, from $1,949,773 during the same period in 2005. The
decrease in cost of sales is directly due to the decrease in revenue. Our gross
profit margin for the three months period ended March 31, 2006, was 43.0%, up
from 33.2% for the same period in 2005. The majority of the increase is due to a
considerable decrease in CirTran-Asia sales which have more favorable margins
compared to the electronics assembly and Ethernet technology business
operations. The sales in these divisions have remained consistent.
Inventory
We use just-in-time manufacturing, which is a production technique that
minimizes work-in-process inventory and manufacturing cycle time, while enabling
us to deliver products to customers in the quantities and time frame required.
This manufacturing technique requires us to maintain an inventory of component
parts to meet customer orders. Inventory at March 31, 2006, was $2,203,537, as
compared to $2,271,604 at December 31, 2005. The decrease in inventory is
nominal.
Selling, General and Administrative Expenses
During the three months ended March 31, 2006, selling, general and
administrative expenses were $837,520 versus $959,891 for the same period in
2005, a 12.7% decrease. The decrease in selling, general and administrative
expenses is nominal.
Interest Expense
Interest expense for three months ended March 31, 2006, was $1,086,253 as
compared to $143,770 for the same period in 2005, an increase of 655.5%. The
increase is primarily due to the derivative treatment of the convertible
debenture, discussed below.
As a result of the above factors, we have net loss of $277,998 for the quarter
ended March 31, 2006, as compared to $201,728 for the quarter ended March 31,
2005. This net loss is attributed to a substantial decrease in sales.
Liquidity and Capital Resources
Our expenses are currently greater than our revenues. We have had a history of
losses preceeding this quarter, and our accumulated deficit has increased to
$19,605,311 at March 31, 2006, compared to $19,327,310 at December 31, 2005. Our
net loss for the quarter ending March 31, 2006, was $277,998, compared to
$201,728 for the quarter ended March 31, 2005. Our current assets exceeded our
current liabilities by $300,528 as of March 31, 2006, and our current
liabilities exceeded our current assets by $1,142,874 as of December 31, 2005.
The change was mostly attributable to settlements of notes payable. For the
three months ended March 31, 2006 and 2005, we had negative cash flows from
operations of $719,698 and $385,701 respectively.
26
Cash
We had cash on hand of $443,637 at March 31, 2006, and $1,427,865 at December
31, 2005.
Net cash used in operating activities was $719,698 for the three months ended
March 31, 2006. Cash received from customers of $2,076,845 was not sufficient to
offset cash paid to vendors, suppliers, and employees of $2,128,964. The
non-cash charges were for depreciation and amortization of $114,939 and
accretion expense of $965,512. Because the Company has negative cash flows from
operations, it must rely on sources of cash other than customers to support its
operations. It is anticipated that various methods of equity financing will be
required to support operations until cash flows from operations are positive.
Net cash used in investing activities during the three months ended March 31,
2006, consisted of equipment and furniture purchases of $166,730.
Net cash used by financing activities was $97,600 during the three months ended
March 31, 2006 and was primarily related to payments on notes payable to
stockholders of $95,806.
Accounts Receivable
At March 31, 2006, we had receivables of $3,019,960, net of a reserve for
doubtful accounts of $158,374, as compared to $3,358,981 at December 31, 2005,
net of a reserve of $158,374.
This decrease was primarily attributed to decreased sales in the last two months
of the first quarter as compared to the last two months in 2005. Receivables
include the unpaid balance from ABS. (See ABS history beginning on page 19). The
Company has implemented an aggressive process to collect past due accounts over
the past two years. Individual accounts are continually monitored for
collectibilty. As part of monitoring individual customer accounts, the Company
evaluates the adequacy of its allowance for doubtful accounts. Since the
implementation of the new collection process, very few accounts have been deemed
uncollectible.
Accounts Payable
Accounts payable were $528,963 at March 31, 2006, as compared to $1,239,519 at
December 31, 2005. The decrease is related to a drop in sales and paying vendors
in a timely manner.
Liquidity and Financing Arrangements
We have a history of substantial losses from operations and using rather than
providing cash in operations. We had an accumulated deficit of $19,605,311 and a
total stockholders' equity of $3,165,931 at March 31, 2006. As of March 31,
2006, our monthly operating costs and interest expenses averaged approximately
$640,000 per month.
In conjunction with our efforts to improve our results of operations, discussed
above, we are also actively seeking infusions of capital from investors. It is
unlikely that we will be able, in our current financial condition, to obtain
additional debt financing; and if we did acquire more debt, we would have to
devote additional cash flow to paying the debt and securing the debt with
assets. We may therefore have to rely on equity financing to meet our
anticipated capital needs. There can be no assurances that we will be successful
in obtaining such capital. If we issue additional shares for debt and/or equity,
this will dilute the value of our common stock and existing shareholders'
positions.
27
Convertible Debentures
Highgate - On May 26, 2005, the Company entered into an agreement with Highgate
to issue to Highgate a $3,750,000, 5% Secured Convertible Debenture (the
"Debenture"). The Debenture is due December 2007 and is secured by all of the
Company's property.
Accrued interest is payable at the time of maturity or conversion. The Company
may, at its option, elect to pay accrued interest in cash or shares of the
Company's common stock. If paid in stock, the conversion price shall be the
closing bid price of the common stock on either the date the interest payment is
due or the date on which the interest payment is made. The balance of accrued
interest owed at March 31, 2006 and December 31, 2005, was $152,349 and
$111,986, respectively.
At any time, Highgate may elect to convert principal amounts owing on the
Debenture into shares of the Company's common stock at a conversion price equal
to the lesser of $0.10 per share, or an amount equal to the lowest closing bid
price of the Company's common stock for the twenty trading days immediately
preceding the conversion date. The Company has the right to redeem a portion or
the entire Debenture then outstanding by paying 105% of the principal amount
redeemed plus accrued interest thereon.
Highgate's right to convert principal amounts into shares of the Company's
common stock is limited as follows:
(i) Highgate may convert up to $250,000 worth of the principal
amount plus accrued interest of the Debenture in any
consecutive 30-day period when the market price of the
Company's stock is $0.10 per share or less at the time of
conversion;
(ii) Highgate may convert up to $500,000 worth of the principal
amount plus accrued interest of the Debenture in any
consecutive 30-day period when the price of the Company's
stock is greater than $0.10 per share at the time of
conversion; provided, however, that Highgate may convert in
excess of the foregoing amounts if the Company and Highgate
mutually agree; and
(iii) Upon the occurrence of an event of default, Highgate may, in
its sole discretion, accelerate full repayment of all
debentures outstanding and accrued interest thereon or may
convert the Debentures and accrued interest thereon into
shares of the Company's common stock.
Except in the event of default, Highgate may not convert the Debenture for a
number of shares that would result in Highgate owning more than 4.99% of the
Company's outstanding common stock.
In connection with the issuance of the Highgate Debenture, the Company granted
Highgate registration rights related to the issuance of the debenture.
The Company determined that the features of the Debenture fell under derivative
accounting treatment. As of March 31, 2006 the carrying value of the Debenture
was $1,068,604. The carrying value will be accreted each quarter over the life
of the Debenture until the carrying value equals the unconverted face value of
$3,000,000. The fair value of the derivative liability as of March 31, 2006 was
$1,767,254.
In connection with the issuance of the Debenture, $2,265,000 of the proceeds
were paid to Cornell to repay promissory notes. Fees of $256,433 were withheld
from the proceeds, were capitalized, and are being amortized over the life of
the note. As such, of the total Debenture of $3,750,000, the net proceeds to the
28
Company were $1,228,567. The proceeds were used for general corporate and
working capital purposes, at the Company's discretion.
In January 2006, Highgate converted $750,000 of its convertible debenture into
24,193,548 shares of the Company's common stock at a conversion rate of $0.031
per share, which was the lower of $0.10 or 100% of the lowest closing bid price
of the Company's commons stock over the 20 trading days preceding the
conversion.
Cornell - On December 30, 2005, the Company entered into an agreement with
Cornell Capital Partners, L.P. ("Cornell") to issue to Cornell a $1,500,000, 5%
Secured Convertible Debenture (the "Cornell Debenture"). The Cornell Debenture
is due July 30, 2008, and is secured by all the Company's property, junior to
the Highgate security interest.
Accrued interest is payable at the time of maturity or conversion. The Company
may, at its option, elect to pay accrued interest in cash or shares of the
Company's common stock. If paid in stock, the conversion price shall be the
closing bid price of the common stock on either the date the interest payment is
due or the date on which the interest payment is made. The balance of accrued
interest owed at March 31, 2006 and December 31, 2005, was $18,082 and zero,
respectively.
At any time, Cornell may elect to convert principal amounts owing on the Cornell
Debenture into shares of the Company's common stock at a conversion price equal
to an amount equal to the lowest closing bid price of the Company's common stock
for the twenty trading days immediately preceding the conversion date. The
Company has the right to redeem a portion or the entire Cornell Debenture then
outstanding by paying 105% of the principal amount redeemed plus accrued
interest thereon.
Cornell's right to convert principal amounts into shares of the Company's common
stock is limited as follows:
(i) Cornell may convert up to $250,000 worth of the principal
amount plus accrued interest of the Cornell Debenture in any
consecutive 30-day period when the market price of the
Company's stock is $0.10 per share or less at the time of
conversion;
(ii) Cornell may convert up to $500,000 worth of the principal
amount plus accrued interest of the Cornell Debenture in any
consecutive 30-day period when the price of the Company's
stock is greater than $0.10 per share at the time of
conversion; provided, however, that Cornell may convert in
excess of the foregoing amounts if the Company and Cornell
mutually agree; and
(iii) Upon the occurrence of an event of default, Cornell Capital
Partners, LP may, in its sole discretion, accelerate full
repayment of the debenture outstanding and accrued interest
thereon or may convert the Debenture and accrued interest
thereon into shares of the Company's common stock.
Except in the event of default, Cornell may not convert the Cornell Debenture
for a number of shares that would result in Cornell owning more than 4.99% of
the Company's outstanding common stock.
The Cornell Debenture was issued with 10,000,000 warrants with an exercise price
of $0.09 per share that vest immediately and have a three year life.
29
In connection with the issuance of the Cornell Debenture, the Company granted
Cornell registration rights related to the issuance of the Cornell Debenture and
warrants.
The Company determined that the features on the Cornell Debenture and the
associated warrants fell under derivative accounting treatment. As of March 31,
2006 the carrying value of the Cornell Debenture was $143,160. The carrying
value will be accreted each quarter over the life of the Cornell Debenture until
the carrying value equals the face value of $1,500,000. The fair value of the
derivative liability as of March 31, 2006 was $$1,368,906.
In connection with the issuance of the Cornell Debenture, fees of $130,000 were
withheld from the proceeds, capitalized, and will be amortized over the life of
the Cornell Debenture. As such, of the total Cornell Debenture of $1,500,000,
the net proceeds to the Company were $1,370,000. The proceeds will be used for
general corporate and working capital purposes, at the Company's discretion
As of March 31, 2006, Cornell had not converted any of the Cornell Debenture
into shares of the Company's common stock.
Forward-looking statements
Certain of the statements contained in this Report (other than the historical
financial data and other statements of historical fact) are forward-looking
statements. These statements include, but are not limited to our expectations
with respect to the development of a new offices or divisions; the achievement
of certain revenue goals; the receipt of new business and contracts; and our
intentions with respect to financing our operations in the future. Additional
forward-looking statements may be found in the "Risk Factors" Section of our
Annual Report on Form 10-KSB, together with accompanying explanations of the
potential risks associated with such statements. You are encouraged to review
the "Risk Factors" Section of our Annual Report.
Forward-looking statements made in this Quarterly Report, are made based upon
management's good faith expectations and beliefs concerning future developments
and their potential effect upon the Company. There can be no assurance that
future developments will be in accordance with such expectations, or that the
effect of future developments on CirTran will be those anticipated by
management. Forward-looking statements may be identified by the use of words
such as "believe," "expect," "plans," "strategy," "prospects," "estimate,"
"project," "anticipate," "intends" and other words of similar meaning in
connection with a discussion of future operating or financial performance.
You are cautioned not to place undue reliance on these forward looking
statements, which are current only as of the date of this Report. We disclaim
any intention or obligation to update or revise any forward-looking statements,
whether as a result of new information, future events, or otherwise. Many
important factors could cause actual results to differ materially from
management's expectations, including those listed in the "Risk Factors" Section
of our Annual Report for the year ended December 31, 2005, as well as the
following:
* unpredictable difficulties or delays in the development of new
products and technologies;
* changes in U.S. or international economic conditions, such as
inflation, interest rate fluctuations, foreign exchange rate
fluctuations or recessions in CirTran's markets;
30
* pricing changes to our supplies or products or those of our
competitors, and other competitive pressures on pricing and
sales;
* difficulties in obtaining or retaining the management,
engineering, and other human resource competencies that we
need to achieve our business objectives;
* collection of customer balances due on account;
* the impact on CirTran or a subsidiary from the loss of a
significant customer or a few customers;
* risks generally relating to our international operations,
including governmental, regulatory or political changes;
* transactions or other events affecting the need for, timing
and extent of our capital expenditures; and
* the extent to which we reduce outstanding debt.
Item 3. Evaluation of Disclosure Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We maintain disclosure
controls and procedures designed to ensure that information required to be
disclosed in our reports filed under the Securities Exchange Act of 1934, as
amended (the Exchange Act), is recorded, processed, summarized, and reported
within the required time periods, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer, who was
also our Chief Financial Officer, as appropriate, to allow for timely decisions
regarding disclosure. On May 15, 2006, the Company entered into an agreement
with Richard T. Ferrone, CPA, whereby Mr. Ferrone became the Chief Financial
Officer of the Company. (See discussion below)
As disclosed in our Annual Report on Form 10-KSB for the year ended December 31,
2005, as required by Rule 13a-15(b) under the Exchange Act, we conducted an
evaluation, under the supervision of our Chief Executive Officer/Chief Financial
Officer, of the effectiveness of our disclosure controls and procedures as of
December 31, 2005. In our evaluation, we identified deficiencies that existed in
the design or operation of our internal control over financial reporting that we
and our independent registered public accounting firm considered to be "material
weaknesses." A material weakness is a significant deficiency or combination of
significant deficiencies that results in more than a remote likelihood that a
material misstatement of the annual or interim financial information will not be
prevented or detected.
Based on the matters identified above, our Chief Executive Officer/Chief
Financial Officer concluded that our disclosure controls and procedures were not
effective. These deficiencies have been disclosed to our Board of Directors.
The deficiencies in our internal control over financial reporting related
primarily to the failure to properly measure and disclose equity and debt
transactions. The deficiencies were detected in the evaluation process and the
transactions have been appropriately recorded and disclosed in this Quarterly
Report on Form 10-QSB. We are in the process of improving our internal control
over financial reporting in an effort to resolve these deficiencies through
improved supervision and training of our accounting staff, but additional effort
is needed to fully remedy these deficiencies. Our management and directors will
continue to work with our new CFO, our auditors and outside advisors to ensure
that our controls and procedures are adequate and effective.
31
In an effort to resolve the deficiencies in internal control, mentioned above,
the Company, in concurrence with the recommendation of our registered
independent public accounting firm, embarked upon an executive search for a
qualified candidate to fill the position of chief financial officer (CFO). The
Company successfully concluded the executive search on May 15, 2006 when it
signed a three year contract with Richard T. Ferrone, CPA, as the new CFO of the
Company. The addition of an experienced financial executive is a major
achievement in addressing and resolving the deficiencies in our financial
controls and also provides the Company with the capacity to develop and advance
the overall financial capabilities of the Company.
Quarterly Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer/Chief Financial Officer, after evaluating the effectiveness of the
Company's "disclosure controls and procedures" (as defined in the Securities
Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end
of the period covered by this quarterly report, has concluded that our
disclosure controls and procedures were not effective to provide reasonable
assurance that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized, and
reported within the applicable time periods.
Changes in Internal Control over Financial Reporting. As noted above, we are in
the process of improving our internal control over financial reporting in an
effort to resolve these deficiencies through improved supervision and training
of our accounting staff. Additionally, we have recently hired a new Chief
Financial Officer. However, additional effort is needed to fully remedy these
deficiencies. Our management and directors will continue to work with our new
CFO, our auditors and outside advisors to ensure that our controls and
procedures are adequate and effective.
Limitations on Effectiveness of Controls. A system of controls, however well
designed and operated, can provide only reasonable, and not absolute, assurance
that the system will meet its objectives. The design of a control system is
based, in part, upon the benefits of the control system relative to its costs.
Control systems can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the control. In
addition, over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. In addition, the design of any control system is based in part upon
assumptions about the likelihood of future events.
While our disclosure controls and procedures provide reasonable assurance that
the appropriate information will be available on a timely basis, this assurance
is subject to limitations inherent in any control system, no matter how well
designed and administered.
Section 404 Assessment. Section 404 of the Sarbanes-Oxley Act of 2002 requires
management's annual review and evaluation of our internal controls, and an
attestation of the effectiveness of these controls by our independent registered
public accountants beginning with our Form 10-KSB for the fiscal year ending on
December 31, 2007. We plan to dedicate significant resources, including
management time and effort, and to incur substantial costs in connection with
our Section 404 assessment. The evaluation of our internal controls will be
conducted under the direction of our senior management. We will continue to work
to improve our controls and procedures, and to educate and train our employees
on our existing controls and procedures in connection with our efforts to
maintain an effective controls infrastructure at our Company.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
32
In November 2003, the Company entered into an agreement with the Utah State Tax
Commission to allow the Company to pay certain accrued tax liabilities for
delinquent payroll taxes, including interest and penalties, incurred by CirTran
Corporation owing to the State of Utah in equal monthly installments over a two
year period. Under the agreement, the Company would make monthly payments of
$4,000 per month through November 2005 to pay the tax liability only. We
completed the payment of the taxes owing in November 2005, and subsequently paid
off the agreed-upon interest and penalties in January 2006.
We also assumed certain liabilities of Circuit Technology, Inc., in connection
with our transactions with that entity in the year 2000, and as a result we are
defendant in a number of legal actions involving nonpayment of vendors for goods
and services rendered. We have accrued these payables and have negotiated
settlements with respect to some of the liabilities, including those detailed
below, and are currently negotiating settlements with other vendors. As of May
18, 2006, the only remaining liability of Circuit Technology is C/S Utilities,
discussed below.
C/S Utilities notified the Company that (as successor to Circuit Technology,
Inc.) it believes it has a claim against the Company in the amount of $32,472
regarding utilities services. The claim was assigned to BC Services, Inc., which
obtained a judgment against Circuit Technology, Inc., for $37,966 in El Paso
County, Colorado, District Court on February 13, 2003. The Company is reviewing
its records in an effort to confirm the validity of the claims and is evaluating
its options.
We (as successor to Circuit Technology, Inc.) were a defendant in an action in
El Paso County, Colorado District Court, brought by Sunborne XII, LLC
("Sunborne"), a Colorado limited liability company, for alleged breach of a
sublease agreement involving facilities located in Colorado. Our liability in
this action was originally estimated to range up to $2.5 million, and we
subsequently filed a counter suit in the same court against Sunborne in an
amount exceeding $500,000 for missing equipment. Following several attempts to
settle the claims, we entered into a settlement agreement with Sunborne,
pursuant to which we paid a total of $200,000 in settlement of all claims
subsequent to year end. The action has been dismissed with prejudice.
CirTran Asia v. Mindstorm Civil No. 050902290, Third Judicial District Court,
Salt Lake County, State of Utah. In February, 2005, CirTran Asia brought suit
against Mindstorm Technologies, LLC, for nonpayment for goods provided. On April
22, 2005, the defendant filed its answer and counterclaim, following which
defendant's counsel withdrew from representation. CirTran Asia notified
defendant that under governing rules it was required to appoint successor
counsel. The defendant failed to do so, and failed to prosecute its claim.
CirTran Asia moved for default judgment, which was granted. CirTran Asia
submitted a proposed order of default judgment in the amount of $288,529 to the
court in September 2005, which has been signed.
CirTran Asia v. Robinson, Civil No. 050915272, Third Judicial District Court,
Salt Lake County, State of Utah. On August 30, 2005, CirTran Asia brought suit
against Glenn Robinson, one of the principals of Mindstorm Technologies, LLC,
for nonpayment for goods provided. Mr. Robinson filed an answer and subsequently
filed for personal bankruptcy. CirTran Asia is reviewing its options and intends
to vigorously pursue this action. On March 30, 2006, CirTran Asia filed a
complaint against Mr. Robinson under Section 523 of the U.S. Bankruptcy Code
seeking a determination that any debts owed by Mr. Robinson to CirTran Asia are
excepted from any discharge granted to Mr. Robinson. As of the date of this
Report, the case was proceeding in discovery.
CirTran Asia, et al. v. International Edge, et al., Civil No. 2:05 CV 413BSJ,
U.S. District Court, District of Utah. On May 11, 2005, CirTran Asia, UKING
System Industry Co., Ltd., and Charles Ho filed suit against International Edge,
Inc., Michael Casey Enterprises, Inc., Michael Casey, David Hayek, and HIPMG,
33
Inc., for breach of contract, breach of the implied covenant of good faith and
fair dealing, interference with economic relationships, and fraud in relation to
certain licensing issues relating to the Ab King Pro. The defendants
counterclaimed, alleging breach of contract, fraud, defamation and related
claims, all related to the Ab King Pro, seeking damages in the amount of
$10,000,000. CirTran Asia and the other plaintiffs filed their reply to the
counterclaim, disputing all of the allegations and claims. International Edge
filed a motion to dismiss for lack of jurisdiction, which was pending as of the
date of this report. Sales from this product in the year ended December 31, 2004
were approximately $3,510,000, and in the year ended December 31, 2005, were
approximately $960,000. CirTran Asia intends to vigorously pursue this action.
CirTran Corporation vs. Advanced Beauty Solutions, LLC, and Jason Dodo, Civil
No. 060900332, Third Judicial District Court, Salt Lake County, State of Utah.
On January 9, 2006, CirTran Corporation brought suit against Advanced Beauty
Solutions ("ABS") and Jason Dodo, asserting claims including breach of contract,
breach of the implied covenant of good faith and fair dealing, interference with
economic relations, fraud and unjust enrichment.
On January 24, 2006, ABS filed a voluntary petition for relief under chapter 11
of the United States Bankruptcy Code in the United States Bankruptcy Court for
the Central District of California, San Fernando Valley Division (the
"Bankruptcy Court"), Case No. SV 06-10076 GM. On January 30, 2006, a hearing
("Hearing") was held to consider the Emergency Motion for Order Approving the
Settlement and Compromise of the Disputed Secured Claims of Inventory Capital
Group, Inc. ("ICG"), and Media Funding Corporation ("MFC") (the "Settlement
Motion") filed by ABS. The continued Hearing on the Settlement Motion was held
on February 16, 2006, at which time the settlement was modified. Prior to a
separate hearing held on March 24, 2006, on ABS's Motion for Order: (1)
Approving Sale and Assignment of Substantially All Assets of the Estate Free and
Clear of Liens; (2) Approving Assumption and Assignment of Leases and Executory
Contracts Included in the Sale and Rejection of Leases and Executory Contracts
Not Included in the Sale; and (3) Granting Related Relief (the "Sale Motion"),
the settlement was further modified. The modifications to the proposed
settlement were read into the Bankruptcy Court's record at the Hearing on the
Settlement Motion and the March 24, 2006 hearing on the Sale Motion ("Proposed
Modifications"). Written notice of the Proposed Modifications was provided to
creditors and parties in interests on March 27, 2006, and the Declaration of
James C. Bastian, Jr., attesting that no objections to the Proposed
Modifications have been received by ABS, was filed with the Bankruptcy Court. As
of May 18, 2006, an order approving the settlement and the sale had not been
entered by the bankruptcy court.
Subject to and conditioned upon the approval of the settlement by the Bankruptcy
Court and Bankruptcy Court approval of and consummation of the sale of
substantially all of ABS's assets to the Company pursuant to the Sale Motion,
the Company shall have an allowed claim against the ABS's estate in the amount
of $2,350,000, of which $750,000 shall be credited to the purchase of
substantially all of ABS's assets. Under the settlement, the Company shall be
allowed to participate as a general unsecured creditor of ABS's estate in the
amount of $1,600,000 on a pari passu basis with the $2,100,000 general unsecured
claim of certain insiders of ABS and subject to the prior payment of certain
secured, priority, and non-insider claims in the amount of approximately
$1,507,011. Subject to final negotiation and execution of a definitive purchase
agreement and Bankruptcy Court Approval of the sale, CirTran Corporation shall
purchase substantially all of ABS's assets in exchange for (i) a cash payment in
the amount of $1,125,000, (ii) a reduction of CirTran's allowed claim in the
Bankruptcy Case by $750,000, (iii) the assumption of any assumed liabilities,
and (iv) the obligation to pay ABS a royalty equal to $3.00 per True Ceramic Pro
flat iron unit sold by ABS (the "Royalty Obligation"). The Royalty Obligation
shall be capped at $4,135,000. To the extent the amounts paid to ABS on account
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of the Royalty Obligation equal less than $435,000 on the 2 year anniversary of
the Closing, then, within 30 days of such anniversary, the Company shall pay ABS
an amount equal to $435,000 less the royalty payments made to date. As part of
the settlement, the Company shall exchange general releases with, among others,
ABS, Jason Dodo (the manager of ABS), Inventory Capital Group ("ICG"), and Media
Funding Corporation ("MFC"). The settlement also resolves a related dispute with
ICG in which ICG will assign $65,000 of its secured claim against ABS to the
Company.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
In January 2006, Highgate converted $750,000 of its convertible debenture into
24,193,548 shares of the Company's restricted common stock at a conversion rate
of $0.031 per share, which was the lower of $0.10 or 100% of the lowest closing
bid price of the Company's commons stock over the 20 trading days preceding the
conversion.
In February 2006, we issued 4,000,000 shares of our restricted common stock and
a warrant to purchase an additional 7,000,000 shares with an exercise price of
$0.06 per share in settlement of litigation.
In each case the securities were issued in connection with private transactions
with accredited investors pursuant to Section 4(2) of the Securities Act of 1933
and the regulations promulgated thereunder.
Item 5. Other Information
Abacas Ventures
An explanation of the relationship between CirTran and Abacas Ventures, Inc., is
as follows:
Two trusts, the Saliba Living Trust and the Saliba Private Annuity Trust
(collectively, the "Saliba Trusts"), were investors in Circuit Technology, a
Utah corporation and predecessor entity of the Company. The trustees of the
trusts are Tom and Betty Saliba, and Tom Saliba, respectively. (Tom Saliba is
the nephew of the grandfather of Trevor Saliba, one of the directors of
CirTran.) In July 2000, CirTran Corporation merged with Circuit Technology.
Through that merger, the Saliba Trusts became shareholders of CirTran. The
Saliba Trusts are also two of the shareholders of an entity named Abacas
Ventures, Inc. ("Abacas"). At the time of the merger, CirTran was in default on
several of its obligations, including an obligation to Imperial Bank. The Saliba
Trusts, through Abacas, purchased the bank's claim against CirTran to protect
their investment in CirTran. Since that time, Abacas has continued to settle
debts of CirTran to improve Abacas's position and to take advantage of certain
discounts that creditors of CirTran offered to settle their claims. On two
occasions, the Abacas shareholders have agreed to convert outstanding debt owed
by CirTran to Abacas into shares of CirTran common stock (discussed below).
Abacas continues to work with the company to settle claims by creditors against
CirTran, and, on occasion, to provide funding. There can be no assurance that
Abacus will agree to convert its existing debt, or any debt it acquires in the
future, into shares of CirTran, or that conversions will occur at a price and on
terms that are favorable to CirTran. If Abacus and CirTran cannot agree on
acceptable conversion terms, Abacus may demand payment of some or all of the
debt. If CirTran does not have sufficient cash or credit facilities to pay the
amount then due and owing by CirTran to Abacus, Abacus may exercise its rights
as a senior secured lender and commence foreclosure or other proceedings against
the assets of CirTran. Such actions by Abacus could have a material adverse
effect upon CirTran and its ability to continue in business.
35
In January, 2002, the Company entered into an agreement with Abacas under which
the Company issued an aggregate of 19,987,853 shares of common stock to four of
Abacas's shareholders in exchange for cancellation by Abacas of an aggregate
amount of $1,499,090 in senior debt owed to the creditors by the Company. The
shares were issued with an exchange price of $0.075 per share, for the aggregate
amount of $1,500,000.
In December, 2002, the Company entered into an agreement with Abacas under which
the Company issued an aggregate of 30,000,000 shares of common stock to four of
Abacas's shareholders in exchange for cancellation by Abacas of an aggregate
amount of $1,500,000 in senior debt owed to the creditors by the Company. The
shares were issued with an exchange price of $0.05 per share, for the aggregate
amount of $1,500,000.
During 2002, the Company entered into a verbal bridge loan agreement with
Abacas. This agreement allows the Company to request funds from Abacas to
finance the build-up of inventory relating to specific sales. The loan bears
interest at 24% and is payable on demand. There are no required monthly
payments. During the years ended December 31, 2004 and 2003, the Company was
advanced $3,128,281 and $350,000, respectively, and made cash payments of
$3,025,149 and $875,000, respectively.
During the year ended December 31, 2004, Abacas completed negotiations with
several vendors of the Company, whereby Abacas purchased various past due
amounts for goods and services provided by vendors, as well as notes payable
(see Note 6). The total of these obligations was $1,263,713. The Company has
recorded this transaction as a $1,263,713 non-cash increase to the note payable
owed to Abacas, pursuant to the terms of the Abacas agreement.
The total principal amount owed to Abacas between the note payable and the
bridge loan was $1,530,587 and $163,742 as of December 31, 2004 and 2003,
respectively. The total accrued interest owed to Abacas between the note payable
and the bridge loan was $430,828 and $230,484 as of December 31, 2004 and 2003,
respectively, and is included in accrued liabilities.
In March 2005, the shareholders of Abacas agreed to cancel $2,050,000 of
principal and accrued interest in return for the Company's issuing 51,250,000
shares of our restricted common stock to certain shareholders of Abacas. No
registration rights were granted.
As of May 18, 2006, no further loans had been made to the Company from Abacas.
As of December 31, 2001, Iehab Hawatmeh had loaned us a total of $1,390,125. The
loans were demand loans, bore interest at 10% per annum and were unsecured.
Effective January 14, 2002, we entered into four substantially identical
agreements with existing shareholders pursuant to which we issued an aggregate
of 43,321,186 shares of restricted common stock at a price of $0.075 per share
for $500,000 in cash and the cancellation of $2,749,090 principal amount of our
debt. Two of these agreements were with the Saliba Private Annuity Trust, one of
our principal shareholders, and a related entity, the Saliba Living Trust. The
Saliba trusts are also principals of Abacas Ventures, Inc., which entity
purchased our line of credit in May 2000. Pursuant to the Saliba agreements, the
trusts were issued a total of 26,654,520 shares of common stock in exchange for
$500,000 cash and the cancellation of $1,499,090 of debt. We used the $500,000
cash from the sale of the shares for working capital. As a result of this
transaction, the percentage of our common stock owned by the Saliba Private
Annuity Trust and the Saliba Living Trust increased from approximately 6.73% to
approximately 17.76%. Mr. Trevor Saliba, one of our directors and officers, is a
passive beneficiary of the Saliba Private Annuity Trust. Pursuant to the other
two agreements made in January 2002, we issued an aggregate of 16,666,666 shares
of restricted common stock at a price of $0.075 per share in exchange for the
cancellation of $1,250,000 of notes payable by two shareholders, Mr. Iehab
Hawatmeh (our president, a director and our principal shareholder) and Mr. Rajai
36
Hawatmeh. Of these shares, 15,333,333 were issued to Iehab Hawatmeh in exchange
for the cancellation of $1,150,000 in debt. As a result of this transaction, the
percentage of our common stock owned by Mr. Hawatmeh increased from 19.9% to
approximately 22.18%.
In February 2000, prior to its acquisition of Vermillion Ventures, Inc., a
public company, Circuit Technology, Inc., while still a private entity, redeemed
680,145 shares (as presently constituted) of common stock held by Raed Hawatmeh,
who was a director of Circuit Technology, Inc. at that time, in exchange for
$80,000 of expenses paid on behalf of the director. No other stated or unstated
rights, privileges, or agreements existed in conjunction with this redemption.
This transaction was consistent with other transactions where shares were
offered for cash.
In 1999, Circuit entered into an agreement with Cogent Capital Corp., or
"Cogent," a financial consulting firm, whereby Cogent agreed to assist and
provide consulting services to Circuit in connection with a possible merger or
acquisition. Pursuant to the terms of this agreement, we issued 800,000
(pre-forward split) restricted shares (12,000,000 post-forward split shares) of
our common stock to Cogent in July 2000 in connection with our acquisition of
the assets and certain liabilities of Circuit. The principal of Cogent was
appointed a director of Circuit after entering into the financial consulting
agreement and resigned as a director prior to the acquisition of Circuit by
Vermillion Ventures, Inc. on July 1, 2000.
Also, as of December 31, 2004 the company owed I&R Properties, LLC, the previous
owner of our principal office and manufacturing facility for unpaid accrued rent
and accrued interest. The Company settled with owed I&R Properties, LLC., on
accrued rent and interest of $400,000 by issuing 10,000,000 shares of
unregistered common stock in March 2005.
Management believed at the time of each of these transactions and continues to
believe that each of these transactions were as fair to the Company as could
have been made with unaffiliated third parties.
Item 6. Exhibits
Exhibits:
10.1 Employment Agreement with Richard Ferrone (previously
filed as an exhibit to a Current Report on Form 8-K filed
with the Commission on May 15, 2006, and incorporated here
in by reference).
10.2 Marketing and Distribution Agree between CirTran
Corporation and Harrington Business Development, Inc.,
dated as of October 24, 2005.
10.3 Amendment to Marketing and Distribution Agree between
CirTran Corporation and Harrington Business Development,
Inc., dated as of March 31, 2006.
31 Certification
32 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
37
SIGNATURES
In accordance with the Securities Exchange Act of 1934, the registrant caused
this report to be signed on its behalf by the undersigned thereunto duly
authorized.
CIRTRAN CORPORATION
Date: May 19, 2006 By: /s/ Iehab J. Hawatmeh
-------------------------------------
Iehab J. Hawatmeh
President and Chief Financial Officer
(Principal Executive Officer,
Principal Financial Officer)
38
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