Circuit Research Labs (CRLI) 10QSB/A 2006 Q3 Quarterly report (small business) (amended)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB/A

T

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

For the quarterly period ended September 30, 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 No.: 0-11353

CIRCUIT RESEARCH LABS, INC.

(Exact name of small business issuer as specified in its charter)

Arizona (State or other jurisdiction of incorporation or organization) 86-0344671 (I.R.S. Employer Identification No.)

7970 S. Kyrene Road, Tempe, Arizona 85284

(Address of principal executive offices) (Zip code)

Registrant’s telephone number, including area code: (480) 403-8300

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 preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     YesT      No£

The number of shares outstanding of each class of our common equity as of November 14, 2006 is as follows:

Class of Common Equity

Number of Shares

Common Stock, par value $.10

8,623,459

EXPLANATORY NOTE

This quarterly report on Form 10-QSB/A is being filed to amend our quarterly report on Form 10-QSB for the quarter ended September 30, 2006, which was originally filed with the Securities and Exchange Commission ("SEC") on November 14, 2006.  Accordingly, pursuant to Rule 12b-15 of the Securities Exchange Act of 1934, as amended, this Form 10-QSB/A contains current dated certifications from the Principal Executive Officer and the Principal Financial Officer.

This 10-QSB/A is being amended to correct a clerical error in the presentation of the Consolidated Condensed Statement of Operations.  Under the column “Nine Months Ended September 30, 2006” the line item “NET INCOME (LOSS)” is corrected from ($663,938) to ($633,938).  

Other than as set forth above, we have not updated the information contained

herein for events occurring subsequent to November 14, 2006, the filing date of

the original Form 10-QSB.

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Circuit Research Labs, Inc.

Index to Form 10-QSB Filing

For the Quarter Ended September 30, 2006

                                                            Table of Contents

                                                                                   Page

19

19

20

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PART I — FINANCIAL INFORMATION

CIRCUIT RESEARCH LABS, INC. and SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

	September 30,	December 31,
	2006	2005
	(unaudited)
CURRENT ASSETS
Cash	$33,219	$137,743
Accounts receivable, trade, net of allowance for doubtful accounts of $33,361 in 2006 and in 2005	775,504	700,175
Inventories	3,185,768	2,687,585
Other current assets	152,626	162,188
Total current assets	4,147,117	3,687,691
PROPERTY, PLANT AND EQUIPMENT - Net	292,515	418,525
OTHER ASSETS:
Goodwill	7,476,008	7,476,008
Other	369,652	358,468
	7,845,660	7,834,476
TOTAL	$12,285,292	$11,940,692
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$2,043,430	$1,248,944
Notes payable to stockholders	1,195,000	720,000
Current portion, notes payable, Harman	487,500	487,500
Current portion of other long-term debt	1,045,836	1,013,398
Accrued salaries and benefits	555,103	586,826
Customer deposits	415,895	268,213
Other accrued expenses and liabilities	661,171	992,678
Total current liabilities	6,403,935	5,317,559
LONG-TERM DEBT, LESS CURRENT PORTION	2,469,095	3,162,270
Total liabilities	8,873,030	8,479,829

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(continued)

CIRCUIT RESEARCH LABS, INC. and SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS - continued	September 30,	December 31,
	2006	2005
	(unaudited)
STOCKHOLDERS’ EQUITY
Preferred stock, $100 par value – authorized, 500,000 shares, None issued
Common stock, $.10 par value – authorized, 20,000,000 shares, 8,623,459 and 7,946,337 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively.	862,347	794,634
Additional paid-in capital	8,944,571	8,426,947
Accumulated deficit	(6,394,656)	(5,760,718)
Total stockholders’ equity	3,412,262	3,460,863
TOTAL	$12,285,292	$11,940,692

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CIRCUIT RESEARCH LABS, INC. and SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(unaudited)

	Three  Months Ended		Nine Months Ended
	September 30,		September 30,
	2006	2005	2006	2005
NET SALES	$2,699,216	$3,934,374	$9,364,320	$11,583,297
COST OF GOODS SOLD	1,243,564	1,561,309	4,023,224	4,602,402
Gross profit	1,455,652	2,373,065	5,341,096	6,980,895
OPERATING EXPENSES:
Selling, general and administrative	1,198,309	1,585,525	3,845,266	4,634,314
Research and development	485,169	462,073	1,368,454	1,233,094
Depreciation	22,697	13,258	69,711	89,703
Total operating expenses	1,706,175	2,060,856	5,283,431	5,957,111
INCOME (LOSS) FROM OPERATIONS	(250,523)	312,209	57,665	1,023,784
OTHER (INCOME)  EXPENSE
Convertible debt rights, other share related and other expenses	86,946	14,550	510,413	(33,948)
Gain on debt restructure	0	0		(2,041,975)
Interest	63,084	39,695	181,190	403,892
Total other (income) expense	150,030	54,245	691,603	(1,672,031)
INCOME (LOSS ) BEFORE INCOME TAXES	(400,553)	257,964	(633,938)	2,695,815
PROVISION FOR INCOME TAXES	0	0	0	0
NET INCOME (LOSS)	($400,553)	$257,964	($633,938)	$2,695,815
NET INCOME (LOSS)  PER COMMON SHARE - BASIC	($0.05)	$0.03	($0.08)	$0.42
NET INCOME (LOSS)  PER COMMON SHARE -  DILUTED	($0.05)	$0.02	($0.08)	$0.27
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING
Basic	8,623,459	7,946,337	8,569,092	6,384,326
Diluted	8,623,459	11,527,337	8,569,092	9,965,326

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CIRCUIT RESEARCH LABS INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

	Nine Months Ended September 30,
	2006	2005
OPERATING ACTIVITIES:
Net Income (Loss)	($633,938)	$2,695,815
Adjustments to reconcile net income (loss) to net cash provided by operating activities
Depreciation and amortization	138,409	152,663
Expense for anti-dilution shares issued	126,080
Expense for options and convertible debt rights	400,306
Reduction in variable option accrual	(388,300)
Gain on debt restructure		(2,041,975)
Gain on sale of building	(131,610)
Changes in assets and liabilities:
Accounts receivable	(75,329)	(107,026)
Inventories	(498,183)	(980,649)
Prepaid expenses and other assets	(1,622)	52,298
Accounts payable and accrued expenses	1,333,511	1,309,501
Net cash provided by operating activities	239,324	1,080,627
INVESTING ACTIVITIES:
Capital expenditures	(29,475)	(97,875)
Deposit for the purchase of  building	(10,000)
Proceeds from sale of building	170,068
Net cash provided by (used in) investing activities	130,593	(97,875)
FINANCING ACTIVITIES:
Proceeds from stockholder advances	658,000	53,000
Repayment of  stockholder advances	(117,000)	(53,000)
Principal payments on long-term debt	(1,015,441)	(988,425)
Net cash used in financing activities	(474,441)	(988,425)
NET DECREASE IN CASH	(104,524)	(5,673)
CASH AT BEGINNING OF PERIOD	137,743	108,488
CASH AT END OF PERIOD	$33,219	$102,815

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(continued)

CIRCUIT RESEARCH LABS INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

	Nine Month Ended
	September 30,
	2006	2005
Supplemental Disclosures of Cash Flow Information
Cash paid for interest	$         196,011	$         244,245
Cash paid for income taxes	$           33,396	$                   0
Supplemental schedule of non-cash financing activities:
Debt settled by issuance of common shares	$                   0	$      4,255,000
Cashless option exercise	$           60,000	$                   0
Accounts payable converted to debt issued	$         320,849	$                   0

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CIRCUIT RESEARCH LABS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

1.

The Consolidated Condensed Financial Statements included herein have been prepared by Circuit Research Labs, Inc. (“CRL” or the “Company”), pursuant to the rules and regulations of the Securities and Exchange Commission.  The Consolidated Condensed Balance Sheet as of September 30, 2006 and the Consolidated Condensed Statements of Operations for the three and nine  months ended September 30, 2006 and 2005 and the Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2006 and 2005 have been prepared without audit.

Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading.  You should read the Consolidated Condensed Financial Statements in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2005.

In the opinion of management, the Consolidated Condensed Financial Statements for the unaudited interim periods presented herein include all adjustments, consisting only of normal recurring adjustments, necessary to present a fair statement of the results of operations for such interim periods.  Net operating results for any interim period may not be comparable to the same interim period in previous years, nor necessarily indicative of the results that may be expected for the full year.

2.

Significant Accounting Policies are as follows:

a.

Net income (loss) per share

For the three and nine months ended September 30, 2006, the effects of 2,467,000 shares relating to options to purchase common stock and 1,216,667 shares related to convertible debt as well as the anti-dilution rights of a shareholder were not used for computing diluted earnings per share because the results would be anti-dilutive.

For the three  and nine months ended September 30, 2005, the 3,581,000 shares relating to options to purchase common stock were used for computing diluted earnings per share because the option prices were lower than the market price of the common stock.

  Earnings per share is calculated as follows:

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	Three Months Ended		Nine Months Ended
	September 30		September 30
	2006	2005	2006	2005
Numerator
Net Income (loss)	($400,553)	$257,964	($633,938)	$2,695,815
Denominator
Weighted average shares – basic	8,623,459	7,946,337	8,569,092	6,384,326
Weighted average shares – diluted	8,623,459	11,527,337	8,569,092	9,965,326
Basic income (loss) per share	($0.05)	$0.03	($0.08)	$0.42
Diluted income (loss) per share	($0.05)	$0.02	($0.08)	$0.27

b.

New accounting pronouncements

SFAS No. 123, (Revised 2004) (SFAS No. 123(R)),Share-Based Payment, was issued in December 2004.  SFAS No. 123(R) is a revision of FASB Statement 123,Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and its related implementation guidance, which allowed companies to use the intrinsic method of valuing share-based payment transactions.  SFAS No. 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires a public entity with share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on the fair-value method as defined in Statement 123.  Pro forma disclosure is no longer an alternative.  Tha t cost will be recognized over the period during which an employee is required to provide service in exchange for the award.  This statement was adopted by the Company effective with the interim reporting period beginning January 2006.

c.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of trade accounts receivables and cash balances in excess of FDIC limits.

At September 30, 2006, the Company had trade receivables due from three customers which represented an aggregate of approximately 54% of the receivable balance.  At September 30, 2005, the Company had trade receivables due from one customer representing approximately 37% of the receivable balance.

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3.

INVENTORIES

Inventories consist of the following at September 30, 2006 and December 31, 2005:

	September 30,	December 31,
	2006	2005
	(Unaudited)
Raw materials and supplies	$3,495,340	$3,049,228
Work in process	1,029,314	935,212
Finished goods	570,524	612,555
Total	5,095,178	4,596,995
Less obsolescence reserve	(1,909,410)	(1,909,410)
Inventories, net	$3,185,768	$2,687,585

4.

LONG-TERM DEBT

Long term-debt at September 30, 2006 and December 31, 2005 consisted of the following:

	September 30,	December 31,
	2006	2005
	(Unaudited)
Orban acquisition note to stockholder	$180,000	$180,000
Avocet Instruments, Inc.	27,367	27,367
Dialog4 Engineering GmbH (Note 6)	294,840	840,040
Solectron GmbH see (Note 6)	227,107	227,107
Harman  (Note 5)	2,415,030	2,752,530
Harman accumulated interest, long-term portion	148,297	243,460
Note payable to private investor	200,000	200,000
Vendor notes	429,791	190,663
Employee notes	80,000	2,000
Total long-term debt	4,002,432	4,663,168
Less current portion Harman and others	1,533,336	1,500,898
Total long-term debt, less current portion	$2,469,095	$3,162,270

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Scheduled principal payments due within one year aggregate $1,533,336 as of September 30, 2006. Long-term debt at September 30, 2006 includes $2,415,030 owed to Harman.  Non-current maturities at September 30, 2006 include the $148,297 of future interest due to Harman (Note 5).

In connection with its acquisition of the assets of Orban in 2000, the Company issued $205,000 in long-term debt to an unrelated stockholder in consideration for his role in such acquisition.  The note bears interest at 7.5% per annum.  The Company signed a new promissory note to replace the original note on August 3, 2004, which took effect August 1, 2004, for $180,000, payable on or before July 1, 2007, with interest only payments to be made monthly in arrears at the rate of 10% per annum commencing August 1, 2004. In the event an interest payment is not received before the 16^th of the month, the interest rate will increase to 12% per annum from the date of delinquency until the accrued interest is brought current.  

On May 31, 2001, the Company acquired the assets of Avocet Instruments, Inc. for $82,980 plus other costs of $3,350. The remaining unpaid purchase price is being offset by periodic product purchases by the lender. As of September 30, 2006, $27,367 is the balance of the note.

In the fourth quarter of 2001, the Company converted various trade payables into notes payable and long-term debt totaling $179,903. In 2005, the Company converted approximately $363,000 of various trade payables into notes payable. During the 3 months ended September 30, 2006 the Company converted approximately $321,000 into notes payable.  As of September 30, 2006, the unpaid portion of these notes payable is $429,791.

On October 12, 2005, a private investor, who is not related to the Company or any of its executives, loaned the Company $200,000 secured by a promissory note with an interest rate of 11% per annum.  The note matures October 12, 2010 and has interest only payments payable monthly. At anytime on or before the maturity date, the holder of the note may convert the note into restricted shares of common stock for $0.75 per share. The Company expensed $117,096 related to the conversion rights in 2005.

On August 31, 2006, the Company converted $320,849 of accounts payable to notes payable.

Notes payable to stockholders

During June 2003, two stockholders, unrelated to the Company or any executives of the Company, loaned the Company $10,000 and $20,000, pursuant to one-year notes accruing interest at 9.0% per annum. Both notes were due and payable with interest in June 2004.  As previously agreed, in the second quarter of 2005, the Company issued options to the lenders to purchase an aggregate of 60,000 shares of common stock of the Company for a purchase price of $0.45 per share. The proceeds from these notes were used to reduce the accrued and unpaid interest owed to Harman. The two non-related stockholders verbally agreed to extend the loans and the Company continued to accrue interest under the loans.  Upon the request of one of the

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stockholders, on October 21, 2005, the Company repaid the principal amount of $10,000 together with the accrued interest of $2,140.

On October 4, 2004, Jayson Russell Brentlinger, the father of the Company’s President and CEO, loaned the Company $700,000 in connection with the Harman debt restructure. The loan bears interest at 11.5% per annum and requires monthly interest-only payments.  Management is negotiating with Mr. Brentlinger concerning the terms of repayment and the possibility of converting the note into preferred or common stock of the Company. No agreement about the terms and conditions of the payment or conversion has yet been completed.

On January 18, 2006, Mr. McMartin, the Company's Executive Vice-President and Chief Financial Officer, loaned the Company $100,000 represented by a promissory note at a rate 21% per annum. The note was due January 31, 2006 and now bears interest at a rate of 25% per annum until paid.  The remaining balance as of September 30, 2006 is $60,000.

On February 1, 2006, Mr. Clarkson, the Company's Vice-President and General Manager, loaned the Company $20,000 represented by a promissory note at a rate 21% per annum. The note was due February 14, 2006 and now bears interest at a rate of 25% per annum until paid.  The remaining balance as of September 30, 2006 is $20,000.

The two preceding obligations are included in long term debt. Interest expense on all stockholder loans for the three and nine months ended September 30, 2006 was $57,774 and $132,394 respectively, as compared to $26,486 and $74,021 for the same periods in 2005.

On March 31, 2006, Jayson Russell Brentlinger, the father of C. Jayson Brentlinger, the Company’s Chief Executive Officer, President and Chairman, loaned the Company $475,000, secured by a demand note (the “Note”).  All of the proceeds of the Note were used to pay the April 2006 installment of the settlement with Dialog4.  The Note is payable within 30 days upon demand and has an interest rate of 11.5%.  In addition, Jayson Russell Brentlinger may, at any time, convert the then outstanding principal of the Note into either common shares at $0.50 per share, or cumulative preferred shares $100 par value per share.  A holder of the preferred shares is entitled to an 11.5% dividend per annum payable monthly.  The preferred shares are alternatively convertible into the Company’s common shares at a price of $0.50 per share and may be redeemed by the Company at any time.  If, before March 31, 2007, the Company satisfies the Note and Jayson Russell Brentlinger has not exercised his right to convert the then outstanding principal of the Note, then he will be awarded options to purchase 950,000 shares of our common stock at a purchase price of $0.50 per share.  If such options are granted, those 950,000 options will expire on March 31, 2007.  In the quarter ended March 31, 2006, the Company recorded an expense of $328,312 associated with the conversion right.  The expense was determined by using the Black Scholes method to value the conversion option.

On July 20, 2006, Mr. McMartin, the Company's Executive Vice-President and Chief Financial Officer, loaned the Company $68,000 (including a $5,000 origination fee) represented by a promissory note at a rate 16% per annum. The note was due and repaid July 30, 2006. Mr. McMartin received 126,000 options at the market price of $0.56. The options will expire July 2011.

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After the quarter end, on October 12, 2006, Mr. McMartin, the Company's Executive Vice-President and Chief Financial Officer, loaned the Company $77,000 (including a $7,000 origination fee) represented by a promissory note at a rate 16% per annum. The note was due and repaid October 30, 2006. Mr. McMartin received 140,000 options at the market price of $0.52. The options will expire October 12, 2011.

5.

HARMAN

On May 31, 2000, the Company acquired the assets of Orban, Inc., which was then a wholly-owned subsidiary of Harman, including the rights to the name “Orban.”  The purchase price was paid partially in cash and partially by issuing notes payable to Harman.

On October 12, 2004, the Company executed a letter agreement with Harman, whereby its indebtedness, then in an amount of almost $8.5 million plus $1.0 million of accrued but unpaid interest, would be restructured, subject to certain conditions, including the execution by the parties of definitive documents.  These documents were executed on April 29, 2005.

The Harman debt restructure consisted of:

·

In October 2004, the Company paid Harman a $1,000,000 principal payment as a condition to restructuring the remaining indebtedness.  The funds for this payment came from $300,000 generated from the Company’s operations, and $700,000 from a short-term loan from the father of the Company’s President and Chief Executive Officer.

·

Prior to the debt restructure, the Company’s debt to Harman bore interest at a rate of 12% per annum.  As part of the debt restructure, Harman waived all interest accrued after April 1, 2003 in excess of 6.0% per annum, which resulted in Harman waiving $763,380 of approximately $1.0 million in accrued interest.  The remaining $249,530 in accrued interest was added to the outstanding principal balance of the Company’s indebtedness to Harman.  After giving effect to the $1.0 million principal payment, the principal amount due Harman was $7,482,000.  Adding the remaining unpaid interest of $249,530 to principal resulted in a total unpaid principal loan balance of $7,731,530 as of September 30, 2004.  

·

In April 2005, Harman exchanged $2,104,000 of the remaining indebtedness for 2,104,000 shares of the Company’s common stock, which Harman then sold to the Company’s President and Chief Executive Officer for $1,000,000.  Payment was made by delivery of a promissory note due and payable on September 30, 2007.  Harman’s recourse for non-payment under the note is limited to a security interest in the shares purchased.  

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·

In April 2005, Harman exchanged an additional $2,400,000 of indebtedness for 19% of the shares of the Company’s common stock, which consisted of approximately 1,509,000 shares at the time of the restructure.  This exchange included an anti-dilution provision, which entitles Harman to receive additional shares equaling 19% of the amount of any shares that are issued as a result of exercise of options in existence on the date of the restructure. This could result in the issuance of 815,927 additional shares to Harman, if all currently outstanding options are exercised.  Also, if the father of the Company’s President and Chief Executive Officer, who holds the $700,000 loan, elects to convert the obligation into shares of common stock, Harman will receive additional shares such that Harman will continue to own 19% of the shares of the Company’s common stock. Harman will have no right to additional shares as the result of new share issuances occurring after the date of the restructure.  

The remaining $3,227,530 of indebtedness, after giving effect to the transactions described above, is evidenced by a new note, secured by a security interest covering all of the Company’s assets, that (i) renews and extends (but does not extinguish) the indebtedness owed to Harman, and (ii) reduces the interest rate on the debt to 6.0% per annum, with interest payable monthly in arrears.  Principal repayment of the note is amortized over a five year period, and the final principal payment is due September, 2009.  The Company is required to make monthly principal payments of $66,667 through September 2005; $37,500 commencing in October 2005 through September 2007; $41,666 commencing in October 2007 through September 2008 and $118,961 commencing in October 2008 through September 2009.

In summary, Harman waived $858,000 of unpaid interest, and was issued 3,613,000 shares of the Company’s common stock to reduce the Company’s principal obligation by $4,255,000.  This total $5,113,000 debt reduction has been recorded as a $361,000 increase to common stock par value, a $2,710,000 increase to additional paid in capital and a $2,042,000 gain on debt restructure.  A per share fair value of $0.85 was used to measure the gain, which was the shares’ quoted market price in October 2004 when the letter agreement to restructure the debt was concluded.

The debt restructure reducedthe Company’s debt service to Harman by approximately $824,000 a year.  In addition, the restructured debt is a long-term obligation, compared to the demand note status of the previous debt structure.

In recording the restructure, the obligation to Harman for unpaid interest was not eliminated, but was reduced to equal the aggregate future 6.0% interest payments scheduled under the restructured obligation.  Accordingly, no additional interest expense will be recorded while the restructured obligation is outstanding.

6.

DIALOG4 System Engineering, GmbH (“Dialog4”)

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Dialog4 was a German corporation that produced products within the Company’s industry, including its Codec line of products. The Company purchased the assets of Dialog4 on January 18, 2002. The Company and Dialog4 had disputes that arose in connection with this transaction which were submitted to arbitration in Germany.

On October 8, 2004, the Company learned the Arbiter had awarded Dialog4 approximately $1.0 million. The Company increased its reserves from $712,000, the amount of principal and interest then due under its note payable to Dialog4, to $1,393,000. The increase of $681,135 was reported as resolution of business acquisition contingency in the 2004 Statements of Operations.  The increase represents the amount awarded by the Arbiter on account of Dialog4’s costs and fees incurred in connection with the arbitration and the amount of a liability to a third party vendor to Dialog4.  Dialog4 filed an action in the U.S. District Court for the District of Arizona (Arizona Litigation) to enforce the arbitration award.

On March 30, 2005, the Company and Dialog4 agreed upon settlement terms for all disputes between them. The Company paid Dialog4 $490,000 at the time the settlement papers were signed on April 15, 2005 and paid an additional $475,000 on April 1, 2006. The Company also filed with the SEC a registration statement under the Securities Act covering sales by Dialog4 of the 1,250,000 shares of stock issued in 2002 as partial payment of the purchase price.  

In March 2005, as part of the Dialog4 settlement, the Company agreed to resolve a separate employment dispute being litigated in Germany between Berthold Burkhardtsmaier and the Company. Mr. Burkhardtsmaier agreed to resign from the Board of Directors, and the Company agreed to pay him approximately $421,200 in monthly installments of $7,020 for 60 months.

Dialog4 dismissed the Arizona litigation without prejudice, and when all the terms and conditions of the settlement agreement have been met, Dialog4 and the Company will release each other from any further claims arising out of or related to the Asset Purchase Agreement.

On August 9, 2002, the Company agreed to purchase all existing inventory of parts related to its Sountainer product from Solectron GmbH for a total price of $829,328, payable in 24 equal monthly installments including interest.  Solectron had purchased the inventory pursuant to an agreement with Dialog4 approximately two years prior to the Company’s purchase of the assets of Dialog4.  The price was equal to the amount paid by Solectron for the inventory, which the Company expects to realize from future sales of that inventory.  The agreement settled a dispute between the Company and Solectron in which Solectron claimed the Company became liable for the obligation of Dialog4 to purchase the inventory when the Company acquired the assets of Dialog4.  The Company maintains it did not undertake the obligation of Dialog4, but to settle the dispute, it agreed to purchase the inventory, which it will use in the manufacture of Sountainer products.  On January 20, 2004, the Company renegotiated the terms and agreed to pay monthly installments of principal and interest in the amount of $25,000 with the final installment being due October 15, 2005 in the amount of $15,681. The Company currently owes Solectron $227,107 because the Company has not received $233,000 of inventory pursuant to the materiality agreement entered into between Dialog 4 and Solectron for which it was found to be responsible. The Company owes Solectron $227,107 as of September 30, 2006 and has stopped making debt service payments.  This obligation was a result of claims

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originating between Solectron and Dialog4.  As of September 30, 2006, the Company has cumulatively paid Solectron $487,830 in principal and $72,733 in interest. Charles Jayson Brentlinger, President and CEO of the Company has also signed a personal guarantee under the revised settlement agreement. The Company further agreed to indemnify Mr. Brentlinger should he be required to make any payment under this guarantee. The inventory of $233,000 is reported in other assets pending delivery of that amount of inventory by Solectron.

7.

STOCK OPTIONS AND STOCK-BASED COMPENSATION

On January 1, 2006, we adopted SFAS No. 123(R),Share-Based Payment, which requires employee stock options to be accounted for under the fair value method and eliminates the ability to account for these instruments under the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees, which was allowed under the original provisions of SFAS 123,Accounting for Stock-Based Compensation. Prior to the adoption of SFAS 123(R) and as permitted by SFAS 123 and SFAS 148,Accounting for Stock-Based Compensation Transition and Disclosure, we elected to follow APB 25 and related interpretations in accounting for our employee stock options and implemented the disclosure-only provisions of SFAS 123 and SFAS 148. Under APB 25, stock compensation expense was recorded only when the exercise price of employee stock options was less than the fair value of the underlying stock on the date of grant.

We adopted SFAS 123(R) using the modified prospective method. Under this transition method, stock compensation expense for the first quarter of 2006 included the cost for all share-based payments granted prior to January 1, 2006, as well as those share-based payments granted subsequent to December 31, 2005. This compensation cost was based on the grant-date fair values determined in accordance with SFAS 123 and SFAS 123(R), which we estimate using the Black-Scholes option pricing model and recorded in selling, general and administrative expenses. Results for prior periods have not been restated.

In 2006, stock option expense charged against income for the first time was $53,718, or approximately $0.01 per diluted share. During the quarter ended September 30, 2006, 126,000 options were issued at an expense of $17,275.

The following table illustrates the effect on net income and earning per common share as if we had elected to adopt the expense recognition provisions of SFAS 123 for the nine months ended September 30, 2005:

Net income as reported    

$2,695,815

Add: stock-based expense included in reported net income

0

Less: total stock-based employee compensation expense determined under

fair value based methods for all awards

15,233

Pro forma

$2,680,560

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Basic income per common share

As reported

$0.42

Pro forma

$0.42

We utilize the Black-Scholes option pricing model to calculate our actual and pro forma stock-based employee compensation expense, and the assumptions used for options issued in the quarter ended September 30, 2005 are as follows:

Weighted average risk free interest rates

4.28%

Weighted average life (in years)

4

Volatility

52

Expected dividend yield

0

Substantially all options have been issued in connection with loan transactions. All options issued vested immediately. The expected life of each grant is generally estimated to be a period approximately one half of the exercise period, plus one year, for all periods presented. Expected volatility of our stock price is based generally on historical volatility after the completion of the Harman loan restructure. The estimated fair value is not intended to predict actual future events or the value ultimately realized by employees who receive equity awards.

As of December 31, 2005	# of Options to purchase 1 share of Common	Strike Price	Expiration Date
	116,000	$ 0.30	3/3/2009
	360,000	$ 0.45	4/29/2009
	1,250,000	$ 0.55	1/23/2009
	1,865,000	$ 0.70	12/29/2009
Total number of options	3,591,000
As of September 30, 2006	# of Options to purchase 1 share of Common	Strike Price	Expiration Date
	116,000	$ 0.30	3/3/2009
	360,000	$ 0.45	4/29/2009
	126,000	$      0.56	07/20/2011
	1,865,000	$ 0.70	12/29/2009
Total number of options	2,466,000

On December 29, 2004, the company modified the strike price of the 1,765,000 options to $0.70 per share and extended the expiration date to December 29, 2009. On that date the modified strike price exceeded the market price. Also on that date, we had not adopted 123R and  

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accordingly reported the treatment of the options under Financial Accounting Standards Board Interpretation 44, pursuant to which stock compensation expense is recorded when the strike price for the options is less than the market price of the underlying shares. Each quarter we adjust the option expense when the market price of the underlying shares exceeds the strike price. The market price did not exceed the strike price at either September 30, 2006 or 2005. The reduction in previously recorded expense related to these options for the quarter ended March 31, 2006 was $211,800 which, together with a reduction of $176,500 for the quarter ended June 30, 2006, reduced the amount of the previously recorded obligation to $0 at June 30, 2006. At September 30, 2006 the strike price was greater than the market price for the underlying shares which kept the obligation at $0.

On January 23, 2006, the C. Jayson Brentlinger Family Limited Partnership, of which the Company’s Chief Executive Officer, President and Chairman is the General Partner, converted 1,250,000 options to purchase shares of the Company’s common stock (the “Options”) at the option price of $0.55 per share (the market price of the shares on the date the option was issued), in the form of a cashless exercise, into 548,469 of the Company’s common shares (the market price of the shares was $0.98 on the day the options were exercised).

Harman Pro North Company, an existing stockholder was issued 128,653 shares on January 23, 2006 as part of anti-dilution provision required by the Harman debt restructure.

8. BUILDING SALE

On May 30, 2006, we exercised the option to purchase the manufacturing and office facility at 1302 W. Drivers Way, Tempe, Arizona.  The purchase price was $1,300,000.  On the same day, we sold the property for $1,550,000, which resulted in a gain, net of transaction costs, of approximately $131,000.

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PART  II  -  OTHER INFORMATION

ITEM 6.  EXHIBITS

Exhibit Number	Description
31.1	Certification of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-B.  (Filed herewith).
31.2	Certification of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-B.  (Filed herewith).
32.1	Certification of Chief Executive Officer pursuant to item 601(b)(32) of Regulation S-B.  (Filed herewith).
32.2	Certification of Chief Financial Officer pursuant to item 601(b)(32) of Regulation S-B.  (Filed herewith).

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SIGNATURES

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

CIRCUIT RESEARCH LABS, INC.

Dated: December 29, 2006.

By:/s/ Robert W. McMartin

Robert W. McMartin

Vice President, Treasurer and

Chief Financial Officer

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Exhibit Index

Exhibit Number	Description
31.1	Certification of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-B.  (Filed herewith).
31.2	Certification of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-B.  (Filed herewith).
32.1	Certification of Chief Executive Officer pursuant to item 601(b)(32) of Regulation S-B.  (Filed herewith).
32.2	Certification of Chief Financial Officer pursuant to item 601(b)(32) of Regulation S-B.  (Filed herewith).

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