Vystar Corp - Annual Report: 2012 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

For the Fiscal Year Ended December 31, 2012

OR

For the Transition Period from                            to                          

Commission File No. 000-53754

VYSTAR CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (770) 965-0383

Securities registered pursuant to Section 12(b) of the Act:

NONE

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.0001 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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. Yes o No þ

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No þ

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of June 30, 2012, the last business day of the registrant’s most recently completed second fiscal quarter, based on the last private sale price of the registrant’s common shares on such date $4,112,734.  See Item 12.

The number of shares outstanding of each of the registrant’s classes of common stock, as of March 31, 2013 was as follows:

Vystar Corporation

Annual Report on Form 10-K

For the Year Ended December 31, 2012

Table of Contents

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

Certain oral and written statements made by Vystar Corporation about future events and expectations, including statements in this Annual Report on Form 10-K (the “Report”) contain forward-looking statements, within the meaning of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the Securities Act of 1933, as amended ( the “Securities Act”), that involve risks and uncertainties.  For those statements, we claim the protection of the safe-harbor for forward-looking statements contained in the Private Securities Litigation Act of 1995.  In some cases, forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may” and similar expressions.  You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Report or the statement.  All of these forward-looking statements are based on information available to us at this time, and we assume no obligation to update any of these statements.  Actual results could differ from those projected in these forward-looking statements as a result of many factors, including those identified in “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere.  We urge you to review and consider the various disclosures made by us in this Report, and those detailed from time to time in our filings with the Securities and Exchange Commission (the “SEC”), that attempt to advise you of the risks and factors that may affect our future results.  We qualify any forward-looking statements entirely by these cautionary factors.

The above mentioned risk factors are not all-inclusive.  Given these uncertainties and that such statements speak only as of the date made, you should not place undue reliance on forward-looking statements.  We undertake no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

PART I.

Vystar Corporation (“Vystar”, the “Company”, “we”, “us”, or “our”) is the creator and exclusive owner of the innovative technology to produce Vytex® Natural Rubber Latex ("NRL"). In addition, on September 13, 2012, we acquired SleepHealth, LLC and SleepHealth North Carolina, LLC (“SleepHealth”), privately-held sleep diagnostic companies headquartered in Monroe, Georgia. SleepHealth provides sleep lab management services to physicians’ offices, specialty and multi-specialty clinics in Georgia, North Carolina and South Carolina. As a result of the acquisition, Vystar Corporation is comprised of two segments, a Vytex Division, focused on expanding the licensing and utilization of its proprietary source natural rubber latex technology and a SleepHealth Division focused on the sleep diagnostic and Durable Medical Equipment (“DME”) businesses.

Our patented technology reduces antigenic and total protein in natural rubber latex products to virtually undetectable levels. Vytex NRL, our “ultra low protein” natural rubber latex has been introduced throughout the worldwide marketplace that uses NRL or latex substitutes as a raw material for end products. Natural rubber latex or latex substitutes are used in an extensive range of products including balloons, textiles, footwear and clothing (threads), adhesives, foams, furniture, carpet, paints, coatings, protective equipment, sporting equipment, and, especially health care products such as condoms, surgical and exam gloves, among others. Our challenge has been that a manufacturer’s conversion from the use of standard latex or synthetic raw material to Vytex NRL involves a protracted sales cycle ranging from twelve to eighteen months. Additionally, in the past, our primary method of distribution was via toll manufacturing. We now have a licensing agreement in place for global distribution that will allow us to focus on and transition to a licensing model.

The strategic acquisition of SleepHealth is expected to be mutually beneficial by providing each company with expansion options. SleepHealth presents an indirect vertical integration opportunity as a potential channel for recently announced Vytex^R NRL foam bedding products such as pillows, mattress toppers and mattresses produced by one of Vystar’s licensees. SleepHealth also provides Vystar with access into the healthcare market for future products made with Vytex NRL, such as gloves, cohesive bandages, etc. Vystar and its executive team bring to SleepHealth added expertise, management, marketing and capital resources needed for business expansion and growth.

Products and Services

Natural Rubber Latex

Natural rubber latex is an agricultural product produced from the sap of the rubber tree, Hevea brasiliensis. According to data presented at the India Rubber Expo in March 2011 by the International Rubber Study Group, Singapore, an estimated 10.7 million metric tonnes of natural rubber was consumed in 2010. The Study Group has also reported that over 1.3 million tonnes of this consumption was liquid natural rubber latex, which is used in the production of dipped goods, (e.g. gloves, condoms, balloons, catheters), adhesives, various types of foams and numerous other products.  Substantially all of the latex processors are located in Southeast Asia, India, Africa and Latin America and are owned by local groups or large multinational corporations.  Some reports show a shortage of NRL in the coming decade as demand in developing countries such as China and India continue to grow. This future demand is awakening interest in other areas of the world where the climate is suitable, particularly in Guatemala, where it is expected the latex industry will grow from 57,000 tonnes produced in 2006 to over 95,000 tonnes by 2016, a 40% increase, according to a report issued by the office of Consulate General of Guatemala, Atlanta, Georgia in 2008. This is particularly attractive to U.S. manufacturers of latex products who could potentially see reduced transportation costs and lead times over the usual Asian sources.

Our initial product portfolio included Vytex NRL in high ammonia (HA) and low ammonia (LA) formulations. New specialized formulations are projected to come to market over the next year. Vystar has used its technology to work with customers to solve production issues and provide them with a point of difference.

Vytex NRL is produced at the latex processor level and can be integrated into the current processing environments without additional capital equipment investment.  The protein removal and modification process that leads to Vytex NRL allows manufacturers to lower manufacturing costs with the benefit of reduced protein levels.  We presented a paper on this topic (“technical paper”) at the RAPRA Latex and Synthetic Polymer Dispersions 2010 Conference in Amsterdam in March 2010.  Reduced leaching times and resulting reductions in energy, water and material handling consumption can lead to realized cost savings. 

In January 2011, William Doyle, our Chairman and Chief Executive Officer, presented a paper entitled, “Eco-Friendly Manufacturing of High Performance Latex using Ultra Low Antigenic Protein Latex” at the India Rubber Expo (IRE 2011) in Chennai, India. This paper reviewed some of the learnings Vystar had made since commercializing Vytex NRL. Among these discoveries were: improved air and helium retention in balloons, reduced leaching needs for some dipped products, truer colors for dipped products that are dyed and low latex odor in foams. Later in the year, Vystar published and Matt Clark, our Vice President of Technical Sales, presented a paper, “Further Development of Vytex® Natural Rubber Latex Leads to Strong Niche Market Advances”, at the July meeting of the International Latex Conference (ILC 2011) in Akron, Ohio. This paper added additional learnings related to slow release foam formulations and other technical improvements helping customers solve their new product development challenges.

In November 2012, Matthew Clark, Vice President of Technical Sales, attended MEDICA, the world’s largest medical tradeshow, in Dusseldorg, Germany, to promote Vytex NRL to potential new users.

In January 2013 William Doyle presented a paper entitled, “The Non Enzymatic Deproteinization of Natural Rubber Latex (DPNRL) Enabling the Greater Versatility in End Product Applications” at the India Rubber and Tyre Expo (IRE 2013) in Mumbai, India. This paper discussed improvements that extend beyond the ultra-low allergenicity of the DPNRL and include improved color, absence of rubber odor, and improved physiocochemical attributes. Improved air and helium retentions results were reported. The potential to extend applications into other non-conventional areas other than latex end products was discussed.

 We are transitioning from toll manufacturing agreements to licensing agreements. Licensing agreements eliminate the need to maintain a costly infrastructure along with the other investment and regulatory compliance costs to develop and operate a processing or manufacturing facility. All of these costs are or will be borne by our manufacturing and distribution contractors and/or customers. This means we must show the NRL producers and product manufacturers the economic value proposition of including Vytex NRL in their product lines, hence the technical paper presentations we have made and continue to make.  In addition, as an all natural raw material, Vytex NRL puts the main component in gloves and other products back in the environmentally friendly arena.

We have had a toll manufacturing agreement with Revertex (Malaysia), the world’s largest producer of prevulcanized natural rubber lattices, since 2008.  In October 2011, we signed a toll manufacturing agreement with Mardec-Yala (Thailand). Given the significant percentage of NRL consumption in Southeast Asia, Mardec-Yala increases availability of Vytex NRL close to the production sites for most of the world’s NRL products. In addition to being one of the largest processors globally, Mardec-Yala is a division of one of the largest distributors.  

To implement our licensing model, in March 2010 we signed a licensing agreement with Pica de Hule Natural, a division of GrupoAgroindustrialOccidente (“Occidente”), located in Guatemala.  Occidente is the largest processor of natural rubber latex in Latin America and the largest exporter serving more than 15 countries.  Under the agreement, Occidente will manufacture, sell and market Vytex NRL throughout Latin America as well as supply Vytex NRL to North America and Europe through our existing distribution system. The distributor for North America and Europe purchases and sells Vytex NRL for specific orders in their territory and does not purchase inventory to hold. 

In October 2010, we signed a second licensing agreement with KA Prevulcanized Latex (KAPVL) to manufacture and sell Vytex NRL in the SAARC region which includes India, Pakistan, Sri Lanka, Bangladesh, Bhutan and Nepal.  India is the second largest consumer of concentrated latex behind China. 

In addition, in January 2009, we entered into a  Distribution Agreement with Centrotrade Minerals & Metals, US and Centrotrade Deutschland, GmbH, Germany, the leading global distributors of latex raw materials, to create a worldwide distribution network that will further enhance our ability to cost effectively reach and service manufacturer customers in these key manufacturing areas.  This provides an expansive distribution network that facilitates both the licensing and toll manufacturing models and can assist with various processors in taking their products to market. On December 19, 2012, we amended our agreement with Centrotrade to expand Vytex NRL distribution rights to the world’s largest NRL consuming markets in Southeast Asia, specifically Malaysia and Thailand. Centrotrade will control production scheduling of Vytex NRL, inventory, sales, pricing and customer financing, while Vystar will focus on marketing, customized product development and support activities.

Sleep Diagnostics and Durable Medical Equipment

SleepHealth offers physicians and multi-specialty clinics tailored programs and joint venture opportunities to manage their patients’ sleep disorders as well as provide the Durable Medical Equipment (DME) that may be prescribed to the patient. We adhere to American Academy of Sleep Medicine (AASM) and Joint Commission (JCAHO) guidelines, assuring the highest standards in sleep medicine for patients.

Our programs provide:

As of December 31, 2012, we operated and managed twenty-one sleep centers in our clients’ existing office space or clinic. As of March 31, 2013, we are operating sixteen sleep centers. The founder and former owner of SleepHealth, Ailene Miller, has over 19 years of sleep industry experience. She has operated SleepHealth since 2002 and she continues as the General Manager of the SleepHealth division of Vystar. 

Competition

Natural Rubber Latex

Synthetic raw materials such as ethylene, propylene, styrene and butadiene compete with NRL.  Currently, it is estimated that NRL processors have lost one-half of the overall latex market to synthetic latex.  Despite the switch to non-latex alternatives, it is estimated that in U.S. hospitals as recently as September, 2010 over 70% of exam gloves and nearly 80% of surgical gloves were still made with NRL.

Several attempts, including new source crops, synthetic latices and various treatment methods, have been made to eliminate problem proteins from Hevea NRL by biological, physical and/or chemical methods that act on proteins.  One approach has been to introduce the latex articles to multiple leaching steps and chlorination.  While it does reduce the protein levels in the finished product, it weakens the latex film thus compromising the desirable physical properties of the product.  Another attempt to reduce proteins in NRL is the use of proteolytic enzymes to degrade the proteins in the latex solution but this approach introduces another protein (the enzyme) to the latex, which may itself be allergenic.  Attempts to commercialize two other non-Hevea NRL materials have been made in the United States: guayule rubber latex and Taraxacum kok-saghyz, also known as the Russian dandelion.  These materials are reported to be higher in cost compared to natural rubber latex and presently are available only in limited quantities.

These facts, coupled with the uncomplicated transition to the utilization Vytex NRL, make it very attractive for the processors to regain lost business by switching to Vytex NRL. We believe our unique patented technology offers a viable alternative to the marketplace. The licensing model will allow the message to spread through more sales channels than we could reach in the past.

Sleep Diagnostics and Durable Medical Equipment

We compete against numerous sleep diagnostic providers, from smaller physicians’ offices to larger healthcare providers, including clinics and hospitals. While the competition is intense, we believe we have good relationships with our physician clients and the ability to help them market and grow their practices. Our business model is unique in that we utilize the physician practices’ offices versus investing in new facilities. Since sleep studies are performed overnight, the practice gains another revenue stream in off hours. Sleep-related problems are a public health crisis, with an estimated 50 to 70 million Americans experiencing sleep disorders.

Intellectual Property

Vystar has four issued patents by the United States Patent Trademark Office (“USPTO”) that were issued in 2005 (Patent No. 6,906,126), 2006 (Patent No. 7,056,970), 2011 (Patent No. 8,048,951) and 2012 (Patent No. 8,324,312). International patents include one issued patent from the Republic of South Africa in 2009 (2008/00886), a second foreign patent issued by China in 2011 (No. 200580051526.1), a third foreign patent issued by Japan in 2012 (No. 4944885) and a fourth foreign patent issued by Hong Kong in 2013 (HK1125959). In 2005, we sought international patent protection of our application that would become our U.S. Patent No. 6,906,126 pursuant to the Patent Cooperation Treaty (“PCT”) (No. PCT/US2005/025018), and this application has been nationalized in the following countries and regions: The European Union (No.05775523.3), Canada (No. 2,614,945), India (No.295/DELNP/2008), and Sri Lanka (No.14827). Additionally, this PCT was nationalized back into the United States to expand our protection to both method and composition claims (No.11/988,498). We expect patents to be issued in these countries without objection.

On January 18, 2012, we converted the provisional patent filed January 18, 2011 (No. 61/433,853) to full utility applications based on new discoveries and unexpected results (No. 13/374,851). We also sought international protection for the new developments and unexpected results reflected in this 2009 USPTO patent application through another PCT application (No. PCT/US2009/031445). This PCT application was nationalized in the following countries in 2010: the European Union (No. 09702339.4), Brazil (No. PI0906513-0), Guatemala (No. 2010-000208), India (No.2487/KOLNP/2010), Indonesia (No. W-00201002436), and Malaysia (No. PI2010003317). In addition, we filed the same patent application that was the subject of our USPTO patent application No. 12/356,355 and PCT/US2009/031445 directly into Thailand (No. 0901000201).

Vystar filed and has received registered trademark protected status in the United States for the marks “Vystar”, “Vytex” and “Created by Nature. Recreated by Science.”  In 2010 Vystar filed for international trademark protection of “Vytex” in Malaysia (No.2010013149) and India (No. 1992991), which was granted in India.

While we believe that the pending patent and trademark applications will be granted without objection, there are no guarantees that all such patents or trademarks will be granted by each relevant governing body. No assurance can be given that such patent and trademark protection will provide substantial protection from competition. We realize that the market for Vytex NRL is an industrialized world concern and we are committed to aggressively challenging any infringements of our patents and/or trademarks.

Research and Development

Vytex NRL has produced protein test results on finished products that are both “below detection” and “not detectable” in terms of the amount of proteins remaining in these finished goods made with Vytex NRL.  These results have been reproduced in many subsequent tests.  From inception through December 31, 2012, Vystar's research and development costs have been approximately $2.4 million, with an additional $60,000 budgeted for continued efforts in 2013.  These efforts past and future have been and will continue to be patented and/or trademarked.  As of December 31, 2012, Vystar has expended, since inception, approximately $244,000 on such patent and trademark costs and has budgeted approximately $30,000 more for the year ended December 31, 2013 to continue to pursue and maintain its patents and trademarks around the world.

Government Regulation

Vytex Divison:

In the United States, healthcare and many food and food-based packaging products are subject to regulation by the Food and Drug Administration (FDA).   Vystar is not directly subject to regulation by the FDA due to the fact that it does not manufacture a finished medical device or other product, but only provides Vytex NRL as a component or raw material to healthcare or other product manufacturers.  However, there will be FDA regulation of the labeling of healthcare and food-based packaging products that are produced with Vytex NRL and the FDA has promulgated standards for good manufacturing practices for manufacturing the end products, which makes the end product manufacturers responsible for seeing that all of their components and component manufacturers, including Vytex NRL, are produced using good manufacturing processes. Additionally, the FDA prohibits the use of the term “hypoallergenic” or “low protein” on any natural rubber latex product it regulates.  In order to make any such claim, the latex product manufacturer must seek a waiver from the FDA of such regulatory prohibitions.  Commentary by the FDA in its guidance documents and other rulings indicate that the prohibition on the use of the “hypoallergenic”  or “low protein” label is based, at least in part, on the fact that, although the use of such terms in such labeling may be intended to indicate that the risk of allergic reaction to residual levels of processing chemicals has been reduced, consumers may interpret the labeling to mean that the risk of allergic reactions to any component in the device would be minimal.  Thus the hypoallergenic or low protein label is deemed misleading.  There can be no assurance, however, that we will succeed in securing FDA approval for any claim regarding the “hypoallergenic” “low protein” or reduced allergy potential of latex produced with the Vytex NRL process.  Failure to secure, if required, such FDA approval, could delay or otherwise detrimentally affect our introduction to natural rubber latex healthcare and/or food packaging products regulated by the FDA.  Notwithstanding, the medical or food packaging manufacturer will be able to use the Vytex NRL trademark on its label if size permits to indicate only that the Vytex NRL component was used in the production of the healthcare product, and what protein levels the end product does contain, but no further claim is asserted.  We have been able to provide sufficient testing data to the FDA to support our protein level claims with respect to the natural rubber latex antigenic and total proteins present in end products made with Vytex NRL.

On May 1, 2009, a condom manufactured from Vytex NRL received 510(k) clearance from the U.S. Food and Drug Administration. This was the first medical product available in the U.S. made from Vytex NRL, which had less than 2 micrograms/dm2, virtually undetectable levels, of the antigenic proteins that cause an allergic response, while retaining and improving upon all of the desirable qualities of latex. While the product is no longer available, this condom is a predicate device for future products. Vystar continues to seek other U.S. manufacturers interested in pursuing similar claims for products.

On July 22, 2009, an unpowdered medical exam glove manufactured with Vytex NRL received 510(k) clearance from the FDA, with an approved claim of less than 50 micrograms/gram of total proteins. As with the condom product, Vystar continues to pursue U.S. manufacturers using this exam glove as a predicate device.

SleepHealth Division:

Our business is subject to extensive federal, state and local regulation including the Health Insurance Portability and Accountability Act (“HIPAA”), Health Information Technology for Economic and Clinical Health (“HITECH”) Act, the Affordable Care Act, and the Fair Debt Collection Practices Act relating to, among other things, licensure, conduct of operations, privacy of patient information, physician relationships, addition of facilities and services, reimbursement rates for services, and consumer debt collections.

The laws, rules and regulations governing the health care industry are extremely complex and, in certain areas, the industry has little or no regulatory or judicial interpretation for guidance. If a determination is made that we were in violation of such laws, rules or regulations, we could be subject to penalties or liabilities or required to make significant changes to our operations.

Inflation and Seasonality

We do not believe that our operations are significantly impacted by inflation. Our NRL business is not seasonal in nature, but is subject to commodity pricing.  Our NRL product is a commodity-based raw material and prices for such material fluctuate from day-to-day, though this will have less impact as we transition to sales via licensing fees.

The sleep diagnostic business shows a decrease in revenue in the fourth quarter, particularly in November and December, due to holiday commitments making patients reluctant to schedule tests as compared to other times of the year.

Employees

As of December 31, 2012, we had a total of 35 associates. The SleepHealth division had 28 associates: 11 full-time and 14 part-time employees, 1 full time contractor and 2 part-time contractors. The Vystar division had 7 associates: 3 full-time employees, 3 full time contractors and one part time contractor.

Corporate Information

Vystar Corporation is a Georgia corporation that was incorporated in 2003.  Our predecessor company, Vystar LLC, was formed by our founder, Travis Honeycutt, in February 2000 as a Georgia limited liability company.

Our principal executive offices are located at 3235 Satellite Boulevard, Building 400, Suite 290, Duluth, Georgia 30096, and our telephone number is 770-965-0383. Our website address is www.vytex.com.  The information contained on, or that can be accessed through, our website is not a part of this Report. We have links on our website to reports, information statements, and other information that we file electronically with the Securities and Exchange Commission, or SEC, at the Internet website maintained by the SEC, www.sec.gov.  In addition to visiting our website and the SEC’s website, you may read and copy public reports we file with or furnish to the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549.  You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

Our business is subject to a number of risks and uncertainties — many of which are beyond our control — that may cause our actual operating results or financial performance to be materially different from our expectations. If one or more of the events discussed in the following risks were to occur, actual outcomes could differ materially from those expressed in or implied by any forward-looking statements we make in this report or our other filings with the SEC, and our business, financial condition, results of operations or liquidity could be materially adversely affected; furthermore, the trading price of our common stock could decline and our shareholders could lose all or part of their investment.

 Neither of our business divisions presently generate the cash needed to finance our current and anticipated operations.

We have had very limited revenue in our history prior to 2011 and transitioned from the development stage to the operational stage during the fourth quarter of 2009.  We are still in the early stages of establishing our business including attracting new customers and increasing sales; our financial success will be dependent upon the soundness of our business concept, our management’s ability to successfully and profitably execute our plan, and our ability to raise additional capital.

In the Vytex Division, while we anticipate that revenue will continue to grow from what we achieved after transitioning from the development stage to the operational stage, our limited operating history makes it difficult to evaluate our business.  We expect to make significant future operating expenditures to develop and expand our business. We may incur significant losses in the future for a number of reasons, including due to the other risks described in this Report, and we may encounter unforeseen expenses, difficulties, complications and delays and other unknown events. Accordingly, we may not be able to achieve or maintain profitability, and we may incur significant losses for the foreseeable future.   See additional discussion under Liquidity and Capital Resources.

In the SleepHealth Division, we also anticipate that revenue will continue to grow due to better utilization of existing capacity, signing new accounts and expanding into Durable Medical Equipment (“DME”) servicing, we may encounter unforeseen expenses, difficulties, complications and delays and other unknown events. Accordingly, we may not be able to achieve or maintain profitability, and we may incur losses for the forseeable future. See additional discussion under Liquidity and Capital Resources.

At December 31, 2012 we had $91,919 cash on hand and an accumulated deficit of $20,405,547.  We plan to finance our operations for the next twelve (12) months through the use of cash on hand, increased revenue from better utilization of existing facilities and opening of new facilities, new credit facilities, stock warrant exercises from existing shareholders, raising of capital through private placements and the possible acquisition of cash flow positive businesses in the sleep health industry.  You should consider, among other factors, our prospects for success in light of the risks and uncertainties encountered by companies that, like us, have not generated net earnings on an annual basis. Various factors, such as economic conditions, regulatory and legislative considerations, and competition, may also impede our ability to expand our market presence. We may not successfully address these risks and uncertainties or successfully implement our operating strategies. If we fail to do so, it could materially harm our business and impair the value of our common stock. Even if we accomplish these objectives, we may not generate positive cash flows or profits we anticipate in the future.

The following risk factors apply to our Vytex Division:

Our Vytex operating results could fluctuate and differ considerably from our financial forecasts.

Our business model is based on assumptions derived from (i) the experience of the principals of the Company, and (ii) third party market information and analysis. There are no assurances that these assumptions will prove to be valid for our future operations or plans.

Our operating results may fluctuate significantly as a result of a variety of factors, including:

Our Vytex NRL Division business is totally dependent on market demand for, and acceptance of, the Vytex Natural Rubber Latex process.

We expect to derive most of our Vytex NRL Division revenue from the sales of our Vytex Natural Rubber Latex raw material to various manufacturers of rubber and rubber end products using NRL through our distribution agreement with Centrotrade Deutschland. We pay natural rubber latex processors a fee for the service of manufacturing and creating Vytex NRL for us under our toll manufacturing agreements. Conversely, Vystar collects a fee under the Centrotrade and Occidente (PICA) licensing models. Our Vytex NRL product operates within broad, diverse and rapidly changing markets. As a result, widespread acceptance and use of product is critical to our future growth and success. If the market for our product fails to grow or grows more slowly than we currently anticipate, demand for our product could be negatively affected.

Our ability to generate significant revenue in the Vytex Division is substantially dependent upon the willingness of consumers to make discretionary purchases and the willingness of manufacturers to utilize capital for research and development and the retooling of their manufacturing process, both of which are impacted by the state of the economy.

The current state of the world economy has and likely will in the future impact upon our ability to increase revenue.  Certain of the products that we anticipate will be manufactured with our Vystar NRL process, such as mattresses and sponge products, are considered discretionary consumer purchases which decline during economic downturns.  Additionally, certain manufacturers who might otherwise utilize the Vytex NRL process in the manufacturing of products with NRL have determined not to expend capital to complete the research of the Vytex NRL process or to retool their manufacturing process because of the general downturn in the economy.  As part of a strategy to increase awareness of the Vytex NRL brand, the Company has been aggressively seeking to have end products produced and labeled “made with Vytex NRL” such as SleepHealth pillows. As these products enter the market, the Company plans to create consumer awareness of these end products and in so doing begin to develop consumer demand pull through as part of the Company’s efforts to complete the push-pull cycle using an ingredient branding strategy.

Assertions by a third party that our Vytex process infringes its intellectual property, whether or not correct, could subject us to costly and time-consuming litigation or expensive licenses.

There is frequent litigation based on allegations of infringement or other violations of intellectual property rights. As we face increasing competition and become increasingly visible as an operating company, the possibility of intellectual property rights claims against us may grow.

Any intellectual property rights claim against us or our customers, with or without merit, could be time-consuming, expensive to litigate or settle and could divert management attention and financial resources. An adverse determination also could prevent us from offering our process, require us to pay damages, require us to obtain a license or require that we stop using technology found to be in violation of a third party’s rights or procure or develop substitute services that do not infringe, which could require significant resources and expenses.

The latex market in which we will participate is competitive and if we do not compete effectively, our operating results may be harmed.

The markets for our product are competitive and rapidly changing. With the introduction of new technologies, increasing scrutiny of alternative lattices such as Russian dandelion, and market entrants, we expect competition to intensify in the future. In addition, pricing pressures and increased competition generally could result in reduced sales, reduced margins or the failure of our products to achieve or maintain widespread market acceptance.

While early interest was strong in a new innovative product in the natural rubber latex industry, pricing and regulatory approvals remain a key selling factor especially in the exam glove arena. There is no exam glove manufacturer signed to date that has accepted Vytex NRL into its product mix.

Our Vytex revenue will vary based on fluctuations in commodity prices for NRL.

NRL is a commodity and, as such, its price fluctuates on a daily basis. Since 2009 the market prices have been particularly volatile with prices rising 222% from a low of approximately $1080/wet metric tonne (“mT”) in January 2009 to a peak of over $3475/wet mT in February 2011. While prices have come down from this high to as low as $2100/wet mT in December 2011, 2012 prices started to rise again primarily due to seasonality. The pricing model for 2013 continues with the rollercoaster ride and is presently at a low price mid-year. As a result, our revenue (even licensing fees) and cost of goods will also fluctuate upward or downward based upon changing market prices for the raw material used to produce Vytex NRL. Prolonged periods of elevated market prices can also cause manufacturers to look for lower cost alternatives to NRL.

While Vytex NRL has received 510(k) clearance from the FDA for condoms and exam gloves, there is no assurance that future applications will be cleared.

In order for Vytex to be used in medical device applications, the manufacturer of the end product must submit an application to the FDA.  If the device is classified by the FDA as Class II (e.g., condoms, surgical gloves, and most non-cardiac and non-renal/dialysis catheters) and in some cases Class I (e.g., exam gloves), a 510(k) application must be filed with the FDA seeking clearance to market the device based on the fact that there is at least one other predicate or similar device already marketed.  If the product is classified as a Class III product (e.g., most cardiac and renal/dialysis catheters, certain adhesives and other in vivo devices), or is otherwise a new device with no predicate on the market already, then the manufacturer of the end product must submit a Pre-Market Approval (“PMA”) application seeking approval by the FDA to market the device.  The PMA approval process is much more in depth and lengthy and requires a greater degree of clinical data and FDA review than does a 510(k) clearance process.

Since Vytex is a raw material and not an end-product, Vystar is not the entity that files with the FDA for any clearance or approval to market a device.  Instead, the end-product manufacturers who will be selling and marketing the device(s) must submit applications and seek FDA clearance or approval depending upon the device classification.  Vystar’s role in this process is only as background support to the manufacturers to supply information and any technical or test data regarding the Vytex raw material if and to the extent needed.

An American manufacturer of condoms and exam gloves had been engaged in production work and had completed required testing and received FDA clearance for using Vytex NRL in their condom and exam glove lines. However this manufacturer is not currently producing products made with Vytex NRL or any other type of raw material.   Notwithstanding such approvals, we have no assurance that future products will provide acceptable test results and even if they do, there is no certainty that the FDA will approve the applications.

Each of the above mentioned 510(k)s have been sold to other manufacturers.

Vytex may seek to have lower protein claims than what is currently on the market today for exam gloves, and may ultimately seek to have latex warnings removed from or modified on all FDA-regulated products, but it cannot guarantee that either of such actions will be approved by the FDA.

The FDA heavily scrutinizes any and all claims categorizing the protein levels and other claims of an NRL product. Currently, the FDA has allowed claims only stating the level of less than 50 micrograms/gram of total extractable proteins pursuant to only one of two FDA-recognized standards on exam or surgical gloves. Vystar intends to claim protein levels pursuant to both of the two FDA-recognized standards, which will result in claiming the lowest level of antigenic proteins for a Hevea NRL product currently on the market. Although the FDA has cleared such claims on the condom using Vytex NRL, the FDA rejected those claims for the exam glove. There is no guarantee that the FDA will ultimately or ever allow these claims on an exam glove.

Additionally, for many years, the FDA has required warnings on products containing latex due to the latex allergy issue that exists. Vystar plans on petitioning the FDA to have that label removed from or modified on products manufactured with Vytex NRL, by filing a Citizen’s Petition. The Petition will be filed when we see that the benefits of filing will far outweigh the costs since such Petition is likely to require clinical test results indicating acceptable allergic reactions associated with Vytex NRL. There are no assurances that the FDA will grant that request.

Manufacturers are implementing trials of Vytex NRL in their facilities but final data are not yet available from all these manufacturers on its viability for their particular environments. 

Over the past several years, samples of Vytex NRL have been made available to over 50 natural rubber latex and latex substitute end product manufacturers, 30 of which have been in place since early 2009. Since the completion of the Vytex NRL Standard Operation Procedures (SOPs), Vytex has been produced at Revertex (Malaysia), Occidente (Guatemala), KAPVL (India) and most recently Mardec-Yala (Thailand) and MMG (Thailand). Manufacturers that have signed a ‘sampling’ agreement with us have been provided with samples of Vytex NRL for validating its use in their manufacturing processes. To date, a number of manufacturers have completed those runs and feedback is often minimal. Although most feedback to date has been positive, there is no assurance that such feedback continues to be satisfactory. 

Another risk is the validity of the customer as testing completes. Recently Vystar has completed more than three years of a specialized version of Vytex NRL only to have the end product manufacturer fail to upgrade their production line and fulfill their own contract.

  As part of the Company’s learnings, we have found that in listening closely to customer challenges and needs, our technical team has been able to develop solutions. The Company has come to realize that what we offer is not just a raw material but often a technology solution to a production or product development challenge.

While many of these new formulations look promising there is no guarantee that these technological innovations will be successfully scaled up or successfully implemented by the customer.

The following risk factors apply to our SleepHealth Division:

Our revenue may vary based on changes in reimbursement rates from third party providers received by our physician and multi-specialty clients.

Although our contracts require payment of our fees independent of reimbursements rates or the timing of third party medical reimbursements, should reimbursements change, we may have to adjust our fees accordingly.

If we are unable to enter into and maintain contractual arrangements on acceptable terms, if we experience material reductions in the contracted rates we receive or if we have difficulty collecting from our clients, our results of operations could be adversely affected.

Our future success depends, in part, on our ability to retain and renew our service contracts and enter into new service contracts on terms favorable to us. Other health care providers may impact our ability to enter into acceptable contractual arrangements or negotiate increases in our rates and other favorable terms and conditions. Any material reductions in the contracted rates we receive for our services, coupled with any difficulties in collecting receivables from our contracted clients, could have a material adverse effect on our financial condition, results of operations or cash flows.

Specifically, the success of our business depends in significant part on the number, quality and specialties of the physicians with whom we contract to provide services and maintaining good relations with those physicians. If we are unable to attract and retain sufficient numbers of quality physician referrals by providing adequate support personnel, technologically advanced equipment and facilities that meet the needs of those physicians and their patients, physicians may be discouraged from referring patients to our facilities, admissions may decrease and our operating performance may decline.

We cannot predict with certainty the effect the Affordable Care Act may have on our business, financial condition, results of operations or cash flows.

The Affordable Care Act was enacted to change how health care services in the United States are covered, delivered and reimbursed. The expansion of health insurance coverage under the law may result in a material increase in the number of patients using our facilities who have either private or public program coverage. Reductions to reimbursements under the Medicare and Medicaid programs by the Affordable Care Act could adversely affect our business and results of operations.

In June 2012, the U.S. Supreme Court upheld the Affordable Care Act’s individual mandate and struck down its penalties for states that refused to comply with Medicaid expansion provisions. We remain unable to predict with certainty the full impact of the Affordable Care Act on our future revenue and operations at this time due to the law’s complexity and the limited amount of implementing regulations and interpretive guidance, as well as our inability to foresee how individuals and businesses will respond to the choices available to them under the law. Furthermore, many of the provisions of the Affordable Care Act that expand insurance coverage will not become effective until 2014 or later. In addition, the Affordable Care Act will result in increased state legislative and regulatory changes in order for states to participate in Medicaid expansion and the grants and other incentive opportunities under the law, and we are unable to predict the timing and impact of changes resulting from actions individual states have taken or might take with respect to expanding Medicaid coverage at this time.

In general, there is significant uncertainty with respect to the positive and negative effects the Affordable Care Act may have on reimbursement, utilization and the future designs of provider networks and insurance plans (including pricing, provider participation, coverage, co-pays and deductibles), and the multiple models that attempt to predict those effects may differ materially from our expectations.

Further changes in the Medicare and Medicaid programs or other government health care programs could have an adverse effect on our business.

In addition to the changes affected by the Affordable Care Act, the Medicare and Medicaid programs are subject to: other statutory and regulatory changes, administrative rulings, interpretations and determinations concerning patient eligibility requirements, funding levels and the method of calculating payments or reimbursements, among other things; requirements for utilization review; and federal and state funding restrictions, all of which could materially increase or decrease payments from these government programs in the future, as well as affect the cost of providing services to our patients and the timing of payments to our facilities, which could in turn adversely affect our overall business, financial condition, results of operations or cash flows. Any material adverse effects resulting from future reductions in payments from government programs could be exacerbated if we are not able to manage our operating costs effectively.

In general, we are unable to predict the effect of future government health care funding policy changes on our operations. If the rates paid by governmental payers are reduced, if the scope of services covered by governmental payers is limited or if one or more of our physician partners are excluded from participation in the Medicare or Medicaid program or any other government health care program, there could be a material adverse effect on our business, financial condition, results of operations or cash flows.

Our health care business operates in a competitive environment, and competition is one reason increases in patient volumes have been constrained.

Overall, our health care business operates in a competitive environment, and we believe increases in patient volumes have been constrained, in part, by competition for market share in high margin services and for quality physicians and personnel. Generally, other hospitals and outpatient centers in the local communities we serve provide services similar to those we offer, and, in some cases, competing facilities are more established or newer than ours. Furthermore, competing facilities (1) may offer a broader array of services to patients and physicians than ours, (2) may have larger or more specialized medical staffs to admit and refer patients, (3) may have more favorable contracts with managed care plans, (4) may have a better reputation in the community, or (5) may be more centrally located with better parking or closer proximity to public transportation. We also face increased competition from specialty clinics (some of which are physician-owned) and unaffiliated freestanding outpatient centers for market share in high margin services and for personnel. Furthermore, some of the hospitals that compete with our business are owned by government agencies or not-for-profit organizations. These tax-exempt competitors may have certain financial advantages not available to our facilities, such as endowments, charitable contributions, tax-exempt financing, and exemptions from sales, property and income taxes. In addition, in certain markets in which we operate, large teaching hospitals provide highly specialized facilities, equipment and services that may not be available at our locations. If competing health care providers are better able to attract patients, recruit and retain physicians, expand services or obtain favorable managed care contracts at their facilities, our patient volume levels may suffer.

Our labor costs could be adversely affected by competition for staffing and the shortage of experienced licensed personnel.

Our operations depend on the efforts, abilities and experience of our management and technicians, as well as our physician partners. We compete with other health care providers in recruiting and retaining qualified technicians responsible for the daily operations of our sleep labs. In addition, like others in the health care industry, we continue to experience a shortage of experienced licensed technicians in certain key geographic areas. As a result, from time to time, we may be required to enhance wages and benefits to recruit and retain experienced technicians or hire more expensive temporary or contract personnel. In general, our failure to recruit and retain qualified personnel, or to control labor costs, could have a material adverse effect on our business, financial condition, results of operations or cash flows.

Our licensed sleep labs are heavily concentrated in certain market areas in Georgia, North Carolina and South Carolina, which makes us sensitive to economic, regulatory, environmental and other conditions in those areas.

As of December 31, 2012, our twenty-one sleep labs were concentrated in Georgia (33%), North Carolina (48%) and South Carolina (19%). These concentrations increase the risk that, should any adverse economic, regulatory, environmental or other condition occur in these areas, our overall business, financial condition, results of operations or cash flows could be materially adversely affected.

Furthermore, a natural disaster or other catastrophic event could affect us more significantly than other companies with less geographic concentration, and the property insurance we obtain may not be adequate to cover our losses.

Our business and financial results could be harmed by violations of existing regulations or compliance with new or changed regulations.

Our business is subject to extensive federal, state and local regulation including the Health Insurance Portability and Accountability Act (“HIPAA”) and Health Information Technology for Economic and Clinical Health (“HITECH”) Act relating to, among other things, licensure, conduct of operations, privacy of patient information, physician relationships, addition of facilities and services, and reimbursement rates for services. The laws, rules and regulations governing the health care industry are extremely complex and, in certain areas, the industry has little or no regulatory or judicial interpretation for guidance. If a determination is made that we were in violation of such laws, rules or regulations, we could be subject to penalties or liabilities or required to make significant changes to our operations. In addition, SleepHealth’s failure to comply with the laws and regulations applicable to it could result in reduced demand for its services, invalidate all or portions of some of its service agreements with its customers, or give customers the right to terminate SleepHealth’s service agreements with them, among other things, any of which could have an adverse effect on SleepHealth’s business. Even a public announcement that we are being investigated for possible violations of law could have a material adverse effect on our business, financial condition or results of operations, and our business reputation could suffer. Furthermore, health care, as one of the largest industries in the United States, continues to attract much legislative interest and public attention. We are unable to predict the future course of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations. Further changes in the regulatory framework affecting health care providers could have a material adverse effect on our business, financial condition, results of operations or cash flows.

We are also required to comply with various federal and state labor laws, rules and regulations governing a variety of workplace wage and hour issues.

The failure to comply with debt collection and consumer credit reporting regulations could subject SleepHealth to fines and other liabilities, which could harm SleepHealth’s reputation and business, and could make it more difficult for SleepHealth to retain existing customers or attract new customers.

The Fair Debt Collection Practices Act regulates persons who regularly collect or attempt to collect, directly or indirectly, consumer debts in default that are owed or asserted to be owed to another person. Many states impose additional requirements on debt collection communications, and some of those requirements may be more stringent than the federal requirements. Moreover, regulations governing debt collection are subject to changing interpretations that may be inconsistent among different jurisdictions. SleepHealth could incur costs or could be subject to fines or other penalties under the FDCPA, the Fair Credit Reporting Act and the Federal Trade Commission Act if it is determined to have mishandled protected information. SleepHealth’s customers could be required to report such breaches to affected consumers or regulatory authorities, leading to disclosures that could damage SleepHealth’s reputation, making it more difficult to retain existing customers or attract new customers, or otherwise harm SleepHealth’s business.

We could be subject to substantial uninsured liabilities or increased insurance costs as a result of significant legal actions.

We are subject to medical malpractice lawsuits, class action lawsuits and other legal actions in the ordinary course of business. Some of these actions may involve large demands, as well as substantial defense costs. Even in states that have imposed caps on damages, litigants are seeking recoveries under new theories of liability that might not be subject to such caps. Our professional and general liability insurance does not cover all claims against us, and it may not continue to be available at a reasonable cost for us to maintain at adequate levels, as the health care industry has seen significant increases in the cost of such insurance due to increased litigation. We cannot predict the outcome of current or future legal actions against us or the effect that judgments or settlements in such matters may have on us or on our insurance costs. Additionally, all professional and general liability insurance we purchase is subject to policy limitations. If the aggregate limit of any of our professional and general liability policies is exhausted, in whole or in part, it could deplete or reduce the limits available to pay any other material claims applicable to that policy period. Any losses not covered by or in excess of the amounts maintained under insurance policies will be funded from our working capital. Furthermore, one or more of our insurance carriers could become insolvent and unable to fulfill its or their obligations to defend, pay or reimburse us when those obligations become due. In that case or if payments of claims exceed our estimates or are not covered by our insurance, it could have a material adverse effect on our business, financial condition, results of operations or cash flows.

Our business could be negatively impacted by security threats, catastrophic events and other disruptions affecting our information technology and related systems.

As a provider of health care services, we rely on our information technology which are regulated by HIPAA and HITECH in the day-to-day operation of our business to process, transmit and store sensitive or confidential data, including electronic health records, other protected health information, and financial, payment and other personal data of patients, as well as to store our proprietary and confidential business performance data. Although we have redundancies and other measures designed to protect the security and availability of the data we process, transmit and store, our information technology and infrastructure is vulnerable to computer viruses, attacks by hackers or breaches due to employee error or malfeasance. Furthermore, our network and technology systems are subject to disruption due to events such as a major earthquake, fire, telecommunications failure, terrorist attack or other catastrophic event. Any such breach or system interruption could result in the unauthorized disclosure, misuse or loss of confidential, sensitive or proprietary information, could negatively impact our ability to conduct normal business operations (including the collection of revenue), and could result in potential liability and damage to our reputation, any of which could have a material adverse effect on our business, financial position, results of operations or cash flows.

The economic downturn and other economic factors have impacted, and may continue to impact, our business, financial condition and results of operations.

We continue to be impacted by a number of industry-wide challenges, including constrained growth in patient volumes. We believe factors associated with the economic downturn — including higher levels of unemployment, reductions in commercial managed care enrollment, and patient decisions to postpone or cancel elective and non-emergency health care procedures — have impacted our volumes. If industry trends or general economic conditions worsen, we may not be able to reach profitability, and our liquidity and ability to repay our outstanding debt may be harmed.

Furthermore, the availability of liquidity and credit to fund the continuation and expansion of many business operations worldwide has been limited in recent years. Our ability to access the capital markets on acceptable terms has been severely restricted at a time when we need, to access these markets, and has had a negative impact on our growth plans, our flexibility to react to changing economic and business conditions, and our ability to refinance existing debt. The economic downturn or other economic conditions could also adversely affect the counterparties to our agreements.

Trends affecting our actual or anticipated results may require us to record charges that would adversely affect our results of operations.

As a result of factors that have negatively affected the health care industry generally and the sleep diagnostic business specifically, we have been required to record various charges in our results of operations. Our impairment tests presume stable, improving or, in some cases, declining operating results in our sleep labs. If these projections are not met, or if in the future negative trends occur that impact our future outlook, future impairments of long-lived assets and goodwill may occur, and we may incur additional restructuring charges. Future restructuring of our operating structure could also result in future impairments of our goodwill. Any such charges could adversely affect our results of operations.

The following risk factors apply to our company as a whole:

We do not expect to declare any dividends in the foreseeable future.

We do not anticipate declaring any cash dividends to holders of our common stock in the foreseeable future.  Consequently, shareholders must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment.  Investors seeking cash dividends should not purchase our common stock.

There is no assurance that any significant public market for our shares of common stock will develop.

While our shares of common stock trade on the OTC Bulletin Board under the symbol “VYST”, there is currently no significant public market for our common stock and there is no assurance that there will be any such significant public market for our common stock in the future. 

The utilization of our tax losses could be substantially limited if we experience an ownership change as defined in the Internal Revenue Code.

Because of net operating losses we have experienced for federal income tax purposes, at December 31, 2012, we had federal net operating loss (“NOL”) carryforwards of approximately $13.3 million pretax available to offset future taxable income. Our ability to utilize NOL carryforwards to reduce future taxable income may be limited under Section 382 of the Internal Revenue Code if certain ownership changes in our Company occur during a rolling three-year period. These ownership changes include purchases of common stock under share repurchase programs, the offering of stock by us, the purchase or sale of our stock by 5% shareholders, as defined in the Treasury regulations, or the issuance or exercise of rights to acquire our stock. If such ownership changes by 5% shareholders result in aggregate increases that exceed 50 percentage points during the three-year period, then Section 382 imposes an annual limitation on the amount of our taxable income that may be offset by our NOL carryforwards or tax credit carryforwards at the time of ownership change. The limitation may affect the amount of our deferred income tax asset and, depending on the limitation, a significant portion of our NOL carryforwards or tax credit carryforwards could expire before we are able to use them. In such an event, our business, financial condition, results of operations or cash flows could be adversely affected.

We believe that we have not experienced an ownership change under Section 382 of the Internal Revenue Code as of May 31, 2013; however, the amount by which our ownership may change in the future could be affected by purchases and sales of stock by 5% shareholders and new issuances of stock by us, should we choose to do so.

None

Our headquarters are located in approximately 2,500 square feet of leased office space in Duluth, Georgia, a suburb of Atlanta.  The lease term expires in January 2014.

Although we believe that our current space is adequate for the foreseeable future, if additional office space is required, we believe that suitable space will be available at market rates.

None

Not applicable

PART II.

Market Price Information

Our common stock is traded in the United States on the Over the Counter Bulletin Board (OTCBB) under the symbol “VYST.”  The following table shows the range of high and low closing prices for our common stock.

Holders

As of March 31, 2013, there were 431 holders of record of our common stock.

Dividends

We have never paid or declared any cash dividends on our common stock and we do not intend to pay or declare dividends on our common stock in the near future.  We presently expect to retain any future earnings to fund continuing development and growth of our business.  Our payment of dividends is subject to the discretion of our board of directors and will depend on earnings, financial condition, capital requirements and other relevant factors.

 Issuer Purchases of Equity Securities

We did not make any repurchases of our equity securities during the fourth quarter of 2012.

Securities Authorized for Issuance Under Equity Compensation Plans

Information concerning our equity compensation plans is set forth in Item 12 of Part III of this Annual Report on Form 10-K.

Recent Sales of Unregistered Securities

Common Stock and Warrant Grants

From October 1, 2012 through December 31, 2012, we issued 433,172 shares of our common stock valued at $108,293 for services rendered to the Company in 2012.

From October 1, 2012 through December 31, 2012, we issued warrants to purchase 573,618 shares of common stock for services rendered to the Company per the following:

Stock Option Grants

From October 1, 2012 through December 31, 2012, we issued 605,000 options to purchase common stock exercisable at $0.25 to $0.35 per share to Board members and employees.

Application of Securities Laws and Other Matters

No underwriters were involved in the foregoing sales of securities. The securities described above were issued to investors in reliance upon the exemption from the registration requirements of the Securities Act, as set forth in Section 4(2) under the Securities Act and Regulation D promulgated thereunder, as applicable, relative to sales by an issuer not involving any public offering, to the extent an exemption from such registration was required.

The issuance of stock options as described above were issued pursuant to written compensatory plans or arrangements with our employees, directors and consultants, in reliance on the exemption provided by Rule 701 promulgated under the Securities Act. All recipients either received adequate information about us or had access, through employment or other relationships, to such information.

All of the foregoing securities are deemed restricted securities for purposes of the Securities Act. All certificates representing the issued shares of common stock, warrants and options described above included appropriate legends setting forth that the securities had not been registered and the applicable restrictions on transfer.

As a smaller reporting company, we are not required to provide the information required by this Item pursuant to 301(c) of Regulation S-K.

This analysis of our results of operations should be read in conjunction with the accompanying financial statements, including notes thereto, contained in Item 8 of this Report.  This Report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Exchange Act.  Statements that are predictive in nature and that depend upon or refer to future events or conditions are forward-looking statements.  Although we believe that these statements are based upon reasonable expectations, we can give no assurance that projections will be achieved.  Please refer to the discussion of forward-looking statements included in Part I of this Report.

Overview

Vystar LLC, the predecessor to the Company, was formed February 2, 2000, as a Georgia limited liability company by Travis W. Honeycutt. Operations under the LLC entity were focused substantially on the research, development and testing of the Vytex® Natural Rubber Latex ("NRL") process, as well as attaining intellectual property rights. In 2003, the Company reorganized as Vystar Corporation, a Georgia corporation, at which time all assets and liabilities of the limited liability company became assets and liabilities of Vystar Corporation, including all intellectual property rights, patents and trademarks.

We are the creator and exclusive owner of the innovative technology to produce Vytex NRL. This technology reduces antigenic protein in natural rubber latex products to virtually undetectable levels in both liquid NRL and finished latex products.  We have introduced Vytex NRL, our “ultra low protein” natural rubber latex, throughout the worldwide marketplace that uses NRL or latex substitutes as a component of manufactured products.  Natural rubber latex is used in an extensive range of products including balloons, textiles, footwear and clothing (threads), adhesives, foams, furniture, carpet, paints, coatings, protective equipment, sporting equipment, and especially health care products such as condoms, surgical and exam gloves. We produce Vytex through toll manufacturing and licensing agreements and have introduced Vytex NRL into the supply channels with aggressive, targeted marketing campaigns directed to the end users.

We transitioned from a development stage company to the operating stage during the last quarter of 2009. During the last three years, our financial condition and results of operations have experienced substantial fluctuations as we provided introductory pricing in 2010 and then began to switch to a licensing rather than a toll model in 2011. Accordingly, the financial condition and results of operations reflected in our historical financial statements are not expected to be indicative of our future financial condition and results of operations.

We believe that the key for increased Vytex NRL product acceptance is to focus on companies seeking solutions to production challenges or ways to differentiate their product offering. Vystar’s technical team has been successful in developing customized formulations to meet specific manufacturer needs. Some of these formulations will become new line extensions. Vystar is becoming less of a raw material provider and more of a technology innovator through its technical consultation and formulation activities.

In addition to this technology focus, we are determined to have the “made with Vytex” claim added to products made using various forms of Vytex NRL. To help drive this effort we’re focusing on products that benefit from Vytex NRL low non-rubber features. As part of this effort, we are working with a licensee to launch a line of foam core products used in various bedding products including pillows, mattresses and mattress toppers.

In order to bring a more predictable stream of revenue to Vystar to balance the lengthy sales cycles associated with Vytex, during 2012 management was searching for an acquisition target.

On September 13, 2012, we acquired SleepHealth, LLC (“SleepHealth”), a privately-held sleep diagnostics company headquartered in Monroe, Georgia. SleepHealth provides sleep lab management services to physician’s offices and specialty and multi-specialty clinics in Georgia, North Carolina and South Carolina. This strategic acquisition is expected to be mutually beneficial by providing each company with new expansion options. SleepHealth presents an indirect vertical integration opportunity as a potential channel for Vytex® NRL foam bedding products such as pillows, mattress toppers and mattresses. Additionally, SleepHealth provides Vystar with access into the healthcare market for future products made with Vytex NRL, such as gloves, cohesive bandages, etc. Vystar and its executive team bring to SleepHealth added expertise, management, marketing and capital resources needed for business expansion and revenue growth.

In the fourth quarter of 2012, Vystar and SleepHealth entered into two durable medical equipment (“DME”) service agreements to furnish DME to SleepHealth patients, adding a needed layer to overall patient care. This is the first step to offer a full service line for SleepHealth referrals with home sleep studies being evaluated as well. We expect these expansion projects will expand our business.

As a result of the acquisition, Vystar is comprised of two segments, a Vytex Division, focused on expanding the licensing and utilization of its proprietary source natural rubber latex technology and a SleepHealth Division focused on the sleep diagnostic and DME business.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. As such, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. Our management reviews its estimates on an on-going basis. We base our estimates and assumptions on historical experience, knowledge of current conditions and our understanding of what we believe to be reasonable that might occur in the future considering available information. Actual results may differ from these estimates, and material effects on our operating results and financial position may result.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

Fair Value Inputs Related to Share-based and Other Equity Compensation

Generally accepted accounting principles require all share-based payments, including grants of employee stock options, stock grants and warrants, to be recognized in the financial statements based on their fair values. We compute the value of awards granted by utilizing the Black-Scholes valuation model based upon their expected lives, expected volatility, expected dividend yield, and the risk-free interest rate. The value of the awards is then straight-line expensed over the service period of the awards.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments.  If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.  At December 31, 2012 and 2011, allowances for doubtful accounts amounted to $33,745 for both years.  

Fixed Asset Lives

We estimate the useful life of equipment and other fixed assets using judgment, conventions in the industries in which we operate, and research on resale values. We review equipment and fixed asset lives annually in our impairment analyses.

Impairment Analyses

We review long-lived assets such as property and equipment for impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable. If the total of the estimated undiscounted future cash flows is less than the carrying value of the assets, an impairment loss is recognized for the excess of the carrying value over the fair value of the long-lived assets.

Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that the assets might be impaired. We utilize a discounted cash flow analysis to determine a reporting unit’s fair value. The methodology used in estimating discounted cash flows is inherently complex and involves significant management assumptions, including expected revenue growth and increases in expenses, to determine an appropriate discount rate and cash flows. Estimated cash flows extend into the future and, by their nature, are difficult to determine over an extended timeframe. Factors that have and may significantly affect the estimates, and ultimately their carrying amount in our financials, include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, government regulation and changes in discount rates or market sector conditions. Significant changes in these assumptions could affect the need to record an impairment charge.

Income Taxes

We account for income taxes using the assets and liability method.   This method requires that the deferred tax consequences of temporary differences between the amounts recorded in our financial statements and the amounts included in our federal and state income tax returns be recognized in the balance sheet. Estimates are often required with respect to, among other things, the potential utilization of any operating and capital loss carry-forwards for both federal and state income tax purposes and valuation allowances required, if any, for tax assets that may not be realizable in the future.  We believe that it is more likely than not that the amounts recorded as deferred income tax assets will not be recoverable through future taxable income generated by us.  As a result, the Company recorded a 100% valuation allowance against our net deferred tax assets as of December 31, 2012 and 2011.  We believe the procedures and estimates used in our accounting for income taxes are reasonable and in accordance with established tax law. A tax benefit arising from an uncertain tax position can only be recognized for financial reporting purposes if, and to the extent that, the position is more likely than not to be sustained in an audit by the applicable taxing authority.  We had no material unrecognized tax benefits and related tax liabilities at December 31, 2012 and 2011. Penalties related to uncertain tax positions would be recorded as a component of general and administrative expenses. Interest relating to uncertain tax positions would be recorded as a component of interest expense.

RESULTS OF OPERATIONS

Year ended December 31, 2012 compared to year ended December 31, 2011

Vystar

Revenue was $240,004 in 2012 compared to $347,250 in 2011, a decrease of $107,246, due to changes in the way Vystar produces and sells Vytex NRL and fluctuations in the base commodity prices of natural rubber latex purchased for conversion to Vytex NRL and its specialty lots. The Vytex segment gross margin percentage was 11.7% in 2012, compared to 34.7% in 2011. In 2012, gross margins were negatively impacted by post-production latex market price reductions for deliverables under toll manufacturing sales agreements. Vystar is transitioning from a toll manufacturing model to a licensing model where cost of goods sold will be carried by the distributor licensing the technology to process Vytex NRL. In December, 2012 Vystar signed an addendum to its existing agreement with Centrotrade Deutschland to license Vytex NRL technology by securing the raw material, processing the Vytex NRL using dispersion kits, storing, shipping, billing, collecting and paying the licensing fee. As this agreement is fully implemented in 2013 we expect additional changes to Vytex NRL revenue.

For the years ended December 31, 2012 and 2011, total operating expenses were $1,936,325 and $2,599,901, respectively, for a decrease of $633,576 or 25.5%.

In 2012, $363,756 was recorded for share-based compensation as well as an additional $135,000 for amortization of deferred compensation.   This compares with $957,246 for share-based compensation and $71,836 for amortization of deferred compensation in 2011.  The deferred compensation expense in 2012 and 2011 represents the amortized fair value of stock and warrants issued for services to non-employees.  Share-based compensation charges to operations in 2012 and 2011 were primarily for stock options granted under our Stock Option Plan to executive officers and were made so that their interests would be aligned with those of shareholders, providing incentive to improve Company performance on a long-term basis.  Grants of stock purchase warrants were also made to third parties for various services rendered and as additional compensation for financing agreements.   Amortization of deferred compensation is recorded in general and administrative expenses.   Share-based compensation expense is included in sales and marketing and general and administrative expenses.   For 2012, the amount of share-based compensation and deferred compensation included in sales and marketing was $146,356 and in general and administrative was $352,402.   For 2011, the amount of share-based compensation and deferred compensation included in sales and marketing was $152,532 and in general and administrative was $804,714.

For the years ended December 31, 2012 and 2011, sales and marketing expenses were $409,963 and $644,612, respectively.  The decrease of $234,649 is primarily due to decreased stock-based compensation due to the departure in 2011 of the full-time Executive Vice President of Sales and a reduction in public relations expenditures for 2012.  Sales and marketing expenses consist primarily of compensation and support costs for sales and marketing personnel, professional services, promotional, marketing and related activities.

For the years ended December 31, 2012 and 2011 general and administrative expenses were $1,489,393 and $1,886,863, respectively.  The decrease of $397,470 is primarily composed of decreases in non-cash stock-based compensation. The decreased compensation expense resulted from the resignation in August 2011 of the Company’s full time Chief Financial Officer who was replaced by a by a part time CFO). General and administrative expenses consist primarily of compensation and support costs for management and administrative staff, and for other general and administrative costs, including professional fees related to accounting, finance, and legal services as well as other operating expenses.

 Other Income (Expense)

Other income (expense) for the year ended December 31, 2012, consisted of $5,702 of interest and other income, net of interest expense of $645,216, compared to 2011 interest income of $545 and interest expense of $1,122,296. The decrease of $477,080 in interest expense is primarily due to paying off a previous credit facility in June 2011.  Amortization of deferred financing costs connected with CMA Investments, LLC were $515,374 and $212,762 in 2012 and 2011, respectively. Amortization of deferred financing costs connected with the previous credit facility was $701,080 in 2011.

Sales Environment

The overall natural rubber markets remain in a state of flux as new plantations come on line in SE Asia in countries such as Vietnam, Cambodia, etc., and increases in production are noted in other countries such as Guatemala. Moves by certain countries to control pricing have succeeded in a few instances but just as often fail as manufacturers do not buy as far forward as the controlled pricing areas would like. Of keen interest is the improvement in non-latex gloves as synthetic glove makers have made great strides in perfecting their offerings. Gloves, as a segment, are the biggest segment of users of natural rubber latex. Vystar has focused on fewer segments of the marketplace as we see trends in areas that look to embrace the low non-rubber aspects of Vytex NRL such as adhesives, balloons, condoms, bandages, etc. Also, Vystar plans to launch a line of branded foam products during the fourth quarter of 2013 once regulatory tags have been received. Initial, non-scientific, market research points to a definite market for pure natural rubber latex foam products made with Vytex NRL.

SleepHealth performance and impairment

SleepHealth’s post acquisition performance has not met Vystar’s expectations. For the period from October 1, 2012 through April 30, 2013, revenue from sleep studies was below projections and $115,000 below the same period last year. There are a number of facts available to Vystar now regarding the valuation of SleepHealth.

Vystar originally based the valuation of SleepHealth on their 2010 and 2011 tax returns and the annualized results of the first six months of 2012 as presented by SleepHealth. At the time of the acquisition, the 2012 accounting had not been assembled by an outside CPA firm and SleepHealth’s 2010 and 2011 books and records required significant work to complete an independent audit. The audited financial statements for 2010 and 2011 actually showed net losses, contrary to what the 2010 and 2011 compilations and tax returns had shown.

At the acquisition date, SleepHealth was invoicing 25 accounts, 13 of which performed fewer than 10 studies per month. Utilization of the rooms available for testing was not ideal. A sleep technician can monitor two to three patients, depending on testing needs, but numerous single patient nights were performed. Increased room utilization and 2:1 patient to technician studies were included in the forward looking projections.

The contracted sleep study fee and SleepHealth’s hourly technician labor costs are the largest factors in determining whether an account is or has the potential to be profitable. SleepHealth requires two patient per night minimums to cover all of its costs and provide acceptable profits. Vystar has now instituted a two patient study per night minimum; has closed eight unprofitable accounts and is working with the remaining accounts to achieve the new goals that benefit both parties.

After the acquisition, Vystar discovered that prior collections efforts resulted in slow cash flow and an inability to timely meet key obligations.

Additionally, the sales pipeline was weaker than anticipated. Vystar has broadened its approach to securing that pipeline.

The number of studies performed at a location over the term of the contract is dependent on the physician’s specialty, size of the physician’s patient base, advertising or partnering with other physicians to grow the patient base, or other reasons outside our direct control. As a physician cycles through his/her patient base, the number of studies from that location can decline over the term of the contract without active management of the account. Vystar has introduced steps that implement active account management.

As a result of the above facts, the valuation of SleepHealth was revised.

The new valuation reduced physician relationships from $193,000 to $29,000; trade names from $29,000 to $19,000 and the non-compete agreement from $20,000 to zero. The reductions in these values were reclassified to goodwill. Vystar also reversed the $8,199 contingent consideration amount due the Seller.

Due to the performance factors detailed above, a goodwill write down of $87,000 was made effective December 31, 2012.

The sleep testing arena is undergoing a transition to Home Sleep Tests (HSTs) that are required by payors when certain co-morbidities are not present. SleepHealth has started working through physician offices to perform these tests and is currently evaluating a few different scenarios to expand into this business segment. In order to help the physicians manage the diagnosed patient, SleepHealth will also be tracking those patients for CPAP re-supply. Launching the new DME program to meet the needs of patients and physician offices is paramount for 2013.

Net Loss

As a result of the factors described above, the consolidated net loss decreased $856,722 to $2,744,304 for the year ended December 31, 2012 compared to $3,601,026 for the year ended December 31, 2011.

LIQUIDITY AND CAPITAL RESOURCES

The Company's financial statements are prepared using the accrual method of accounting in accordance with accounting principles generally accepted in the United States of America and have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities in the normal course of business.  However, we have incurred significant losses and experienced negative cash flow since inception.  At December 31, 2012, the Company had cash of approximately $91,919 and a deficit in working capital of $2,452,674.  For the year ended December 31, 2012, we had a net loss of $2,744,304 and the accumulated deficit amounted to approximately $20,405,547. We use working capital to finance our ongoing operations and since those operations do not currently cover all of our operating costs, managing working capital is essential to our Company’s future success.

Net cash used in operating activities was $1,579,839 for the year ended December 31, 2012 as compared to $1,333,011 for the year ended December 31, 2011.  During the year ended December 31, 2012, cash used in operations was primarily due to the net loss for the year of $ 2,744,304, net of non-cash related add-back of share-based compensation expense of $519,010.

Net cash used by investing activities was $108,424 during the year ended December 31, 2012, as compared to net cash used of $48,666 during the year ended December 31, 2011.  During the year ended December 31, 2012 $32,702 was used for the acquisition of SleepHealth, LLC as discussed in more detail in Note 3, $45,508 for patents and intellectual property, and $30,214 for equipment purchases. During the year ended December 31, 2011, cash used by investing activities was entirely for costs related to our patents and intellectual property.

Net cash provided by financing activities was $1,763,523 during the year ended December 31, 2012, as compared to cash provided of $1,115,711 during the year ended December 31, 2011.   In 2012, the cash provided was from an increase in the related party line of credit of $491,125 (as discussed in more detail in Note 6), equipment financing arrangements of $29,208, a related party promissory note of $100,000 (see Note 6), and the issuance of common stock of $1,196,799 offset by cash financing costs incurred of $42,750. In 2011, the cash provided was from the issuance of notes payable of $525,000, proceeds from the related party line of credit of $938,750, and issuance of common stock from the exercise of warrants of $41,250 offset by financing costs incurred of $389,289. The financing activities in 2011 represent the proceeds we received from the sale of common stock and the exercise of warrants.

As discussed in detail in Note 6, the CMA Note matures on April 29, 2013 and the Shareholder Notes mature on various dates beginning March 11 through May 31, 2013. We fully expect to be able to refinance, restructure, or extend these obligations but if we are unsuccessful, this will constitute defaults under the Agreements with CMA and the Shareholders holding the Shareholder Notes. Any actions by CMA and/or the Shareholders could force us into bankruptcy or liquidation, which would have a material adverse effect on our liquidity and financial position and the value of our common stock. As a result of this history of losses and financial condition, there is substantial doubt about the Company’s ability to continue as a going concern.

A successful transition to attaining profitable operations is dependent upon obtaining sufficient financing to fund the Company’s planned expenses and achieving a level of revenue adequate to support the Company’s cost structure.  Management plans to finance future operations through the use of cash on hand, increased revenue from better utilization of existing SleepHealth facilities and opening of new facilities, increased revenue from Vytex division license fees, our credit facility, accounts receivable financing, stock warrant exercises from existing shareholders, and raising capital through private placement memoranda (see Note 17, Subsequent Events). 

There can be no assurances that we will be able to achieve projected levels of revenue in 2013 and beyond.  If we are not able to achieve projected revenue and obtain alternate additional financing of equity or debt, we would need to significantly curtail or reorient operations during 2013, which could have a material adverse effect on our ability to achieve our business objectives and as a result may require the Company to file for bankruptcy or cease operations.  The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts classified as liabilities that might be necessary should the Company be forced to take any such actions.

Our future expenditures will depend on numerous factors, including: the rate at which we can introduce and license Vytex NRL to manufacturers; the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and market acceptance of our products and services and competing technological developments; rate at which we can open new SleepHealth facilities and the rate at which we are able to build a durable medical equipment business. As we expand our activities and operations, our cash requirements are expected to increase at a rate consistent with revenue growth after we have achieved sustained revenue generation.

Off-Balance Sheet Arrangements

We do not have any material off-balance sheet arrangements.

Certain Relationships and Related Transactions

On April 29, 2011, the Company executed with CMA Investments, LLC, a Georgia limited liability company (“CMA”) a line of credit (Note 5) with a principal amount of up to $800,000 (the “CMA Note”).  CMA is a limited liability company of which three of the directors of the Company are the members.   Proceeds under the line were drawn to pay off amounts owed under the Topping Lift Agreement and for general working capital purposes. Under the terms of the CMA Note, the Company may draw up to a maximum principal amount of $800,000.  Interest and fees will be paid by an affiliate of a director of the Company, to CMA.  Pursuant to an agreement between the Company and such affiliate, the Company will issue common stock to such affiliate with a value equal to such interest and fees paid based on the closing price of the common stock on the OTC Bulletin Board on the date of such payments. The maturity date of the CMA Note is April 29, 2013. The CMA Note is unsecured and no payments of principal are due until the second anniversary of the CMA Note, at which time all outstanding principal is due and payable. As compensation to the directors for providing the CMA Note, the Company issued warrants to purchase 2,600,000 shares of the Company’s common stock to the directors at $.45 per share which was the closing price of the Company’s common stock on that day, later adjusted to $.27 per share, which was the closing price of the Company’s common stock on the day it was adjusted.

On September 14, 2011, the Company’s Board of Directors approved increasing the line of credit to $1,000,000 and the Company’s Chairman and Chief Executive Officer became a member of CMA. As compensation for increasing the line, the directors approved issuing warrants to purchase an additional 1,600,000 shares of the Company’s common stock at $.27 per share, which was the closing price of the Company’s common stock on that day.

On November 2, 2012, the Board of Directors approved an increase in the line of credit from $1,000,000 to $1,500,000. As compensation to the CMA members, we issued warrants to purchase an additional 2,100,000 shares of the Company’s common stock at $0.35 per share. The closing price of the Company’s stock on November 2, 2013 was $0.21. The warrants vest 20% immediately and 16% upon each $100,000 draw above $1,000,000. Substantially all of the additional $500,000 had been drawn as of December 31, 2012 and vesting was completed. Accordingly, $143,726 was capitalized into deferred financing costs for the warrants in 2012. These costs will be amortized to interest expense over the remaining term of the CMA Note.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a smaller reporting company, we are not required to provide the information required by this Item pursuant to 301(c) of Regulation S-K.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Certified Public Accounting Firm

The Board of Directors and Stockholders

Vystar Corporation

We have audited the accompanying consolidated balance sheets of Vystar Corporation (the “Company”) and Subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of loss, stockholders’ deficit, and cash flows for the years then ended.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Vystar Corporation and Subsidiaries as of December 31, 2012 and 2011, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company's recurring losses from operations, capital deficit, and limited capital resources raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters also are described in Note 2. These financial statements do not include any adjustments that may result from the outcome of this uncertainty.

VYSTAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

VYSTAR CORORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF LOSS 

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

VYSTAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT

For the Years Ended December 31, 2012 and 2011

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

VYSTAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

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

VYSTAR CORPORATION AND SUBSIDIARIES 

NOTES TO FINANCIAL STATEMENTS

December 31, 2012 and 2011

NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

History and Nature of Business

Vystar Corporation (“Vystar”, the “Company”, “we”, “us”, or “our”) is the creator and exclusive owner of the innovative technology to produce Vytex® Natural Rubber Latex ("NRL"). Our patented technology reduces antigenic and total protein in natural rubber latex products to virtually undetectable levels. Vytex NRL, our “ultra low protein” natural rubber latex has been introduced throughout the worldwide marketplace that uses NRL or latex substitutes as a raw material for end products. Natural rubber latex or latex substitutes are used in an extensive range of products including balloons, textiles, footwear and clothing (threads), adhesives, foams, furniture, carpet, paints, coatings, protective equipment, sporting equipment, and, especially health care products such as condoms, surgical and exam gloves, among others.

In addition, on September 13, 2012, we acquired SleepHealth, LLC and SleepHealth North Carolina, LLC (“SleepHealth”), privately-held sleep diagnostic companies headquartered in Monroe, Georgia. SleepHealth provides sleep lab management services to physicians’ offices, specialty and multi-specialty clinics in Georgia, North Carolina and South Carolina.

As a result of the acquisition, Vystar Corporation is comprised of two segments, a Vytex Division, focused on expanding the licensing and utilization of its proprietary source natural rubber latex technology and a SleepHealth Division focused on the sleep diagnostic and Durable Medical Equipment (“DME”) businesses.

Basis of Presentation

The consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification.

The Company has evaluated subsequent events through the date of the filing its Form 10-K with the Securities and Exchange Commission. Other than those events disclosed in Note 17, the Company is not aware of any other significant events that occurred subsequent to the balance sheet date but prior to the filing of this report that would have a material impact on the Company’s consolidated financial statements.

Consolidation

The accompanying consolidated financial statements include the accounts of Vystar and SleepHealth. All intercompany accounts and transactions have been eliminated in consolidation.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying disclosures.  Although these estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future, actual results could differ from these estimates. Examples include valuation allowances for deferred tax assets, provisions for bad debts, and fair values of share-based compensation and other equity issuances.

Concentration of Credit Risk

Certain financial instruments potentially subject the Company to concentrations of credit risk.  These financial instruments consist primarily of cash and accounts receivable.  Cash held in operating accounts may exceed the Federal Deposit Insurance Corporation, or FDIC, insurance limits.  While we monitor cash balances in our operating accounts on a regular basis and adjust the balances as appropriate, these balances could be impacted if the underlying financial institutions fail.  To date, we have experienced no loss or lack of access to our cash; however, we can provide no assurances that access to our cash will not be impacted by adverse conditions in the financial markets.

Accounts Receivable

Accounts receivable are stated at the amount management expects to collect from outstanding balances.  Management provides for uncollectible amounts through a charge to earnings and a credit to an allowance for doubtful accounts based upon its assessment of the current status of individual accounts.  Balances that are still outstanding after management has performed reasonable collection efforts are written off through a charge to the allowance and a credit to accounts receivable.  As of December 31, 2012 and 2011, we have provided for uncollectible amounts through a charge to earnings of $33,745, respectively.  We grant credit to our customers without requiring collateral.  The amount of accounting loss for which we are at risk in these unsecured accounts receivable is limited to their carrying value.

Vytex Division customers are located in both the United States and internationally. The SleepHealth Division customer base is located in three southeastern states: Georgia, North Carolina and South Carolina.

Inventory

Inventory consisting of Vytex NRL is stated at the lower of cost or market and cost is determined using the first-in, first-out (FIFO) method.

Property and Equipment

Property and equipment is stated at cost.  Depreciation is provided by the use of the straight-line and accelerated methods for financial and tax reporting purposes, respectively, over the estimated useful lives of the assets, generally 5 years.

Intangible Assets

Patents represent legal and other fees associated with the registration of patents.  The Company has four issued patents with the United States Patent and Trade Office (USPTO) as well as four issued international PCT (Patent Cooperation Treaty) patents.  Patents are carried at cost and are being amortized on a straight-line basis over their estimated useful lives, typically 20 years.

The Company has trademark protection for “Vystar”, “Vytex”, and “Created by Nature.  Recreated by Science.” Trademarks are carried at cost and since their estimated life is indeterminable, no amortization is recognized.  Instead, they are evaluated annually for impairment.

The Company acquired the trade name, SleepHealth. Trade names are carried at cost and are being amortized on a straight-line basis over a period of five years.

The Company acquired various physician relationships. Physician relationships are carried at cost and are being amortized on a straight-line basis over a period of three years.

Impairment of Long-lived Assets

Long-lived assets, including property and equipment and intangible assets with finite lives, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset, an impairment loss is recognized in the amount that the carrying amount of the asset exceeds its fair value.  Fair value is determined based on discounted future net cash flows associated with the use of the asset.

Goodwill Impairment

Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that the assets might be impaired. We utilize a discounted cash flow analysis to determine a reporting unit’s fair value. The methodology used in estimating discounted cash flows is inherently complex and involves significant management assumptions, including expected revenue growth and increases in expenses, to determine an appropriate discount rate and cash flows. Estimated cash flows extend into the future and, by their nature, are difficult to determine over an extended timeframe. Factors that have and may significantly affect the estimates, and ultimately their carrying amount in our financials, include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, government regulation and changes in discount rates or market sector conditions. Significant changes in these assumptions could affect the need to record an impairment charge.

Fair Value of Financial Instruments

The Company’s financial instruments consist of cash, accounts receivable, accounts payable, accrued expenses, lines of credit, shareholder notes payable, and long-term debt.  The carrying values of all the Company’s financial instruments approximate fair value because of their short maturities. In addition to the short maturities, the carrying amounts of our line of credit and shareholder notes payable approximate fair value because the interest rates at December 31, 2012 and 2011 approximate market interest rates for the respective borrowings .

In specific circumstances, certain assets and liabilities are reported or disclosed at fair value.  Fair value is the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in the Company's principal market for such transactions.  If there is not an established principal market, fair value is derived from the most advantageous market.

Valuation inputs are classified in the following hierarchy:

Highest priority is given to Level 1 inputs and the lowest priority to Level 3 inputs.  Acceptable valuation techniques include the market approach, income approach, and cost approach.  In some cases, more than one valuation technique is used.

Income Taxes

The Company follows the asset and liability approach to financial accounting and reporting for income taxes.  Deferred income tax assets and liabilities are computed for temporary differences between the financial statement and tax bases of assets and liabilities and for net operating loss carryforwards that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences or carryforwards are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount more likely than not to be realized.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the net operating losses and temporary differences become deductible.  Income tax expense (benefit) is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. As of December 31, 2012, our accumulated net operating loss was approximately $13,300,000.

In accordance with GAAP, a tax benefit arising from an uncertain tax position can only be recognized for financial reporting purposes if, and to the extent that, the position is more likely than not to be sustained in an audit by the applicable taxing authority.  There were no material unrecognized tax benefits and related tax liabilities at December 31, 2012 and 2011. Penalties related to uncertain tax positions would be recorded as a component of general and administrative expenses. Interest relating to uncertain tax positions would be recorded as a component of interest expense.

Loss Per Share

The Company presents basic and diluted loss per share.  Because the Company reported a net loss in 2012 and 2011, common stock equivalents, including stock options and warrants, were anti-dilutive; therefore, the amounts reported for basic and dilutive loss per share were the same.  Excluded from the computation of diluted loss per share were options to purchase 6,867,500 shares and 6,487,500 shares of common stock for 2012 and 2011, respectively, as their effect would be anti-dilutive.  Warrants to purchase 12,857,926 shares and 7,369,957 shares of common stock for 2012 and 2011, respectively, were also excluded from the computation of diluted loss per share as their effect would be anti-dilutive.

Revenue

The Vytex segment derives revenue from sales of or license fees of Vytex NRL raw material to manufacturers and distributors of rubber and rubber end products.  Under both the direct and licensing agreement sales, the Vytex segment recognizes revenue at the time product is shipped and title passes to the customer. Revenue is recognized when the following four criteria are met: (1) persuasive evidence of an arrangement exists; (2) shipment or delivery has occurred; (3) the price is fixed or determinable and (4) collectability is reasonably assured.

The SleepHealth segment bills its physician base of customers at the end of each month for services provided in that month and is not dependent on the physician collecting from insurance providers or from the patients. The SleepHealth segment recognizes revenue each month for sleep diagnostic services as services are provided.

Cost of Revenue

For the Vytex segment, cost of revenue consists primarily of product and freight costs. For the SleepHealth segment, cost of revenue consists primarily of sleep technician labor costs.

Research and Development

Research and development costs are expensed when incurred.  Research and development costs include all costs incurred related to the research, development and testing of the Company’s process to produce Vytex NRL.

NOTE 2 – LIQUIDITY AND GOING CONCERN

The Company's financial statements are prepared using the accrual method of accounting in accordance with accounting principles generally accepted in the United States of America and have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities in the normal course of business.  However, we have incurred significant losses and experienced negative cash flow since inception.  At December 31, 2012, the Company had cash of $91,919 and a deficit in working capital of $2,452,673.  For the year ended December 31, 2012, we had a net loss of $2,744,304 and the accumulated deficit amounted to approximately $20,405,547. We use working capital to finance our ongoing operations and since those operations do not currently cover all of our operating costs, managing working capital is essential to our Company’s future success.

Net cash used in operating activities was $1,579,839 for the year ended December 31, 2012 as compared to $1,333,011 for the year ended December 31, 2011.  During the year ended December 31, 2012, cash used in operations was primarily due to the net loss for the year of $2,744,304, net of non-cash related add-back of share-based compensation expense of $519,010.

Net cash used by investing activities was $108,424 during the year ended December 31, 2012, as compared to net cash used of $48,666 during the year ended December 31, 2011.  During the year ended December 31, 2012 cash used by investing activities was primarily for the acquisition of SleepHealth, LLC (as discussed in more detail in Note 3), equipment purchases, and patent costs. During the year ended December 31, 2011, cash used by investing activities was entirely for costs related to our patents and intellectual property.

Net cash provided by financing activities was $1,763,523 during the year ended December 31, 2012, as compared to cash provided of $1,115,711 during the year ended December 31, 2011.   In 2012, the cash provided was from an increase in the related party line of credit of $491,125 (as discussed in more detail in Note 6), equipment financing arrangements of $29,208, a related party promissory note of $100,000 (see Note 6), and the issuance of common stock of $1,196,799 offset by cash financing costs incurred of $42,750. In 2011, the cash provided was from the issuance of notes payable of $525,000, proceeds from the related party line of credit of $938,750, and issuance of common stock from the exercise of warrants of $41,250 offset by financing costs incurred of $389,289. The financing activities in 2011 represent the proceeds we received from the sale of common stock and the exercise of warrants.

As discussed in detail in Note 6, the CMA Note matures on April 29, 2013 and the Shareholder Notes mature on various dates beginning March 11 through May 31, 2013. We fully expect to be able to refinance, restructure, or extend these obligations but if we are unsuccessful, this will constitute defaults under the Agreements with CMA and the Shareholders holding the Shareholder Notes. Any actions by CMA and/or the Shareholders could force us into bankruptcy or liquidation, which would have a material adverse effect on our liquidity and financial position and the value of our common stock. As a result of this history of losses and financial condition, there is substantial doubt about the Company’s ability to continue as a going concern.

A successful transition to attaining profitable operations is dependent upon obtaining sufficient financing to fund the Company’s planned expenses and achieving a level of revenue adequate to support the Company’s cost structure.  Management plans to finance future operations through the use of cash on hand, increased revenue from better utilization of existing SleepHealth facilities and opening of new facilities, increased revenue from Vytex division license fees, our credit facility, accounts receivable financing, stock warrant exercises from existing shareholders, raising capital through private placements of capital stock and debt.

Our future expenditures will depend on numerous factors, including: the rate at which we can introduce and license Vytex NRL to manufacturers; the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and market acceptance of our products and services and competing technological developments; rate at which we can open new SleepHealth facilities and the rate at which we are able to build a Durable Medical Equipment (“DME”) business. As we expand our activities and operations, our cash requirements are expected to increase at a rate consistent with revenue growth after we have achieved sustained revenue generation.

There can be no assurances that the Company will be able to achieve its projected level of revenue in 2013 and beyond.  If the Company is unable to achieve its projected revenue and is not able to obtain alternate additional financing of equity or debt, the Company would need to significantly curtail or reorient its operations during 2013, which could have a material adverse effect on the Company’s ability to achieve its business objectives and as a result may require the Company to file for bankruptcy or cease operations.  The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts classified as liabilities that might be necessary should the Company be forced to take any such actions.

NOTE 3 – ACQUISITION OF SLEEPHEALTH, LLC

On September 13, 2012, Vystar Corporation entered into an LLC Ownership Interest Purchase Agreement (the “ Agreement ”) with Mary Ailene Miller (“ Seller ”), the sole member of SleepHealth, LLC, a Georgia limited liability company (“ SleepHealth ”) to purchase all outstanding membership and ownership interests of SleepHealth, and on the same date completed such purchase (the “ Purchase ”). This strategic acquisition was expected to be mutually beneficial by providing each company with new expansion options. SleepHealth presented an indirect vertical integration opportunity as a potential channel for Vytex® NRL foam bedding products such as pillows, mattress toppers and mattresses. Additionally, SleepHealth provides Vystar with access into the healthcare market for future products made with Vytex NRL, such as gloves, cohesive bandages, etc. Vystar and its executive team bring to SleepHealth added expertise, management, marketing and capital resources needed for business expansion and revenue growth. Pursuant to the Agreement, the Company:

(a) Delivered $53,734 cash to Seller;

(b) Issued a promissory note to Seller in the principal amount of $33,735 payable in twelve (12) equal monthly payments together with interest at an annual rate of five percent (5%);

(c) Issued 636,098 shares of Vystar common stock to Seller.

In addition, the Company agreed to pay an additional $40,993 (the “ Adjustment Amount ”), one-half in cash and one-half in shares of Vystar common stock, in the event that SleepHealth’s EBITDA (earnings before interest, taxes, depreciation and amortization) for the year ended December 31, 2012, was equal to or greater than $129,140. The estimate of the fair value of the contingent consideration was zero as of September 13, 2012.

At closing, the Company and Seller entered into a two year consulting agreement pursuant to which the Seller will provide ongoing services to the Company and SleepHealth as an independent contractor with compensation of $10,000 monthly.

The actual purchase price was based on cash paid, debt issued to the Seller, and the value of our stock ($0.27 per share) on the date of the acquisition. The actual purchase price was allocated as follows:

Working capital purchased in the acquisition was composed of the following:

The acquisition was accounted for as a business combination as defined by FASB Topic 805 – Business Combinations. The allocation of the purchase price to the assets acquired and liabilities assumed was based on respective fair value. As of the date of this filing, the purchase price allocation has not been finalized, and is subject to change.

The values assigned to the finite-lived intangible assets are subject to amortization. The intangible assets were assigned the following lives for amortization purposes:

Goodwill was determined using the residual method and represents the excess of the purchase price paid over the identifiable net assets and liabilities acquired at fair value.

The following unaudited pro-forma financial information presents the consolidated results of operations as if the acquisition of SleepHealth, LLC had occurred on January 1, 2011. The pro-forma results are shown for illustrative purposes only and do not purport to be indicative of the results that would have been reported if the acquisition had occurred on the date indicated or indicative of the results that may occur in the future.

Pro-forma information for the years ended December 31, 2012 and 2011 was as follows:

The 2012 supplemental pro forma earnings were adjusted to exclude $5,577 of acquisition-related legal costs. The 2012 and 2011 supplemental pro forma earnings were adjusted to include $13,464 of amortization costs related to $48,000 in recorded intangible assets. Depreciation adjustments of $5,806 for 2012 and $16,569 for 2011 are included. Interest expense of $1,687 on the 12-month note payable was included in other expenses for 2011. Consulting fees of $120,000 are included for both years. The shares outstanding used in calculating the loss per share for 2012 and 2011 was adjusted to include the 636,098 shares issued as part of the purchase price assuming they had been issued on January 1, 2011. Vystar originally based the valuation of SleepHealth on their 2010 and 2011 tax returns and the annualized results of the first six months of 2012 as presented by SleepHealth. At the time of the acquisition, audited SleepHealth financials were unavailable. Upon audit, financial statements for 2010 and 2011 actually showed net losses, contrary to what the 2010 and 2011 compilations and tax returns had shown.

In addition, as a result of the SleepHealth audit and the segment not meeting projections, we requested an updated valuation of the segment. The new valuation reduced physician relationships from $193,000 to $29,000; trade name from $29,000 to $19,000 and the non-compete agreement from $20,000 to zero. The reductions in these values were reclassified to goodwill. As a result of the substantive changes to the projected future results of the SleepHealth segment, management determined there to be a triggering event and accordingly completed an evaluation of the carrying value of goodwill. This evaluation resulted in an impairment to goodwill of $87,000, leaving the goodwill balance at $68,000 as of December 31, 2012. 

NOTE 4 – PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at December 31:

Depreciation expense for the years ended December 31, 2012 and 2011 was $22,408 and $1,509, respectively.

NOTE 5 – INTANGIBLE ASSETS

Intangible assets were as follows at December 31:

Amortization expense for the years ended December 31, 2012 and 2011 was $18,015 and $11,238, respectively. 

Estimated future amortization expense for finite-lived intangible assets is as follows:

NOTE 6 – NOTES PAYABLE AND LOAN FACILITY

Related Party Line of Credit (CMA Note Payable)

On April 29, 2011, the Company executed with CMA Investments, LLC, a Georgia limited liability company (“CMA”), an unsecured line of credit with a principal amount of up to $800,000 (the “CMA Note”). CMA is a limited liability company of which three of the directors of the Company (“CMA directors”) are the members. Pursuant to the original terms of the CMA Note, the Company could draw up to a maximum principal amount of $800,000. Interest, which is computed at LIBOR plus 5.25% per annum (5.5% at December 31, 2012), on amounts drawn and fees, will be paid by a director of the Company, to CMA. The weighted average interest rate in effect on the borrowings for the year ended December 31, 2012 was 5.51%. Pursuant to an agreement between the Company and such affiliate, the Company will issue common stock to such affiliate with a value equal to such interest and fees paid based on the closing price of the common stock on the OTC Bulletin Board on the date of such payments. From June through December 2011, we issued 110,848 shares of common stock valued at $43,839 for interest and fees related to the CMA Note and in January and February 2012, we issued 28,138 shares of common stock valued at $9,005 for interest for the related party CMA Note. This agreement was modified during February 2012 and the Company assumed responsibility for payment of such interest and fees. The maturity date of the CMA Note is April 29, 2013.

Other terms of the CMA Note include: 

On September 14, 2011, the Company’s Board of Directors approved increasing the line of credit with CMA by $200,000 to a maximum principal amount of $1,000,000 and the Company’s Chairman and Chief Executive Officer became a member of CMA. As compensation to the CMA Directors for increasing the amount available under the CMA Note, the CMA Directors approved modifying the exercise price for the 2,600,000 compensatory stock purchase warrants previously issued to the directors from $0.45 to $0.27 per share, which was the closing price of the Company’s common stock on that date and the Company also issued warrants to purchase an additional 1,600,000 shares of the Company’s stock at $0.27 per share, which was the closing price of the Company’s common stock on September 14, 2011, which vest upon the original terms of the CMA Note. The costs incurred in the modification of the exercise price of the 2,600,000 compensatory stock purchase warrants issued on April 29, 2011 and the additional 1,600,000 warrants issued on September 14, 2011 are being amortized to interest expense over the remaining term of the CMA Note.

On November 2, 2012, the Board of Directors approved an increase in the CMA line of credit from $1,000,000 to $1,500,000.  As compensation to the CMA Directors for increasing the amount available under the CMA Note, warrants to purchase an additional 2,100,000 shares of the Company’s stock at $0.35 per share were issued and recorded as deferred financing cost to be amortized through interest expense over the remaining term of the CMA Note. Amortization of the financing costs associated with the CMA Note amounted to $515,374 and $212,762 for the years ended December 31, 2012 and 2011, respectively.

Bank Line of Credit

On September 13, 2012, the Company as part of the acquisition of SleepHealth, LLC, assumed a line of credit with Wells Fargo Bank, N.A. which is (i) unsecured, (ii) bears interest at an annual rate of Prime plus 1.1% (as of December 31, 2012 was 4.35%), and (iii) is payable upon demand. As of December 31, 2012 the balance under the line of credit was $49,850.

Related Party Notes Payable

On October 9, 2012, the Company issued to a related party a convertible promissory note in the amount of $100,000 together with warrants to purchase an aggregate of 400,000 shares of the Company’s common stock at $0.35 per share exercisable at any time through September 30, 2017. The Note was (i) unsecured, (ii) bore interest at a rate of zero percent (0%) per annum , and (iii) is convertible into shares of the Company’s common stock at the conversion rate of $0.25 of principal and interest for each such share.  No payments of interest or principal were payable until October 31, 2012, at which time the note was converted to common stock.

Shareholder Notes Payable

The following table summarizes the shareholder notes payable:

On March 11, 2011, the Company issued to existing shareholders of the Company an aggregate of $400,000 of convertible promissory notes together with warrants to purchase an aggregate of 160,000 shares of the Company’s common stock at $0.68 per share for two years from the date of issuance.  Such notes are (i) unsecured, (ii) bear interest at an annual rate of ten percent (10%) per annum, and (iii) are convertible into shares of common stock at the conversion rate of $0.68 of principal and interest for each such share.  No payments of interest or principal are payable until March 11, 2013.

On May 31, 2011, the Company issued to existing shareholders of the Company an aggregate of $125,000 of convertible promissory notes together with warrants to purchase an aggregate of 50,000 shares of the Company’s common stock at $0.49 per share for two years from the date of issuance. Such notes are (i) unsecured, (ii) bear interest at an annual rate of ten percent (10%) per annum, and (iii) are convertible into shares of common stock at a conversion rate of $0.49 of principal and interest for each such share. No payments of interest or principal are payable until May 31, 2013.

The computed value of the warrants issued in connection with the Shareholder Notes issued in March and May 2011, was determined to be $29,287 and is reflected as a debt discount and netted against the Shareholder Notes on the balance sheet. Additionally, in conjunction with these transactions, the Company recorded a beneficial conversion feature, given the price allocated to the Shareholder Notes was less than the market price on the date of issuance, creating an intrinsic value in the conversion option. An additional $29,287 was recorded as a reduction in the Shareholder Notes and an increase in paid in capital for the intrinsic value of the conversion feature. The debt discount and beneficial conversion feature amount are being amortized to interest expense over the life of the Shareholder Notes under the effective interest method at 15.58% per annum.

On October 7, 2011, the Company’s Board of Directors approved modifying the exercise price for the 210,000 stock purchase warrants previously issued to existing shareholders holding convertible promissory notes to $0.27 per share, the closing price of the Company’s common stock on September 14, 2011, the date when the exercise price of warrants previously issued to the Company’s directors for providing the CMA Note were modified to $0.27 per share. The Company incurred $10,105 in interest expense for the repricing of the warrants.

Long-Term Debt

The following table summarizes long-term debt as of December 31, 2012:

NOTE 7 – COMMITMENTS

Operating Leases

The Company is obligated under operating leases for its corporate office expiring in January 2014 and office equipment expiring in April 2016.

Aggregate minimum future lease payments are as follows:

Rent expense approximating $56,000 and $52,000 is included in general and administrative expense for the years ended December 31, 2012 and 2011, respectively.

Employment Agreements

The Company has entered into employment agreements with certain members of the executive management, which include provisions for the continued payment of salary and benefits for periods ranging from 3 months to 6 months, as well as a percentage of base salary for compliance with specified covenants in the agreements, upon termination of employment by the Company without cause, as defined.

NOTE 8 – INCOME TAXES

Differences between the income tax benefit for 2012 and 2011 and the amount determined by applying the statutory federal income tax rate (34%) to the loss before income taxes were as follows:

Significant components of the Company’s deferred tax assets are as follows as of December 31:

The change in the total valuation allowance for the years ended December 31, 2012 and 2011 was an increase of $783,000 and $1,110,000, respectively.

As of December 31, 2012, the Company had net operating loss carryforwards of approximately $13,300,000 expiring during the years December 31, 2024 through 2032. This amount can be used to offset future taxable income of the Company.

The tax years 2009 to 2012 remain open to examination by the major taxing jurisdictions to which we are subject.  Additionally, upon inclusion of the NOL carryforward tax benefits in future tax returns, the related tax benefit for the period in which the benefit arose may be subject to examination.

NOTE 9 – DEFERRED COMPENSATION

Deferred compensation, which represents the unamortized fair value of the issuance of warrants and common stock for future services to non-employees, was as follows as of December 31:

NOTE 10 – STOCKHOLDERS’ EQUITY

Common Stock and Warrants

In November 2011, we issued 546,329 shares of common stock valued at $150,000 under an agreement for professional services to be provided over a period of five months. The amortization of deferred compensation expense for the years ended December 31, 2012 and 2011 related to these shares was $90,000 and $60,000, respectively.

During the three month period ended March 31, 2011, we recorded an additional $11,836 in amortization of deferred compensation expense related to 2010 common stock and warrants issuances for services.

On December 16, 2011, we began a new private placement offering to sell up to 4,000,000 shares of common stock. Under the terms of the offering, the Company offered to sell up to 4,000,000 shares of common stock at $0.25 per share. During the first and second quarter of 2012, we received $647,400 and issued 2,589,600 shares of common stock under this offering.

On May 4, 2012, we commenced a new private placement offering to sell up to 3,000,000 shares of common stock. This offering was increased to a maximum of 4,900,000 shares of common stock on August 29, 2012. Under the terms of the offering, we offered to sell up to 4,900,000 shares of common stock at $0.25 per share with one stock purchase warrant exercisable at $0.35 per share for every one share purchased. During the second and third quarters of 2012, we received $482,750 and issued 1,900,000 shares of common stock and warrants to purchase an additional 1,900,000 shares of common stock. Aggregate commissions paid or issued to our placement agent were (1) $42,750 cash, (2) 133,000 shares of common stock valued at $43,890, and (3) warrants to purchase 152,000 shares of common stock at $0.35 per share, valued at $8,934. In June 2012, we sold 400,000 shares of common stock to an existing shareholder under the same terms as the private placement offering, receiving $100,000 and issuing 400,000 shares of common stock and warrants to purchase an additional 400,000 shares of common stock at $0.35 per share. At the same time, we issued 15,000 shares of common stock valued at $4,500 as reimbursement for expenses incurred for purposes of raising capital.

In January 2012, we issued 11,209 shares of common stock valued at $2,914 as reimbursement for expenses incurred.

During August 2012, we issued 400,000 shares of common stock valued at $120,000 under an agreement for professional services to be provided over a period of one year. The amortization of deferred compensation expense related to these shares for the year ended December 31, 2012 was $35,000.

In September 2012, we issued 636,098 shares of common stock valued at $171,746 in connection with the acquisition of SleepHealth, LLC (see Note 3, the Acquisition of SleepHealth).

In November 2012, we issued 400,000 shares of common stock and 400,000 warrants to purchase common stock valued at $26,870, exercisable at $0.35 per share, in order to convert a $100,000 promissory note.

In December, 2012, the Company issued 33,172 shares of common stock valued at $8,293 as reimbursement for expenses incurred on behalf of the Company.

During the year ended December 31, 2012, we issued 67,000 shares of common stock for the exercise of warrants for proceeds of $17,143.

NOTE 11 – SHARE-BASED COMPENSATION

Generally accepted accounting principles require share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values at the date of grant, net of estimated forfeitures.

We used the Black-Scholes option pricing model to estimate the grant-date fair value of awards granted during 2012 and 2011.  The following assumptions were used:

On March 14, 2011, the Company’s Board of Directors approved modifying the exercise price for 5,787,500 compensatory stock options and 425,282 compensatory stock purchase warrants previously issued to the Company’s employees and directors to $0.68 per share, which was the closing price of the Company’s common stock on that date.   As a result of this modification, we recorded non-cash stock compensation expense on March 14, 2011 of approximately $425,000. Additionally on March 14, 2011, the Company’s Board of Directors approved the issuance of 1,150,000 stock options to certain employees.  These new options were granted at the closing market price, $0.68, of the Company’s common stock on the date of issuance and have a 10 year term.  Vesting is immediate for 150,000 options and in equal increments on March 14, 2012; 2013; and 2014 for 1,000,000 of the options. 

In total, the Company recorded $301,108 and $923,737 for the years ended December 31, 2012 and 2011, respectively, of share-based compensation expense related to employee and  board members stock options.    As of December 31, 2012, approximately $475,434 of unrecognized compensation expense related to non-vested share-based awards remains to be recognized over a weighted average period of approximately 2 years.

Stock Options

During 2004, the Board of Directors of the Company adopted a stock option plan (the “Plan”) and authorized up to 4,000,000 shares to be issued under the Plan.  In April 2009, the Company’s Board of Directors authorized an increase in the number of shares to be issued under the Plan to 10,000,000 shares and to include the independent Board Members in the Plan in lieu of continuing the previous practice of granting warrants each quarter to independent Board Members for services.  At December 31, 2012, there were 2,907,500 shares of common stock reserved for issuance under the Plan.  The Plan is intended to permit stock options granted to employees to qualify as incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended (“Incentive Stock Options”).  All options granted under the Plan that are not intended to qualify as Incentive Stock Options are deemed to be non-qualified options.  Stock options are granted at an exercise price equal to the fair market value of the Company’s common stock on the date of grant, typically vest over periods up to 4 years and are typically exercisable up to 10 years.

The weighted-average assumptions used in the option pricing model for stock option grants were as follows:

The following tables summarize all stock option activity of the Company for the years ended December 31, 2012 and 2011:

As of December 31, 2012, there is no aggregate intrinsic value of outstanding stock options as the closing price of the Company’s common stock on the last trading day of the year was below the exercise price of all outstanding stock options.   The amount of aggregate intrinsic value will change based on the fair market value of the Company’s common stock.

Warrants

Warrants are issued to third parties as payment for services, debt financing compensation and conversion and in conjunction with the issuance of common stock.  The fair value of each common stock warrant issued for services is estimated on the date of grant using the Black-Scholes option pricing model.  The following weighted average assumptions were used for warrants granted in 2012 and 2011:

The following table represents the Company’s warrant activity for the years ended December 31, 2012 and 2011:

We granted 905,144 warrants for services during 2012 at exercise prices ranging from $0.19 to $0.35 per share, exercisable over ten years, and 2,300,000 warrants with private placement financing transactions and 2,500,000 warrants in connection with debt financing (Note 6), exercisable over five years.  All of the warrant issuances vested immediately.  The fair value of the warrants was calculated as of the date of the grant utilizing the Black-Scholes option pricing model and assumptions as detailed above.  The total amount of the fair value of warrants totaling $242,179 was recorded in 2012 when vesting occurred.

NOTE 12 – RELATED PARTY TRANSACTIONS

Officers and Directors

During April 2009, the Company’s Board of Directors authorized the inclusion of the board members in the Company’s stock option plan in lieu of continuing the previous practice of granting warrants each quarter to independent board members.  Each board member was granted options to purchase 400,000 shares of the Company’s common stock, valued at approximately $233,000 each, at an exercise price of $1.63.  Vesting occurs at the end of each complete calendar quarter served as an independent board member of the Company at a rate of 20,000 shares each per quarter.  The options are exercisable in whole or in part before September 30, 2019.

NOTE 13 – DEFINED CONTRIBUTION PLAN

The Company maintains a tax-qualified retirement plan that provides all regular employees with an opportunity to save for retirement on a tax-advantaged basis.  Under the 401(k) plan, 100 percent of participants’ contributions up to a maximum of 3 percent of compensation and 50 percent of participants’ contributions up to an additional 2 percent of compensation are matched.  Company contributions under the plan were approximately $13,000 for both December 31, 2012 and 2011.

NOTE 14 – MAJOR CUSTOMERS AND VENDORS

Major customers and vendors are defined as a customer or vendor from which the Company derives at least 10% of its revenue and cost of revenue, respectively.

Vytex Division:

During 2012, the Vytex Division had product revenue from six major customers, which comprised 21%, 17%, 17%, 13%, 12% and 12% of total Vytex revenue.  We had $20,395 in accounts receivable from one major customer at December 31, 2012.  During 2012, we had purchases from four major vendors, which comprised 30%, 25%, 16% and 11% of cost of revenue.   No amounts were owed to major vendors at December 31, 2012.

During 2012, international revenue was approximately 65% and domestic revenue was approximately 35% of total revenue.

During 2011, the Vytex Division’s product revenue was from four major customers, which comprised 23%, 16%, 15%, and 10% of total revenue.  We had accounts receivable of $6,561 at December 31, 2011 from the major customer comprising 10% of the Company’s total revenue.  During 2011, cost of revenue was from three major vendors, which comprised 39%, 36% and 20% of total cost of revenue.  Accounts payable owed to the three major vendors were $24,873, $30,896, and $32,850, respectively, at December 31, 2011.

During 2011, the Company’s revenue were approximately 56% and 44% to customers in the United States and outside of the United States, respectively. 

Sleephealth Division:

During 2012, the SleepHealth Division had service revenue from two major customers, which comprised 11% and 10% of total revenue.  We had accounts receivable from these customers in the amount of $17,350 and $46,448 at December 31, 2012.  Our cost of revenue is primarily technician’s wages and salaries and no individual earnings constitute 10% of cost of sales.

 During 2012, 100% of SleepHealth revenue was earned in the southeastern United States.

NOTE 15 – RISKS AND UNCERTAINTIES

The Company is exposed to commodity price risk, mainly associated with variations in the market price for NRL as well as wintering of the Hevea trees, which differs for each country.  The timing and magnitude of industry cycles are difficult to predict and are impacted by general economic conditions including the buying climate in China.  The Company responds to changes in NRL prices by adjusting sales prices on a weekly basis and by turning rather than holding inventory in anticipation of higher prices.  The Company actively manages its exposure to commodity price risk and monitors the actual and expected spread between forward selling prices and purchase costs and processing and shipping expense.  The Company also currently spreads the processing of Vytex NRL among three continents.  Sales contracts are based on forward market prices, and generally orders are placed 30 to 90 days ahead of shipment date due to these fluctuations.  However, financial results may be negatively impacted where selling prices fall more quickly than purchase price adjustments can be made or when levels of inventory have an anticipated net realizable value that is below cost.

NOTE 16 – SEGMENT INFORMATION AND GEOGRAPHIC DATA

Our operating segments are the Vytex Division and the SleepHealth Division. These segments have distinct lines of business, service or distribution methods, separate financial information and are regularly reviewed by management.

During the greater part of 2012, our Vytex segment sold or patented natural rubber latex in toll manufacturing arrangements. Vystar is transitioning from a toll manufacturing model to a licensing model where cost of goods sold will be carried by the distributor licensing the technology to process Vytex NRL. In December, 2012 Vystar signed an addendum to its existing agreement with Centrotrade Deutschland to license Vytex NRL technology by securing the raw material, processing the Vytex NRL using dispersion kits, storing, shipping, billing, collecting and paying the licensing fee. Vytex segment revenue can be derived from anywhere in the world.

We acquired SleepHealth on September 13, 2012. SleepHealth provides sleep lab management services to physician offices and multi-specialty clinics in the states of Georgia, North Carolina and South Carolina. This line of business is expected to continue to serve customers in the southeastern United States for the foreseeable future.

Total revenue by industry segment includes sales to unaffiliated customers. There are no sales between our industry segments.

The following sets forth key financial information for our segments:

NOTE 17 – SUBSEQUENT EVENTS