Vystar Corp - Quarter Report: 2012 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q 

For the quarterly period ended March 31, 2012

OR

For the transition period from

Commission File Number 000-53754

VYSTAR CORPORATION

(Exact Name of Registrant as Specified in its Charter)

3235 Satellite Blvd.

Building 400, Suite 290

Duluth, GA 30096

(Address of Principal Executive Offices, Zip Code)

(770) 965-0383

(Registrant's telephone number including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by 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    x      NO   ¨

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES   x     NO   ¨

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   ¨     NO   x

As of May 4, 2012, there were 19,072,248 shares of the Registrant’s common stock, par value $0.0001 per share, outstanding.

Vystar Corporation

Form 10-Q for the Quarter Ended March 31, 2012

Index

Part I.       FINANCIAL INFORMATION

ITEM 1.                  Financial Statements

VYSTAR CORPORATION

BALANCE SHEETS

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

VYSTAR CORPORATION

STATEMENTS OF OPERATIONS

(unaudited)

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

VYSTAR CORPORATION

STATEMENTS OF CASH FLOWS

(unaudited)

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

VYSTAR CORPORATION

NOTES TO FINANCIAL STATEMENTS

March 31, 2012 (unaudited)

NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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"). This technology reduces antigenic protein in natural rubber latex products to virtually undetectable levels in both liquid NRL and finished latex products.  Vystar has introduced Vytex NRL, its “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 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. The Company produces Vytex through toll manufacturing and licensing agreements and has introduced Vytex NRL into the supply channels with targeted marketing campaigns directed to the end users.  During 2008, the Company signed an agreement with Revertex (Malaysia) for the production of Vytex NRL.  Revertex is a non-exclusive, toll manufacturer for Vystar.  To implement our licensing model, we signed a licensing agreement with Pica de Hule Natural, a division of GrupoAgroindustrialOccidente (“Occidente”), located in Guatemala, in March 2010.  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.

Basis of Presentation

The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles of the United States of America (“GAAP”) for interim financial information.  Accordingly, certain information and footnotes required by GAAP for complete financial statements may be condensed or omitted.  These interim financial statements should be read in conjunction with our audited financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission ("SEC").  In the opinion of Vystar management, these financial statements contain all adjustments (which comprise only normal and recurring accruals) necessary to present fairly the financial position and results of operations as of and for the three month periods ended March 31, 2012 and 2011.

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.

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 banks in many cases exceeds the Federal Deposit Insurance Corporation, or FDIC, insurance limits.  While we monitor our cash balances 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.

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.

Loss Per Share

Because the Company reported a net loss for the three month periods ended March 31, 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 4,877,500 shares and 4,193,333 shares of common stock for the three months ended March 31, 2012 and 2011, respectively, as their effect would be anti-dilutive.  Warrants to purchase 7,696,896 shares and 1,933,725 shares of common stock for the three months ended March 31, 2012 and 2011, respectively, were also excluded from the computation of diluted loss per share as their effect would be anti-dilutive.

VYSTAR CORPORATION

NOTES TO FINANCIAL STATEMENTS

March 31, 2012 (unaudited)

Revenues

We expect to derive most of our revenue from the sales of or license fees from our Vytex Natural Rubber Latex raw material to various manufacturers of rubber and rubber end products using NRL and/or their distributors.  The Company recognizes revenue 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.    Revenue is recognized at the time product is shipped and title passes to the customer.

Fair Value of Financial Instruments

The Company’s financial instruments consist of cash, accounts receivable, accounts payable, accrued expenses, line of credit and shareholder notes payable.  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 March 31, 2012 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.

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, the Company has incurred significant losses and experienced negative cash flow since its inception.  At March 31, 2012, the Company had cash of $335,481 and a deficit in working capital of $474,828.  Further, at March 31, 2012, the accumulated deficit amounted to $18,346,235.  As a result of the Company's history of losses and financial condition, there is substantial doubt about the ability of the Company 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 revenues adequate to support the Company’s cost structure.  Management plans to finance future operations through the use of cash on hand, increased revenues, and a private placement that is discussed in Note 7.    We also expect to receive proceeds from stock warrant exercises from existing shareholders.  As the Company’s product continues to gain market acceptance, the Company expects sales in 2012 and beyond to continually increase.

There can be no assurances that the Company will be able to achieve its projected level of revenues in 2012 and beyond.  If the Company is unable to achieve its projected revenues 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 2012, 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.

VYSTAR CORPORATION

NOTES TO FINANCIAL STATEMENTS

March 31, 2012 (unaudited)

NOTE 3 – PROPERTY AND EQUIPMENT

Property and equipment consists of the following at March 31, 2012 and December 31, 2011:

Depreciation expense for the three months ended March 31, 2012 and 2011 was $223 and $557, respectively.

NOTE 4 – PATENTS AND TRADEMARKS

Patents represent legal and other fees associated with the registration of patents.  The Company has two patents and two provisional patent submissions with the United States Patent and Trade Office (USPTO), as well as an international PCT (Patent Cooperation Treaty) patent.

The Company has incurred legal and other fees associated with its application to the USPTO for trademark protection for “Vystar”, “Vytex”, and “Created by Nature.  Recreated by Science.” during 2011 and 2010.

Patents and trademarks are as follows:

Amortization expense for the three months ended March 31, 2012 and 2011 was $3,252 and $2,660, respectively.

NOTE 5 – INCOME TAXES

There is no income tax benefit recorded for the losses for the three months ended March 31, 2012 and 2011 since management has determined that the realization of the net deferred tax asset is not assured and has created a valuation allowance for the entire amount of the net deferred tax asset.

VYSTAR CORPORATION

NOTES TO FINANCIAL STATEMENTS

March 31, 2012 (unaudited)

NOTE 6 – NOTES PAYABLE AND LOAN FACILITY

On April 29, 2011, the Company executed with CMA Investments, LLC, a Georgia limited liability company (“CMA”), a 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 terms of the CMA Note, the Company may draw up to a maximum principal amount of $800,000. Interest, which is computed at LIBOR plus 5.25% (5.5% at March 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 three months ended March 31, 2012 was 5.53%. 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. This agreement was modified during the three months ended March 31, 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 on a straight line basis over the remaining term of the CMA Note. Amortization of the financing costs associated with the CMA Note amounted to $103,431 for the three months ended March 31, 2012.

On March 11, 2011, the Company issued to existing shareholders of the Company an aggregate of $400,000 of convertible promissory notes (the “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 from January 1, 2011, and (iii) are convertible into shares of the Company’s 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.  The Notes may be prepaid by the Company without penalty upon 15 days prior notice to the holders. The computed value of the warrants, $23,896, is reflected as a debt discount and netted against the notes payable on the balance sheet. Additionally, in conjunction with this transaction, the Company recorded a beneficial conversion feature, given the price allocated to the Notes was less than the market price on the date of issuance, creating an intrinsic value in the conversion option. An additional $23,896 was recorded as a reduction in the 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 Notes under the effective interest method.

On May 31, 2011, the Company issued to existing shareholders of the Company an aggregate of $125,000 of convertible promissory notes (the “Shareholder 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 Shareholder Notes are (i) unsecured, (ii) bear interest at an annual rate of ten percent (10%) per annum from date of issuance, and (iii) are convertible at any time until maturity at the holder’s option into shares of the Company’s common stock at a weighted average conversion rate of $0.49 of principal and interest for each such share. No payments of interest or principal are payable until March 11, 2013. The Shareholder Notes may be prepaid by the Company without penalty upon 15 days prior notice to the holders.

VYSTAR CORPORATION

NOTES TO FINANCIAL STATEMENTS

March 31, 2012 (unaudited)

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  this transaction, 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%.

The current base conversion price for the Shareholder Notes is $0.68 per share or 1,470.59 shares of the Company’s common stock for each $1,000 of principal and accrued interest. As of March 31, 2012 there had been no conversions.

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.

NOTE 7 – STOCKHOLDERS’ EQUITY

Common Stock and Warrants

On December 16, 2011, the Company 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. As of March 31, 2012 the Company has received $637,400 and issued 2,549,600 shares of common stock under the terms of the offering.

From January through February 2012, the Company issued 28,138 shares of common stock valued at $9,005 for interest for the related party CMA Note (Note 6).

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

The Company recorded $90,000 and $11,836 in amortization of deferred compensation expense during the three-month periods ended March 31, 2012 and 2011, respectively, related to 2011 and 2010 common stock and warrants issuances for services.

NOTE 8 – 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.

Options

The Company used the Black-Scholes option pricing model to estimate the grant-date fair value of awards granted.  No stock option grants were made in the three months ended March 31, 2012. The following assumptions were used for option awards granted during the three months ended March 31, 2011:

VYSTAR CORPORATION

NOTES TO FINANCIAL STATEMENTS

March 31, 2012 (unaudited)

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, the Company recorded non-cash stock compensation expense on March 14, 2011 of $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 issued 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 $190,621 and $589,602 of stock-based compensation expense for the three month periods ended March 31, 2012 and 2011, respectively, related to employee and board member stock options and stock and warrants issued to nonemployees. As of March 31, 2012, $628,000 of unrecognized compensation expense related to non-vested share-based awards remains to be recognized over a weighted average period of approximately 2.3 years.

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, which was also approved by the Company’s shareholders, 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 March 31, 2012, there were 3,512,500 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 typically 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 for the three months ended March 31, 2011:

  The following table summarizes all stock option activity of the Company for the three months ended March 31, 2012:

VYSTAR CORPORATION

NOTES TO FINANCIAL STATEMENTS

March 31, 2012 (unaudited)

 Warrants

Warrants are issued to third parties as payment for services 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 for the three months ended March 31:

The following table represents the Company’s warrant activity for the three months ended March 31, 2012:

The Company issued 375,939 warrants for services during the three months ended March 31, 2012 at exercise prices ranging from $0.26 to $0.43 per share, exercisable over 10 years from the grant date.  All of the warrants 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 was $38,640 and was recorded as noncash share-based compensation expense when vesting occurred.

NOTE 9 – RELATED PARTY TRANSACTIONS

At December 31, 2011, the Company had accrued severance of $3,324, recorded as accrued compensation, payable to the Company’s former CFO, Glenn Smotherman. This liability was paid in full as of March 31, 2012.   

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

GENERAL

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"). This technology reduces antigenic protein in natural rubber latex products made with Vytex to virtually undetectable levels. The allergic reactions to untreated latex are a significant detriment affecting numerous individuals globally that use many different products made with NRL. With non-latex products growing at a rapid rate due to these allergy problems, the costs for alternative materials incurred by the manufacturers of these many different products have greatly increased. Nearly all substitute materials have been more expensive than NRL – by a factor of five in some cases. This fact has changed in the past thirteen months as NRL prices have increased by as much as 66% and continue to fluctuate in the higher priced zone.  Synthetic prices have not kept up with this increase as supply for nitrile and neoprene has exceeded demand, while crude oil prices have not kept up with the increase in NRL thus moving both below NRL itself; and, therefore well below Vytex NRL.  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. We intend for Vytex NRL to become the standard source of latex and latex substitutes, not unlike a standard computer operating system on which many other applications can run. Over 9.7 million tonnes of NRL are produced globally of which just over 1.4 million tonnes are in liquid latex form. There are more than 40,000 products made from the liquid latex while the other eight million plus tonnes are used to produce tires and other hard rubber 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, catheters and other items. We have introduced Vytex NRL into the supply channels with aggressive, targeted marketing campaigns directed to the end users to create the pull-through.  This provides a competitive advantage for manufacturers utilizing Vytex NRL, ranging from those who use it as a raw material to those who are using a product that contains NRL, including manufacturers of the end products.

During the fourth quarter of 2009, we transitioned from the development stage to the operating stage.  This resulted from our completion of substantially all the activities associated with the developmental stage of our business and we are now involved in expanding our operations, particularly increasing market acceptance and sales of Vytex.  We are marketing to multiple industries concurrently, targeting regulated (condoms, surgical and exam gloves) and non-regulated product (foam and non-medical and non-food packaging adhesive) categories to balance the lengthier sales cycles inherent in medical devices.  A manufacturer’s conversion from their standard latex or synthetic raw material to Vytex NRL can be a protracted process, ranging from twelve to eighteen months to complete the sales cycle due to the multiple steps required.  The sales cycle generally starts with a laboratory analysis of Vytex NRL whereby physical properties and protein levels of the finished goods are tested by potential customers to ensure it meets the required specifications and then progresses to a full production run on the manufacturer’s equipment.  A manufacturer’s decision to convert to Vytex NRL is impacted by many functional areas including research and development, manufacturing, sales, marketing, purchasing and finance.   Each of these areas has a significantly different decision-making role per company thus the large difference in the sales cycle.  If the product is regulated and requires regulatory clearances or approvals prior to commercialization, the sales cycle could be extended by another nine to twelve months for testing, filing and agency review.  By diversifying the target product categories we believe this balanced approach will reduce our exposure to individual market fluctuations and increase our aggregate revenues.

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 revenues 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.   Note 1, "Summary of Significant Accounting Policies" of this Form 10-Q and in the Notes to Financial Statements in the Company's 2011 Form 10-K describes the significant accounting policies and methods used in the preparation of the Company's financial statements .

RESULTS OF OPERATIONS

Comparison of the Three Months Ended March 31, 2012 with the Three Months Ended March 31, 2011

Revenues

Revenues for the three months ended March 31, 2012 and 2011 were $124,028 and $119,309, respectively, for an increase of $4,989 or 4.2%.

Operating Expenses

Our operating expenses were $535,184 and $1,067,143 for the three months ended March 31, 2012 and 2011, respectively, for a decrease of $531,959 or 49.8%.   The decrease resulted primarily from a decrease in non-cash share-based compensation expense of $398,979 for the three months ended March 31, 2012 over 2011. In addition, the Company moved to reduce overall operating expenses in the latter months of 2011, resulting in across-the-board lower operating expenses for the first three months of 2012.

For the three months ended March 31, 2012 and 2011, sales and marketing expenses were $95,496 and $250,612, respectively.  The decrease of $155,116 is primarily due to the departure of the Company’s former Executive Vice President of Sales and Business Development on March 31, 2011. 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 three months ended March 31, 2012 and 2011, general and administrative expenses were $431,255 and $790,171, respectively.  The decrease of $358,916 is primarily composed of decreases in non-cash share based compensation of $324,361 and $52,441 in compensation expenses. The decreased compensation expense resulted from the resignation in August 2011 of the Company’s Chief Financial Officer and also by Company officers receiving a portion of their salaries in stock options rather than by cash payment.   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.

Included in our operating expenses for the three months ended March 31, 2012 was $8,433 for research and development expenses compared to $26,360 for the three months ended March 31, 2011 for a decrease of $17,927 or 68%.    Research and development expenses consist primarily of compensation for employees and contractors engaged in internal research and product development activities, laboratory operations, and related operating expenses.

Other Income (Expense)

Other income for the three months ended March 31, 2012, consisted of $5,250 of other income, $84 of interest income on cash deposits, and interest expense of $138,487. The interest expense includes amortization of financing related costs of $103,432, $20,445 incurred in connection with the shareholder notes payable and the beneficial conversion features, interest on the notes payable of $9,249 and miscellaneous interest of $5,361.   This compares to $199 of interest income for the three months ended March 31, 2011 and $37,753 of interest expense.

Net Loss

Net loss was $684,992 and $1,063,538 for the three months ended March 31, 2012 and 2011, respectively, a decrease of $378,546 or 35.6% in the net loss.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2012, we had current assets of $455,453, including $335,481 in cash, and $930,280 of current liabilities, or negative working capital of $474,827.  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.  As a result of the Company's history of losses and financial condition, there is substantial doubt about the ability of the Company 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 revenues adequate to support the Company’s cost structure.  Management plans to finance future operations through the use of cash on hand, increased revenues, and an on-going private placement.   We also expect to receive proceeds from stock warrant exercises from existing shareholders.  As the Company’s product continues to gain market acceptance, the Company expects sales in 2012 and beyond to continually increase.

There can be no assurances that the Company will be able to achieve its projected level of revenues in 2012 and beyond.  If the Company is unable to achieve its projected revenues 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 2012, 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.

Sources and Uses of Cash

For the three months ended March 31, 2012 and 2011, net cash used by operations was $373,906 and $40,984 respectively.  The negative cash flow for the three months ended March 31, 2012 resulted primarily from the net loss of $684,992 reduced by non-cash charges related to non-cash share-based compensation expense of $202,541 and amortization of $124,004.  The negative cash flow for the three months ended March 31, 2011 resulted primarily from the net loss of $1,063,538 reduced by non-cash charges related to non-cash share-based compensation expense of $589,602 and amortization of $29,633.  

Net cash used in investing activities for the three months ended March 31, 2012 was $15,197 of legal and other costs associated with our patents.  Net cash used in investing activities for the three months ended March 31, 2011 was $25,795 of legal and other costs associated with our patents.  

Net cash provided by financing activities for the three months ended March 31, 2012 was $707,925 comprised of $646,800 in proceeds from the purchase of common stock and $61,125 in proceeds from the line of credit.  Net cash provided by financing activities for the three months ended March 31, 2011 was $55,918 comprised of $3,750 in proceeds from the exercise of common stock purchase warrants and $400,000 in proceeds from notes payable offset by $347,832 in costs incurred in securing the line of credit facility and notes payable.

Our future expenditures and capital requirements will depend on numerous factors, including: the rate at which we can introduce and sell 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 competing technological developments. We expect that we will incur approximately $1.2 million for operating expenses over the next 12 months.  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.

We expect that our cash used in operations will continue to increase as a result of the following planned activities:

Off-Balance Sheet Arrangements

 We do not have any off-balance sheet arrangements that may be reasonably likely to have a current or future material effect on our financial condition, liquidity, or results of operations.

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

Our Management’s Discussion and Analysis contains not only statements that are historical facts, but also statements that are forward-looking (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). Forward-looking statements are, by their very nature, uncertain and risky. These risks and uncertainties include international, national and local general economic and market conditions; demographic changes; our ability to sustain, manage, or forecast growth;  product development, introduction and acceptance; existing government regulations and changes in, or the failure to comply with, government regulations; adverse publicity; competition; fluctuations and difficulty in forecasting operating results; changes in business strategy or development plans; business disruptions; the ability to attract and retain qualified personnel; the ability to protect technology; and other risks that might be detailed from time to time in our filings with the Securities and Exchange Commission.

Although the forward-looking statements in this Quarterly Report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by them. Consequently, and because forward-looking statements are inherently subject to risks and uncertainties, the actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. You are urged to carefully review and consider the various disclosures made by us in this report and in our other reports as we attempt to advise interested parties of the risks and factors that may affect our business, financial condition, and results of operations and prospects.

ITEM 3.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

None

ITEM 4.         CONTROLS AND PROCEDURES

               (A)     Evaluation of disclosure controls and procedures

 Our management, including our principal executive and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2012.  Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in this quarterly report on Form 10-Q has been appropriately recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive and principal financial officer, to allow timely decisions regarding required disclosure.  Based on that evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures are effective to the reasonable assurance level.

               (B)     Changes in internal control over financial reporting

We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment.  Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes.

There were no changes in our internal control over financial reporting that occurred during the first quarter of 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II.  OTHER INFORMATION

ITEM 1.         LEGAL PROCEEDINGS

 None.

ITEM 2.         UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Set forth below is information regarding shares of common stock, warrants and options to purchase common stock issued by the Company in the quarter ended March 31, 2012, that were not registered under the Securities Act of 1933, as amended (the “Securities Act”). Also included is the consideration, if any, received by the Company for such shares, warrants and options and information relating to the section of the Securities Act, or rule of the Securities and Exchange Commission, under which exemption from registration was claimed.

(a)     Common Stock and Warrant Financings

From January 1, 2012 through March 31, 2012, the Company issued 2,549,600 shares of its common stock at a price of $0.25 per share.

From January 1, 2012 through March 31, 2012, the Company issued 16,000 shares of common stock upon the exercise of warrants at $0.25 per share.

From January 1, 2012 through March 31, 2012, the Company issued 20,000 shares of common stock upon the exercise of warrants at $0.27 per share.

From January 1, 2012 through March 31, 2012, the Company issued 28,138 shares of its common stock valued at $9,005 for interest associated with the related party line of credit established during 2011.

From January 1, 2012 through March 31, 2012, the Company issued 11,209 shares of its common stock valued at $2,914 for services rendered to the Company.

From January 1, 2012 through March 31, 2012, the Company issued warrants to purchase 172,298 shares of common stock for services rendered to the Company per the following:

(b)     Stock Option Grants

None.

(c)      Application of Securities Laws and Other Matters

No underwriters were involved in the foregoing sales of securities. The securities described in section (a) of this Item 2 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.

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 in this Item 2 included appropriate legends setting forth that the securities had not been registered and the applicable restrictions on transfer.

ITEM 3.         DEFAULTS UPON SENIOR SECURITIES

 None

ITEM 4.         MINE SAFETY DISCLOSURES

 Not applicable

ITEM 5.         OTHER INFORMATION

 None

ITEM 6.         EXHIBITS

Exhibit Index *

* Some Exhibits have certain confidential information redacted pursuant to a request for confidential treatment

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.