VYST Vystar Corporation (PK)

NOTES TO FINANCIAL STATEMENTS

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 global multi-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 (mattresses, pillows, mattress toppers, etc.), furniture (foam and adhesives), carpet, paints, coatings, protective equipment, sporting equipment, and, especially health care products such as condoms, surgical and exam gloves, among others.

Vystar has expanded into the consumer arena with an introduction into mattresses, mattress toppers and pillows aligning with key foam manufacturers, mattresses, toppers, pillow producers, and furniture stores in specific areas of the Unites States. On January 22, 2015, Vystar announced the signing of an exclusive domestic distribution agreement with Worcester, MA based Nature’s Home Solutions (NHS) who sources eco-friendly materials and technologies for use in furnishings and other markets. In September 2016, the Vystar Board of Directors voted to end the January 2015 NHS agreement and replace it with a global exclusive for foam manufactured with Vytex and sold into the home furnishings industry. This change reflects the global nature of the mattress, topper and pillow businesses, the need for local warehousing, and access to container loads of foam cores and pillows for domestic, European and Asian manufacturers.

Basis of Presentation

The accompanying unaudited condensed financial statements (“the 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, 2017, 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 period ended March 31, 2018 and 2017.

Estimates

The preparation of financial statements in conformity with 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, realization and valuation of inventories 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.

Loss Per Share

Because the Company reported a net loss for the three-month periods ended March 31, 2018 and 2017, common stock equivalents, including stock options and warrants, were anti-dilutive; therefore, the amounts reported for basic and diluted loss per share were the same. Excluded from the computation of diluted loss per share were options outstanding to purchase 8,298,271 shares and 9,718,271 shares of common stock for the three months ended March 31, 2018 and 2017, respectively, as their effect would be anti-dilutive. Warrants to purchase 16,469,582 and 18,084,609 shares of common stock for the three months ended March 31, 2018 and 2017, respectively, were also excluded from the computation of diluted loss per share as their effect would be anti-dilutive.

Inventories

Inventory cost includes those costs directly attributable to the product before sale. Inventory consists of foam slabs and is carried at the lower of cost or (net realizable value), using first-in, first-out method of determining cost. As of March 31, 2018, the Company had $103,055 in finished goods inventory. At December 31, 2017 there was no inventory.

Revenues

Revenue Recognition

On January 1, 2018, we adopted FASB Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”). The new guidance sets forth a new five-step revenue recognition model which replaces the prior revenue recognition guidance in its entirety and is intended to eliminate numerous industry-specific pieces of revenue recognition guidance that have historically existed in U.S. GAAP. The underlying principle of the new standard is that a business or other organization will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects what it expects to receive in exchange for the goods or services. The standard also requires more detailed disclosures and provides additional guidance for transactions that were not addressed completely in the prior accounting guidance.

We reviewed all contracts at the date of initial application and elected to use the modified retrospective transition method, where the cumulative effect of the initial application is recognized as an adjustment to opening retained earnings at January 1, 2018. Therefore, comparative prior periods have not been adjusted and continue to be reported under FASB ASC Topic 605, Revenue Recognition, (“ASC 605”). The adoption of the new revenue recognition guidance was immaterial to our condensed consolidated statements of operations, balance sheet, and cash flows as of and for the three months ended March 31, 2018. Refer to Note 2 for additional information regarding our adoption of ASC 606.

Our principal activities from which we generate our revenue are product sales.

Revenue is measured based on consideration specified in a contract with a customer. A contract with a customer exists when we enter into an enforceable contract with a customer. The contract is based on either the acceptance of standard terms and conditions on the websites for e-commerce customers and via telephone with our third-party call center for our print media and direct mail customers, or the execution of terms and conditions contracts with retailers and wholesalers. These contracts define each party’s rights, payment terms and other contractual terms and conditions of the sale. Consideration is typically paid prior to shipment via credit card or check when our products are sold direct to consumers or approximately 30 days from the time control is transferred when sold to wholesalers, distributors and retailers. We apply judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience and, in some circumstances, published credit and financial information pertaining to the customer.

A performance obligation is a promise in a contract to transfer a distinct product to the customer, which for us is transfer of over-the-counter drug and consumer care products to our customers. Performance obligations promised in a contract are identified based on the goods that will be transferred to the customer that are both capable of being distinct and are distinct in the context of the contract, whereby the transfer of the goods is separately identifiable from other promises in the contract. We have concluded the sale of bottled finished goods and related shipping and handling are accounted for as the single performance obligation.

The transaction price of a contract is allocated to each distinct performance obligation and recognized as revenue when or as the customer receives the benefit of the performance obligation. The transaction price is determined based on the consideration to which we will be entitled to receive in exchange for transferring goods to the customer. We issue refunds to e-commerce and print media customers, upon request, within 30 days of delivery. We estimate the amount of potential refunds at each reporting period using a portfolio approach of historical data, adjusted for changes in expected customer experience, including seasonality and changes in economic factors. For retailers, distributors and wholesalers, we do not offer a right of return or refund and revenue is recognized at the time products are shipped to customers. In all cases, judgment is required in estimating these reserves. Actual claims for returns could be materially different from the estimates. The were no estimated reserve for sales returns and allowances at March 31, 2018 and December 31, 2017, respectively.

We recognize revenue when we satisfy a performance obligation in a contract by transferring control over a product to a customer when product is shipped. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by us from a customer, are excluded from revenue. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of product sales.

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, 2018 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.

Recent Accounting Pronouncements

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business . The update provides that when substantially all the fair value of the assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This update is effective for annual and interim periods beginning after December 15, 2017, and interim periods within that reporting period. We adopted this ASU on January 1, 2018 and the impact on our consolidated financial statements will depend on the facts and circumstances of any specific future transactions.

In February 2016, the FASB issued its new lease accounting guidance in ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date. A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and ASC 606, Revenue from Contracts with Customers. The new lease guidance simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. Lessees (for capital and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees may not apply a full retrospective transition approach. While we are currently assessing the impact ASU 2016-02 will have on the consolidated financial statements, we expect the primary impact to the consolidated financial position upon adoption will be the recognition, on a discounted basis, of the minimum commitments on the consolidated balance sheet under our sole noncancelable operating lease for our facility in San Diego resulting in the recording of a right of use asset and lease obligation.

The Company’s financial statements are prepared using the accrual method of accounting in accordance with GAAP 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, 2018, the Company had cash of $632,970 and a deficit in working capital of approximately $3.6 million. Further, at March 31, 2018, the accumulated deficit amounted to approximately $30 million. 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 revenues from our recent acquisitions in the second quarter of 2018 and 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 Vytex division license fees, our credit facility, stock warrant exercises from existing shareholders, raising capital through private placements of capital stock and debt.

The Company’s future expenditures will depend on numerous factors, including: the rate at which the Company can introduce and license Vytex NRL to manufacturers; the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; market acceptance of the Company’s products and services; revenue from the licensing agreement with NHS Holdings, LLC; and competing technological developments. As the Company expands its activities and operations, cash requirements are expected to increase at a rate consistent with revenue growth after the Company has achieved sustained revenue generation.

There can be no assurances that the Company will be able to achieve its projected level of revenue in 2018 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 reorient its operations during 2018, 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.

Intangible assets are as follows:

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

Amortization expense for the three months ended March 31, 2018 and 2017 was $3,920.

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

There is no income tax benefit recorded for the losses for the three ended March 31, 2018 and 2017 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.

Related Party Line of Credit (CMA Note Payable)

On November, 2 2012, the Company executed an increase with CMA Investments, LLC, a related party and a Georgia limited liability company (“CMA”), a line of credit with a principal amount of $1,500,000 (the “CMA Note”). CMA is a limited liability company of which three of the directors of the Company (“CMA directors”) were initially the members. Pursuant to the terms of the CMA Note, the Company may draw up to a maximum principal amount of $1,500,000. Interest, is computed at LIBOR plus 5.25% (6.50% at March 31, 2018), on amounts drawn and fees. The weighted average interest rate in effect on the borrowings for the three months ended March 31, 2018 was 5.25%. There are no available borrowings under the CMA note at March 31, 2018.

Fidelity Note Payable

During the three months ended March 31, 2018 separate investors have guaranteed $100,000 each with Fidelity to establish a $500,000 revolving line of credit with Fidelity. At the present time the Company is paying interest only to Fidelity at a rate of 4.5% per annum, with principal due in 2033.

Shareholder and contingent convertible Notes Payable

The following table summarizes the shareholder notes payable:

Other than the contingent convertible notes disclosed in Note 7, such notes are (i) unsecured, (ii) bear interest at an annual rate ranging from five percent (5%) to ten percent (10%) per annum, and (iii) are contingently convertible at the company’s option based on potential future events into shares of common stock.

Common Stock and Warrants

From January 1, 2018 and through the date of these financial statements, the Company has issued certain convertible promissory notes in varying amounts. The face amount of the notes represents the amount due at maturity along with the accrued interest, at which time that amount will be converted into shares of the Company stock based on the lowest 2 day closing price for the trailing 20 days prior to conversion and carrying a 35% discount.

In connection with the issuance of one of the contingently convertible notes, the Company issued a warrant to purchase 286,875 shares of the Company’s common stock. The exercise term of the warrant is at any time on or after the six (6) month anniversary or prior to the five (5) year anniversary of the related note (February 2023).

The exercise price of the warrant is $.40 per share of the Company’s common stock, as may be adjusted from time to time pursuant to the antidilution provisions of the related warrant.

The Company evaluated the warrant under ASC 480 “Distinguishing Liabilities from Equity” and ASC 815 “Derivatives and Hedging”. Due to the existence of the antidilution provision, which reduces the exercise price in the event of subsequent Dilutive Issuances, the warrant is not indexed to the Company’s common stock, and the Company has determined that the warrant meet the definition of a derivative under ASC 815. The company deemed the warrant immaterial at the date of issuance at March 31, 2018. At each subsequent reporting date, the fair value of the warrant will be remeasured and changes in the fair value will be reported in the condensed Statements of Operations.

On June 30, 2016, the Company issued 997,466 common shares as compensation under the Company’s Business Development Agreement with Blue Oar Consulting, Inc. executed in March 2013 as amended in August 2013 as amended in February 2014, as amended in June 30, 2016 and amended January 3, 2018 issued 8,916,667 shares as part of this agreement issued April 27, 2018. The Company accrued approximately $450,000, which approximates the fair value of the common stock on the measured dates (included in accrued expenses and stock payable on the condensed balance sheet).

On January 3, 2018, the Company agreed to issue 1,502,778 common shares as compensation under the Company’s Business Development Agreement with Designcenters.com issued April 27, 2018. The Company accrued approximately $75,000, which approximates the fair value of the common stock on the measured dates (included in accrued expenses and stock payable on the condensed balance sheet).

On January 3, 2018, the Company agreed to issue 11,000,000 common shares as a signing bonus under an employment agreement to the CEO Steven Rotman issued April 27, 2018. The Company accrued approximately $550,000, which approximates the fair value of the common stock on the measured dates (included in accrued expenses and stock payable on the condensed balance sheet).

On January 3, 2018, the Company agreed to issue 4,833,333 common shares as compensation under an consultant agreement to The Anchor Group issued April 27, 2018. The Company accrued approximately $242,000, which approximates the fair value of the common stock on the measured dates (included in accrued expenses and stock payable on the condensed balance sheet).

These notes are included in the table below:

*Note that these notes can be converted only after 6 months from the issue date.

From January 1, 2018 to February 9, 2018, the Company issued Convertible Promissory Notes (the “Notes”) for contract work, investment and in lieu of salary and expense reimbursement in the amount of $195,635. The Notes are (i) unsecured, (ii) bear interest at an annual rate of five percent (5%) per annum from date of issuance, and (iii) are convertible by the Company upon the closing of the previously announced intention to purchase all of the assets of NHS. The Notes mature one year from issuance but may be extended one (1) additional year by the Company. If converted, the Notes plus accrued interest are convertible into shares of the Company’s common stock at the prior twenty (20) day average closing price with a 50% discount.

On February 5, 2018, the Company issued 1,500,000 shares under the terms of a Consulting Agreement dated January 26, 2018 to STILLH20s Financial, LLC.

Cumulative Convertible Preferred Stock

On May 2, 2013, the Company began a private placement offering to sell up to 200,000 shares of the Company’s 10% Series A Cumulative Convertible Preferred Stock. Under the terms of the offering, the Company offered to sell up to 200,000 shares of preferred stock at $10.00 per share for a value of $2,000,000. The preferred stock accumulates a 10% per annum dividend and was convertible at a conversion price of $0.075 per common share at the option of the holder after a nine-month holding period. The conversion price was lowered to $0.05 per common share for those holders who invested an additional $25,000 or more in the Company’s common stock in the aforementioned September 2014 Private Placement. The preferred shares have full voting rights as if converted and have a fully participating liquidation preference.

At March 31, 2018, the 13,828 shares of outstanding preferred stock had accumulated undeclared dividends of approximately $60,133 and could be converted into 3,968,269 shares of common stock, at the option of the holder.

At December 31, 2017 and 2016, the 13,828 shares of outstanding preferred stock had accumulated undeclared dividends of approximately $63,600 and $49,800 and could be converted into 4,037,977 and 3,761,417 shares of common stock, respectively, at the option of the holder.

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

In total, the Company recorded $1,404,889 and $181,525 of stock-based compensation expense for the three-month period ended March 31, 2018 and 2017, respectively, including shares to be issued related to employee and board member stock options and common stock and warrants issued to non-employees. As of March 31, 2018, $153,000 of unrecognized compensation expense related to non-vested share-based awards remains to be recognized over a period of approximately four years.

Options and Warrants

The Company used the Black-Scholes option pricing model to estimate the grant-date fair value of option and warrant awards granted. The following assumptions were used for warrant awards during the three months ended March 31, 2018:

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 March 31, 2018, there were 2,251,729 shares of common stock available for issuance under the Plan. In 2014, the Board adopted an additional stock option plan which provides for an additional 5,000,000 shares which are all available as of March 31, 2018. 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.

There were no options granted during the three-month period ended March 31, 2018. The following table summarizes all stock option activity of the Company for the period.

Warrants

Warrants are issued to employees for expenses and for compensation in lieu of cash as well as 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 weighted-average assumptions used in the option pricing model for stock warrant grants were as follows:

The following table represents the Company’s warrant activity for the three months ended March 31, 2018: