UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington D.C. 20549





FORM 10-Q





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





For the quarterly period ended June 30, 2012





OR





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





For the transition period from to .





Commission File Number 000-54170






ZYTO CORP


(Exact name of registrant as specified in its charter)







Delaware

20-5534033(State or other jurisdiction ofincorporation or organization)

(I.R.S. EmployerIdentification Number)





387 South 520 West, Suite 200


Lindon, UT


(Address of principal executive offices)





84042


(Zip Code)





Registrant’s telephone number, including area code: (801) 224-7199






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 website every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for 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 definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.




Large accelerated filer

 ̈

Accelerated filer

 ̈Non-accelerated filer

 ̈  (Do not check if a smaller reporting company)

Smaller reporting company

x





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





Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 34,857,543 shares of common stock, par value $0.0001 per share, as of August 14, 2012.








TABLE OF CONTENTS








PART I – FINANCIAL INFORMATION





Item 1.
Financial Statements:
1Condensed Consolidated Balance Sheets as of June 30, 2012, and December 31, 2011 (Unaudited)
1Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2012 and 2011 (Unaudited)
2Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011 (Unaudited)
3Notes to Condensed Consolidated Financial Statements (Unaudited)
4Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
16Item 3.
Quantitative and Qualitative Disclosures about Market Risk
26Item 4.
Controls and Procedures
26PART II – OTHER INFORMATIONItem 5.
Legal Proceedings
27Item 6.
Exhibits
27










PART I – FINANCIAL INFORMATION





Item 1.           Financial Statements





ZYTO CORP AND SUBSIDIARYCONDENSED CONSOLIDATED BALANCE SHEETSJune 30,


December 31,2012


2011ASSETSCurrent Assets:Cash and cash equivalents

$
106,914


$
87,364Accounts receivable, net of allowance for doubtful accounts of $38,903 and $115,633, respectively


354,973



217,712Prepaid expenses


23,490



32,245Inventories


34,325



17,558Other current assets


7,518



7,525Total current assets


527,220



362,404Long-term accounts receivable, net of allowance for doubtful accounts of $44,434 and $13,071, respectively


162,514



117,647Property and Equipment, net of accumulated depreciation of $293,263 and $259,747, respectively


106,929



132,693Technology, net of accumulated amortization of $193,195 and $109,650, respectively


354,864



317,581Total assets

$
1,151,527


$
930,325LIABILITIES AND STOCKHOLDERS' DEFICITCurrent Liabilities:Accounts payable

$
471,764


$
488,967Accrued expenses


201,534



178,121Accrued interest related party


480,276



406,003Line of credit


-



100,000Short-term notes payable


96,942



96,942Deferred revenue


79,563



104,927Current portion of note payable


15,899



-Current portion of capital lease


4,296



4,296Total current liabilities


1,350,274



1,379,256Warranty Reserve


8,476



8,476Note Payable, net of current portion


80,495



-Related Party Note Payable


2,435,620



2,371,241Capital lease, net of current portion


5,573



9,522Total liabilities


3,880,438



3,768,495STOCKHOLDERS' DEFICITCommon stock, par value $.0001 per share, 200,000,000 shares authorized and 34,857,543 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively


3,486



3,486Additional paid-in capital


5,280,170



5,267,765Subscriptions receivable


(2,000
)


(2,000
)Accumulated deficit


(8,010,567
)


(8,107,421
)Total stockholders' deficit


(2,728,911
)


(2,838,170
)Total liabilities and stockholders' deficit

$
1,151,527


$
930,325





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


1


ZYTO CORP AND SUBSIDIARYCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONSFor the Three Months Ended June 30,


For the Six Months Ended June 30,2012


2011


2012


2011Revenues, net

$
1,397,785


$
1,175,176


$
2,484,126


$
1,983,290Cost of sales


115,737



54,014



156,918



123,850Gross Profit


1,282,048



1,121,162



2,327,208



1,859,440Operating Expenses:Selling and marketing expenses


559,039



631,977



902,742



1,087,330General and administrative expenses


499,105



432,024



1,051,634



921,528Research and development expenses


104,514



41,581



163,398



79,978Total operating expenses


1,162,658



1,105,582



2,117,774



2,088,836Income (Loss) from operations


119,390



15,580



209,434



(229,396
)Other Income (Expense):Other income


-



-



66,897



-Interest expense


(88,120
)


(81,818
)


(179,477
)


(167,994
)Total other income (expense)


(88,120
)


(81,818
)


(112,580
)


(167,994
)Net Income (Loss)

$
31,270


$
(66,238
)

$
96,854


$
(397,390
)Basic Income (Loss) Per Share

$
-


$
-


$
-


$
(0.01
)Basic Weighted Average Shares Outstanding


34,857,543



34,824,776



34,857,543



34,683,924Diluted Income (Loss) per Share:Net Income (Loss) per Common Share

$
-


$
-


$
-


$
(0.01
)Diluted Weighted-Average Shares Outstanding


36,854,715



34,824,776



36,833,628



34,683,924





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





2





ZYTO CORP AND SUBSIDIARYCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSSix Months Ended June 30,2012


2011Cash Flows from Operating Activities:Net Income (Loss)

$
96,854


$
(397,390
)Adjustments to reconcile net income (loss) to net cash provided by operating activities:Depreciation and amortization


117,061



84,486Amortization of debt discount


64,380



64,379Provision for bad debt


31,837



13,544Share-based compensation


12,405



55,538Changes in operating assets and liabilities:Accounts receivable


(213,967
)


15,470Inventories


(16,767
)


6,862Prepaid expenses


8,755



528Other current assets


8



(2,806
)Accounts payable


(17,203
)


149,232Accounts payable related party


-



(428
)Accrued expenses


23,413



64,815Accrued interest related party


74,273



40,313Deferred revenue


(25,364
)


5,245Net cash provided by operating activities


155,685



99,788Cash Flows from Investing Activities:Purchase of equipment


(7,752
)


(17,177
)Capitalization of software development costs


(120,828
)


(90,753
)Net cash used in investing activities


(128,580
)


(107,930
)Cash Flows from Financing Activities:Principal payments on notes payable


(3,948
)


(1,849
)Principal payments on line of credit


(3,607
)


-Proceeds from notes payable


-



50,000Net cash provided by (used in) financing activities


(7,555
)


48,151Net Increase in Cash and Cash Equivalents


19,550



40,009Cash and Cash Equivalents, Beginning of Period


87,364



39,360Cash and Cash Equivalents, End of Period

$
106,914


$
79,369Supplemental Disclosure of Cash Flow InformationCash paid for interest

$
102,857


$
126,706Converted line of credit to promissory note


96,393



-Write-off of uncollectible accounts


77,204



-








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


3


ZYTO CORP AND SUBSIDIARY


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


Note 1. Organization and Business Activity








Basis of Presentation - The accompanying unaudited condensed consolidated financial statements of ZYTO Corp and subsidiary (the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles. These accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the SEC on March 31, 2012.





Operating results for the six months ended June 30, 2012, are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2012, or any portion thereof.





Unless the context otherwise requires, all references to “we,” “us,” “our,” the “Company” and “ZYTO” are to ZYTO Corp and subsidiary.





Organization – Our Company consists of ZYTO Corp (a Delaware corporation) and its wholly owned subsidiary, ZYTO Technologies, Inc. (a Nevada corporation)(the “Subsidiary”).





Business Activity – Our operations consist of the manufacturing and distribution of biocommunication devices and software designed to facilitate communication between computers and the human body.





Business Condition – As of June 30, 2012, and December 31, 2011, we had an accumulated deficit of $8,010,567 and $8,107,421 respectively.





During the three months ended June 30, 2012 and 2011, we recognized net income of $31,270 and a net loss of $66,238, respectively. During the six months ended June 30, 2012 and 2011, we recognized net income of $96,854 and a net loss of $397,390, respectively.





As of June 30, 2012, and December 31, 2011, our current liabilities exceeded our current assets by $823,054 and $1,016,852, respectively.





These factors raise substantial doubt about our ability to continue as a going concern.  The accompanying unaudited condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.  To increase revenue, we intend to focus on customer retention and expanding our customer base.






4




ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


Note 2.   Summary of Significant Accounting Policies





This summary of significant accounting policies is presented to assist in understanding our condensed consolidated financial statements.  The condensed consolidated financial statements and notes are representations of Management, which is responsible for their integrity and objectivity.  These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements.





Principles of Consolidation– The accompanying unaudited condensed consolidated financial statements include the accounts of the Company, and its subsidiary in which we have a controlling financial interest. The accompanying unaudited condensed consolidated financial statements of the Company and its subsidiary at June 30, 2012, and for the three months and six months ended June 30, 2012 and 2011, reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary to present fairly the consolidated financial position and results of operations for the periods presented. All significant intercompany transactions and accounts are eliminated in consolidation.





Use of Estimates – In preparing our unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported periods.  Actual results could differ from those estimates.





Revenue Recognition – We recognize revenue from customers upon the delivery of the system hardware.  At the time payment is received, the system hardware is shipped and the customer receives an e-mail which includes a link to download the software.  Upon shipment, the customer has no right of return and the transaction is final.  Thirty days from the date of purchase, the customer is required to pay a monthly subscription fee in order for the software to remain active.  Subscription revenue is recognized upon the performance of services.  In the event the customer cancels his or her monthly subscription or the monthly subscription fee is not received, the software automatically deactivates and the equipment is no longer functional.





We recognize revenue when persuasive evidence of an arrangement exits, delivery has occurred, the customer no longer has the right of return, the fee is fixed or determinable and collection has been made or is reasonably assured.





Revenues are shown net of any related sales or use taxes for sales transactions where applicable.






5
  ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


Accounts Receivable – We record receivables due from our customers at the time the sale is recorded in accordance with our revenue recognition policies. These receivables consist of amounts due from the sale of products and services rendered. The future collectability of these amounts can be impacted by our collection efforts, the financial stability of our customers, and the general economic climate in which we operate. Recent economic conditions have increased the uncertainty in making these estimates. Any adverse change in these factors could have a significant impact on the collectability of these assets and could have a material impact on our consolidated financial statements.





We apply a consistent practice of establishing an allowance for accounts that we believe may become uncollectible through reviewing the historical aging of our receivables. When we become aware of the inability of a customer to meet its financial obligations (e.g., where it is in financial distress or has filed for bankruptcy), we specifically reserve for the potential bad debt to reduce the net recognized receivable to the amount we reasonably believe will be collected. The valuation of receivables is performed on a quarterly basis. Amounts considered uncollectible and shown net of an allowance for doubtful accounts were $83,337 and $128,704 at June 30, 2012, and December 31, 2011, respectively.




During 2011, we began to offer long-term financing to our customers. As a result, we have classified receivables that are reasonably expected to be realized outside of our normal operating cycle as long-term. These long-term receivables are recognized when a customer executes a financing contract for hardware purchases over $5,000.  The financing contracts require a down payment of 20% of the purchase price and an ongoing monthly subscription service to enable the use of the hardware.  The long-term contracts are payable for terms between 3 and 5 years, and bear interest at an annual rate of 24%. In the event the customer defaults, the annual long-term interest increases to 34%. A default occurs when payment according to the contract is not received within 30 days of being due. Once a customer defaults, we may discontinue the subscription until full payment is received.  We recognize interest income from these receivables monthly as it is earned. Interest income is recorded as a component of revenues in our condensed consolidated statement of operations.





Other Income – During the three and six months ended June 30, 2012, other income included a gain on forgiveness of debt of $0 and $66,897.





Basic and Diluted Income (Loss) per Share – Basic income (loss) per share is computed on the basis of the weighted-average number of common shares outstanding during the year. Diluted income (loss) per share is computed on the basis of the weighted-average number of common shares and all dilutive potentially issuable common shares outstanding during the year.




6
  ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


For the Three Months Ended


For the Six Months EndedJune 30,


June 30,2012


2011


2012


2011Net Income (loss)

$
31,270


$
(66,238
)

$
96,854


$
(397,390
)Basic Weighted-Average Common Shares Outstanding


34,857,543



34,824,776



34,857,543



34,683,924Effect of dilutive-securities Options


1,997,172



-



1,976,085



-Diluted Weighted-Average Common Shares Outstanding


36,854,715



34,824,776



36,833,628



34,683,924Basic Income (loss) Per Common ShareNet Income (loss)


0.00



(0.00
)


0.00



(0.01
)Diluted Income (loss) Per Common ShareNet Income (loss)


0.00



(0.00
)


0.00



(0.01
)





Note 3. Inventory





Inventory consisted of the following as of June 30, 2012 and December 31, 2011:





June 30,


December 31,2012


2011Raw Materials

$
8,413


$
4,631Finished Goods


25,912



12,927$
34,325


$
17,558





Note 4. Property and Equipment





Property and equipment consisted of the following as of June 30, 2012 and December 31, 2011:




June 30,


December 31,2012


2011Computer equipment

$
188,511


$
182,678Furniture and fixtures


98,966



98,966Production equipment


62,681



62,681Software


50,034



48,115400,192



392,440Accumulated depreciation


(293,263
)


(259,747
)$
106,929


$
132,693









7
  ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)







Depreciation expense for the three months ended June 30, 2012 and 2011 was $16,660 and $19,344, respectively. Depreciation expense for the six months ended June 30, 2012 and 2011 was $33,516 and $37,949, respectively.





Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, as follows:





LifeComputer equipment
2- yearsSoftware
2-3 yearsFurniture and fixtures
5-7 yearsProduction equipment
3-20  years




Note 5. Line of Credit





On December 14, 2010, we renegotiated and amended our existing line of credit with a financial institution. Under this revolving line of credit, as amended, we had $100,000 of available borrowings with a maturity date of December 5, 2011. As of December 31, 2011 the amount drawn on the line totaled $100,000.  The interest rate applied to the unpaid principal balance was 5.25% per annum.  During the three months ended June 30, 2012 and 2011 we recognized interest expense from the line of credit of $1,223and $1,295, respectively. During the six months ended June 30, 2012 and 2011 we recognized interest expense from the line of credit of $2,532 and $2,589, respectively.
 
 Borrowings under the line were collateralized by a security interest in all of our assets. The line of credit was personally guaranteed by one of our principal officers. The bank had extended our line of credit until April, 2012.


On June 25, 2012 we exchanged our existing line of credit with a financial institution for a promissory note (see Note 6). As of June 30, 2012 and December 31, 2011 the amount drawn on the line totaled $0 and $100,000, respectively.





Note 6. Notes Payable





On August 1, 2009, we amended and restated the terms of a note payable with InteMedica, LLC. This note bears interest at 12% per annum, with $8,000 due monthly until paid in full. As of June 30, 2012, the note payable was in default. As of June 30, 2012, the note payable balance was $46,942 and accrued interest totaled $8,716.





On June 25, 2012, we exchanged our line of credit (see Note 5) for a promissory note with the same financial institution. This note is secured, bears interest at 5.27% per annum and requires monthly payments of principal and interest of $1,837 until the maturity date of July 5, 2017. The note is personally guaranteed by one of our principal officers.




8
  ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


Maturities of the long-term promissory note are as follows:





Long-term Debt2012

$
7,1322013


17,7682014


18,7272015


19,7372016


20,8022017


12,228




On January 28, 2011, we received $50,000 in exchange for a promissory note.  The 18-month note matured on June 28, 2012 and bears interest at 10% per annum. As part of the agreement, we issued the lender 25,000 shares of common stock (see Note 11). We were required to make interest-only payments until the maturity date of June 28, 2012, at which time the full principal amount was payable. This note was amended and restated on July 11, 2012 (see Note 14).






9




ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





Notes payable consisted of the following as of June 30, 2012, and December 31, 2011:




June 30,


December 31,2012


2011Unsecured note payable to InteMedica, LLC, interest at 12%, monthly payments of $8,000, in default

$
46,942


$
46,942Secured note payable to financial institution, interest at 5.27%, monthly payments of $1,837, matures July 5, 2017


96,394



-Unsecured note payable to shareholder, interest at 10%,   interest payments due monthly, principal due at July 31, 2013


50,000



50,000Total notes payable


193,336



96,942Less current portion


(112,841
)


(96,942
)Long-term portion

$
80,495


$
-





During the three months ended June 30, 2012 and 2011 we recognized interest expense on  notes payable of $2,770 and $2,254, respectively. During the six months ended June 30, 2012 and 2011 we recognized interest expense on notes payable of $5,444 and $4,957, respectively.




Note 7. Related Party Note Payable





On March 26, 2012, we executed an amended and restated unsecured promissory note with an officer, extending the maturity date to December 31, 2013.  The amended and restated related party note bears interest at 7% per annum. During the three months ended June 30, 2012 and 2011 we recognized interest expense from the promissory note of $43,630 and $43,631, respectively. During the six months ended June 30, 2012 and 2011 we recognized interest expense from the promissory note of $87,261 and $64,379, respectively. During the six months ended June 30, 2012 and 2011 we paid $13,264 and $49,958 in cash to the officer for accrued interest related to the promissory note, respectively.





Related party note payable consisted of the following as of June 30, 2012, and December 31, 2011:




10




ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


June 30,


December 31,2012


2011Unsecured note payable to shareholder, interest at 7%,  net of discount of $64,380 and $128,759, respectively

$
2,435,620


$
2,371,241Total related party notes payable


2,435,620



2,371,241Less current portion


-



-Long-term portion

$
2,435,620


$
2,371,241




Note 8. Research and Development





During the six months ended June 30, 2012 and 2011 we capitalized $120,828 and $90,753, respectively, of costs relating to significant enhancements and upgrades to our proprietary software. We capitalize certain software development costs incurred subsequent to the establishment of technological feasibility and amortize those costs over the estimated lives of the related products.





During the three months ended June 30, 2012 and 2011 amortization of these costs was $44,474 and $25,346 respectively. During the six months ended June 30, 2012 and 2011 amortization of these costs was $83,545 and $46,537, respectively.





During the three months ended June 30, 2012 and 2011 we expensed $104,514 and $41,851 of research and development costs, respectively. During the six months ended June 30, 2012 and 2011 we expensed $163,398 and $79,978 of research and development costs, respectively. This is recorded in research and development expenses on our condensed consolidated statement of operations.





Amortization is computed on a straight-line basis over the estimated useful lives of the assets. All capitalized software development costs have been amortized over their estimated useful life of 3 years.







11




ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)






Future amortization costs related to capitalized research and development are as follows:





2012

$
91,3432013


182,6862014


72,7272015


8,108Total amortization costs

$
354,864





Note 9. Commitments and Contingencies





Operating Leases – The Company is obligated under certain non-cancelable operating leases for the rental of office space.  Total lease expense for the three months ended June 30, 2012 and 2011 was $46,957 and $45,578, respectively. Total lease expense for the six months ended June 30, 2012 and 2011 was $92,534 and $81,524, respectively.





Future minimum lease payments under non-cancelable operating leases are as follows:





2012

$
93,8912013


192,4772014


32,237Total minimum payments

$
318,605




Lawsuits– Litigation has arisen in the course of our business, none of which is deemed to be material.





Note 10. Capital Lease





In October 2010, we entered into a lease agreement for the purpose of financing capital equipment. The lease agreement is payable in 60 monthly payments and bears interest at a rate of 7.00% per annum. The loan amount is collateralized by the equipment leased.





12








ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)














Future minimum lease payments under our non-cancelable capital lease are as follows:





For the six months ended December 31, 2012

$
2,147For the year ended December 31, 2013


4,296For the year ended December 31, 2014


4,296For the year ended December 31, 2015


14Total future minimum lease payments


10,753Amount representing interest


(884
)Present value of future minimum lease payments


9,869Current portion of capital lease


(4,296
)Capital lease, less current portion

$
5,573




Note 11. Common Stock





There were no issuances of common stock during the six months ended June 30, 2012.





Note 12. Stock Options





On July 8, 2011, the Board of Directors approved the ZYTO Corp 2011 Equity Incentive Plan (“the 2011 Plan”). On December 6, 2011, the stockholders also approved the 2011 Plan.





The 2011 Plan permits the granting of equity awards to purchase up to 5,000,000 shares of common stock. Persons eligible to participate in the 2011 Plan include members of the Board of Directors, our consultants, all of our employees, and our subsidiary, as determined by our Board of Directors.





As of June 30, 2012, there were 3,036,342 shares available for issuance under the 2011 Plan.





On April 2, 2012 we granted options to acquire 100,000 shares of common stock to an employee, valued at $3,899. These options are exercisable at $0.04 per share, based on the closing price of our common stock on the date of issue. These options vest yearly over three years starting April 2, 2013, and expire on April 2, 2022.





On June 1, 2012, we granted stock options to acquire 30,000 shares of common stock to a member of our scientific advisory board for service valued at $640. These options are exercisable at $0.02 a share, based on the closing price of our common stock on the date of issue. These options vest on June 1, 2014, and expire June 1, 2024.





13





ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


The grant-date fair value of the options above was based on the grant-date closing market price per share and on the following weighted-average assumptions: risk free interest rate of 0.93%, expected dividend yield of 0%, expected volatility of 166.99% and an expected life of 6 years from the respective date of issuance.





A summary of the status of stock options at June 30, 2012, and changes during the six months then ended, is presented in the following table:





WeightedWeighted


AverageShares


Average


Remaining


AggregateUnder Option


Exercise


Contractual


Intrinsicor Warrant


Price


Life


ValueOutstanding at December 31, 2011


1,954,998


$
0.03



9.63


$
-Granted or issued


130,000



0.04



9.80



-Forfeited


121,340



0.03



-



-Outstanding at June 30, 2012


1,963,658



0.03



9.18



-Exercisable at June 30, 2012


-



-



-



-




The fair value of stock options is estimated on the date of grant or issuance using the Black-Scholes option pricing model. The expected life of stock options represents the period of time that the stock options granted are expected to be outstanding prior to exercise. The expected volatility is based on the historical price volatility of our common stock. The risk-free interest rate represents the U.S. Treasury constant maturities rate for the expected life of the related stock options. The dividend yield represents anticipated cash dividends to be paid over the expected life of the stock options. The intrinsic values are based on a June 30, 2012, closing price of $0.03 per share.





Generally accepted accounting principles for stock options require the recognition of the cost of services received in exchange for an award of equity instruments in the financial statements, are measured based on the grant date fair value of the award, and require the compensation expense to be recognized over the period during which an employee or other service provider is required to provide service in exchange for the award (the vesting period). No income tax benefit has been recognized for share-based compensation arrangements and no share-based compensation cost has been capitalized in the accompanying condensed consolidated balance sheets at June 30, 2012 and December 31, 2011.





As of June 30, 2012, there was $30,211 of unrecognized compensation cost related to stock options that will be recognized over a weighted average period of approximately 1.98 years. For the three months ended June 30, 2012, we recorded compensation expense related to stock options of $3,580 as a general and administrative expense in our condensed consolidated statement of operations. For the six months ended June 30, 2012, we recorded compensation expense related to stock options of $12,405 as a general and administrative expense in our condensed consolidated statement of operations. There was no compensation expense related to stock options for the three and six months ended June 30, 2011.








14





ZYTO CORP AND SUBSIDIARY
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





Note 13. Concentrations





During the six months ended June 30, 2012, we purchased approximately 75% of our inventory from two suppliers. During the year ended December 31, 2011, we purchased approximately 83% of our inventory from the same two suppliers. We currently purchase all of our Hand Cradle boards and Hand Cradle shells, important components of our products, from two suppliers. Although there are a limited number of manufacturers of these components, management believes that other suppliers could provide similar components on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely.





Note 14. Subsequent Event





On July 11, 2012 we amended and restated a promissory note (see Note 6). The amended and restated 12-month note matures on July 31, 2013, and bears interest at 10% per annum. We are required to make interest-only payments until the maturity date, at which time the principal amount is payable.











15




Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations





Forward-looking Statements




This Form 10-Q contains forward-looking statements.  All statements other than statements of historical facts are forward-looking statements, including any projections of milestones, royalties or other financial items, any statements of the plans and objectives of management for the future operations, any statements concerning research and development, proposed new products of licensing or collaborative arrangements, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing.  In some cases, forward looking statements can be identified by the use of terminology such as “believes,” “might,” “will,” “expects,” “plans,” “anticipates,” “forecasts,” “estimates,” “potential,” or “continue,” or the negative thereof, or other comparable terminology.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements.  Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties. Except as required by U.S. federal securities laws, we expressly disclaim any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise after the date hereof.





About ZYTO Corp





This Quarterly Report sets forth certain financial and business information of ZYTO Corp and its wholly owned subsidiary, ZYTO Technologies, Inc. (collectively, “ZYTO,” “we,” “our,” or “us”).





Our operations consist of the manufacturing and distribution of “biocommunication” devices and software designed to facilitate communication between computers and the human body. Biocommunication is accomplished by providing a direct connection between a computer and a living organism (i.e., humans or animals), which facilitates observing and recording shifts in coherence of energy patterns measured by our Hand Cradle device, and perception reframing.   Coherence is defined as two or more things existing without conflict or interference.  Perception reframing is a technique that opens a person to a different way of seeing a circumstance, opportunity, problem, or relationship.  Both of these applications involve concepts that are natural outgrowths of the field of complementary and alternative medicine. Complementary and Alternative Medicine “CAM” is a diverse group of medical and health care systems, practices, and products that are not generally associated with medicine and medical practices common to western hospitals.  These include, but are not limited to, acupuncture, homeopathy, chiropractic, massage, naturopathic medicine, and the use of herbs and nutritional supplements.  With many CAM modalities becoming more accepted in allopathic medicine (acupuncture, for example), the line between CAM and “mainstream” medicine has become increasingly thin.





Recent Corporate Developments





In April 2012, we launched the "ZYTO Store" to our Internet offering to increase the contact we have with our customers and to take us even more directly into the business of Internet transactions.  This new offering will facilitate the exchange of knowledge and experience among members of the ZYTO community.  Our expectation is that healthcare professionals who purchase our products will enhance each other’s clinical effectiveness through this sharing of information.  We collect a portion of the revenue generated through The Zyto Store.




Our Business Strategy




Our primary financial objective is to market our technology to both healthcare professionals and retail consumers.  We consider retail consumers to be non-healthcare professionals who purchase our technology, an example being distributors of health products who purchase our Compass product.  In addition to placing our product in the aforementioned markets, further financial objectives include collecting initial setup fees, and maintaining and collecting ongoing monthly subscription payments from those with whom we place our products.  Because these payments are nominal, our goal is to place a large number of software installations and to provide service and value that motivates our customers to continue making monthly subscription payments.  All of our products are Internet-centric, meaning that our products are deployed over the Internet, updated through the Internet, and each month the user’s software license is renewed over the Internet by syncing the products that they purchase from us with our secured server.





Software development and improvement is ongoing, and one of our most important functions.  As more powerful development tools are made available and as the Internet becomes a more powerful vehicle for our products, we intend to capitalize on this improvement by improving our products with increased speed and functionality.


16





Marketed Products





Our technology is designed to be used in a ‘fee for services’ environment.  Even the Compass is designed to facilitate the sale of health products, whether the healthcare professional charges the client for the biosurvey or not.  In every instance, a significant measure of our customer’s success is the financial benefit our technology provides them.  Proper use of our products by our customers will include the ability to explain the technology, proper placement and operation of the technology and devices, and billing practices.





By way of background, our technology uses an interface called a Hand Cradle on which the subject places his or her hand. The Hand Cradle is connected to a computer using a USB port, and through the Hand Cradle the subject receives a stimulus from the computer. The computer then measures the changes in the electrical properties from the skin of the subject’s hand caused by the stimulus. The palm of the hand and the five fingers each contact a separate conductive plate that is in turn connected to the PC board, or computer inside the Hand Cradle.





Each stimulus from the computer is referred to as a “VSI”, an acronym for Virtual Stimulus Item.  VSIs are created in the software using a proprietary process wherein a unique binary string, sometimes referred to as a ‘binary signature,’ is generated, converted to a signal, and that signal is then linked to the physical item.   Linking is accomplished using the Tower, a hardware component included in the Elite System which is primarily an array of antennae used to transmit VSI data at the appropriate time.  The computer will output to the Tower the binary signature or frequency of the VSI; the item represented by the VSI is placed in front of the Tower and the two are linked.  The software used in the linking process indicates when the link is complete.  The output at the Tower is in the form of an electromagnetic non-radiating wave.





As a point of clarification, VSIs are linked to specific items, including drugs, nutritional supplements, etc.  The linking process is confidential and proprietary to ZYTO.  Maintaining such a proprietary and confidential status provides a tremendous trade value to ZYTO.  Accordingly, we have not disclosed the particulars of the linking process in this Form 10-Q, or in any other publicly released document.  What can be disclosed, however, is that the software used in the linking process indicates when the link is complete.





Once this proprietary process is complete, the VSI is used as a stimulus in a scanning sequence called a biosurvey.  VSIs can be created for any number of items including drugs, nutritional supplements, allergens, or homeopathic remedies to name a few.  To date, there are approximately fifteen thousand VSIs available in various ZYTO products.  This number varies depending on the product.  Understanding this process is most easily explained by describing the stimulus-response sequence, as follows.





When a biosurvey is initiated, the computer first queries the Hand Cradle to see if it is properly connected with a hand resting on it.  The computer then samples the digital data coming from the hand.  This sampling period lasts for a few seconds, allowing the hand to acclimate to the Hand Cradle.  Next, the Hand Cradle will take a baseline sampling, measuring electrical resistance (or conductance) of the skin at all contact points.  Subtle changes in electrical resistance at each point are then analyzed using a proprietary algorithm to determine a coherent state.   That data is then transmitted to the computer.  The computer then sends a VSI signal to the Hand Cradle.  This signal creates a rapid burst of data, sometimes referred to as a “ping.”  The Hand Cradle then takes a second, or response, reading measuring electrical characteristics of the skin at all contact points and transfers that data to the computer.  The computer then analyzes the baseline against the response and correlates it with the VSI signal.   The variance between the baseline and the response are expressed numerically as a “deviation Ratio” or a “dR.” If the response pattern is more coherent than the baseline, the dR will be positive; if the response is less coherent the dR will be negative.  If the coherence of the response is the same as the baseline the dR will be zero.  Additionally, the computer will determine variance in coherence and will assign a number, the greater the number the more or less coherent the response.





The objective of the stimulus-response exercise, called a biosurvey, is to determine the shift the selected VSI or VSIs create in coherence as measured at the contact points on the hand.   The biosurvey sequence involves a base line measurement, the introduction of the VSI, and a response measurement.  If the energetic position (referred to as “energetic posture”) of the response, measured by the Hand Cradle, differs from the baseline then the VSI is assumed to have influenced that shift.   The only input from the operator is the selection of the biosurvey or the VSIs to use in the biosurvey.





The results of a biosurvey are treated similar to information collected in a health history.  The biosurvey will provide information that helps the practitioner make better decisions faster, but does not provide them any definitive diagnosis.  A shift in coherence is not an indicator of need or deficiency, and no system of the body is evaluated in the process.  Therefore, the biosurvey is not considered a diagnosis.





17





For clarity, we have included the following example, which demonstrates how biosurveys are used clinically:  A healthcare professional consults with a client who suffers from a particular ailment for which the healthcare professional may choose one of a number of drugs to treat.  The healthcare professional then organizes, or creates a biosurvey containing VSIs for all appropriate drug choices.  That biosurvey is then run while the client has his or her hand on the Hand Cradle.  The client’s responses to the items in the biosurvey will be ranked and shown in the final report.  The healthcare professional then takes this data into account when making his prescriptive choice, giving greater consideration to items (drugs) for which the client shows the most positive shift in coherence; the biosurvey allows the healthcare professional to individualize therapy for his clients.





The operator (healthcare professional) decides which biosurvey to use, or which sets of drugs to include in the biosurvey.  One distinct advantage of our technology is the speed at which it operates, allowing the operator to consider a wider variety of choices.  All choices included in a biosurvey will be ranked against the entire list.





Marketing and sales of our Products are segregated into two distinct areas:  The Compass, and Healthcare Professional.





Compass Product Line





The Compass is a consumer or retail device, sold to distributors of health products who sell through direct sales or network marketing channels.  Before we create a Compass with a library of products (“VSIs”) for any direct sales or network marketing company, that company must meet two requirements: at least twenty products in their product offering and at least 5,000 distributors.  Once an eligible company has been identified, we obtain a sample of each of their products.  VSIs for each of these products are then created and organized into a library and the Compass is then offered for sale to product distributors of that company.





The Compass operates similarly to the “Healthcare Professional only” products.  The difference is the presentation of the data in the final report and the VSIs available for inclusion in the biosurvey.  The Compass uses the biosurvey process in the same way as the professional-only line of products but the Compass final report provides much less detail.  The Compass is sold to ‘non-professionals’ who may not have any medical background or licensure.  For this reason, the Compass report does not identify detail such as specific biomarkers or dR numbers (discussed above).  It is also limited in its flexibility.  Compass operators are only allowed to alter the program by filtering its product library according to their physical product inventory.  If the inventory filter is used, the Compass biosurvey will only use the VSIs for products the operator indicates are part of his/her product inventory.





The Compass biosurvey first records the body’s responses to a number of neutral VSIs and calculates what is referred to as ‘Range.’  Range is a dynamic dR value that is used as the point beyond which responses should be noted.   Next, 75 VSIs referred to as biomarkers are scanned.  These VSIs are representative of anatomical components of the body.  The results of this part of the biosurvey are displayed graphically in what is called a “Stress Profile.”  VSIs that generate the most aggressive responses are plotted outside a range circle and are considered “out of range.”  Next, VSIs for a number of products are scanned and ranked according to the body’s responses.  Those generating the most positive response are then used in what is called a balancing rescan process where additional product VSIs are added to the scanning process until all out of range biomarker VSIs respond less aggressively and move into range.





The intent of this scanning process is to provide information that is helpful when choosing what supplements to buy.





Healthcare Professional Product Line





Elite





The Elite is an upgrade to our previous product, the LSA Pro.  It is sold only to healthcare professionals.  This product is the most versatile and capable product in the ZYTO lineup.  It gives operators an extensive library of VSIs and the ability for the healthcare professional to add new VSIs to their library.  This proprietary process is the same as explained above; the Elite creates a unique code, converts it to a frequency and that frequency is then linked to the physical item.  The software used in the linking process indicates when the link is complete.  The VSI is then available for the use in the biosurvey sequence.  The Elite also has the ability to author its own biosurveys and to deploy them to other ZYTO systems, specifically the Select.  Additionally, the Elite is able to scan remotely over the Internet.  Remote biosurveys can be conducted over the Internet with a client who has a Hand Cradle connecting over the Internet to a healthcare professional with ZYTO software in a remote location.







18




Select; Balance





The Select product was released in May 2011 and is an upgrade and replacement for the prior version of the Balance 3.0.  The Select includes full access to products from more than 136 nutritional supplement suppliers and an unlimited range of biosurveys.





The Balance 5.0 product was released in June 2010 and includes full access to products from four nutritional supplement suppliers.  We cooperate in some marketing efforts with these companies as a way to reach a broader audience and as a way to serve their customers better.





The biosurvey built into the Balance (also available in the Select and the Elite) scans a number of VSIs for vertebrae, teeth, organs, and acupuncture meridians, and then draws the body’s response to these items in a graph called a Stress Profile.  The Balance then measures the body’s responses to the VSIs for various nutritional supplements.  VSIs for products that create a positive response are then used in a rescan of the stress profile.





As these product VSIs are introduced throughout the rescan process, the stress profile typically changes.  The change anticipates the physical benefit the client will receive when the supplements are taken, making the process a “simulation” of actually taking the supplements.





The presentation of the data in the final report is both educational and motivating to the client.  The education comes in the form of describing the products whose VSIs created the most positive shift, and the process can be motivational because the descriptions often match what they know about their own health conditions or concerns.  The structure of the report is also motivating, making it simple for the client to understand the benefit that can be expected from the products shown.





The Select and the Balance are sold only to healthcare professionals. Both products are capable of remote scanning over the Internet.





EVOX





The EVOX is a perception reframing tool and sold only to healthcare professionals.  It comes with a Hand Cradle for the purpose of running biosurveys and is used with a headset that plugs into the computer.  The EVOX measures the frequencies (energy) in the voice and uses that information to facilitate what is called perception reframing.





Information carried in the voice exceeds the words spoken.  For example, with a phone call from a stranger, in very few seconds the receiver will likely know the caller’s gender, race, approximate age, general health, and what part of the world they lived in when they were young (their accent).  All this non-articulated information is carried in the voice.  Non-articulated information varies with each topic.  In addition to age, gender, and other information, voice carries attitudes, memories, and beliefs.  In short, voice carries perception.





Perception is important because in many instances it creates an individual’s reality.  Thus, to the extent perception is inadequate, reality can be dysfunctional.  An example of an inadequate perception would be the person who believes all dogs are mean.  While it is true that some dogs are mean, all are not, and a person with this perception will live a dysfunctional “dog” reality.





Another interesting characteristic of perception is that it is almost entirely subconscious, resulting in behaviors that are ‘driven’ by reasons we may not understand or even be aware of.  This subconscious nature makes perceptions almost impossible to alter so they remain static and we live our lives as a recurrent expression of the same dysfunctions.





The EVOX process begins with the creation of a short recording, with the client speaking about a specific topic for about ten to fifteen seconds.  EVOX uses the microphone and the computer’s sound card to record the frequencies in the voice, referred to as voice energy.  Those frequencies are plotted into a graph called a Perception Index.  The Perception Index is then analyzed by the computer and ‘holes or gaps’ (frequencies that are absent) in the frequency pattern are used to determine various frequency VSIs that could be used in the reframe process.  The computer-determined VSIs are then placed into a biosurvey which runs while the client’s hand is on the Hand Cradle.  VSIs that generate a negative dR are deleted; those creating a positive dR are saved and are then output to the Hand Cradle sequentially over a period lasting thirty seconds to ten minutes, depending on operator preference.  During the output period EVOX plays easy-to-listen-to music into headphones worn by the client, and the client is instructed to close his eyes and think about the topic of which he is speaking.  At the end of the output phase, the computer resets for the next recording.  This cycle is called a round.  Over the course of a session (usually consisting of three to ten rounds), the client will usually experience a shift in perception relative to the topic.  This is Perception Reframing.  Perception Reframing can result in an improved golf game, a better relationship with a spouse or child, or the elimination of some self-sabotaging behavior.  This shift is not the result of ‘treating a condition.’ Rather, it is simply expanding or reframing the way the topic is perceived by the client.  Expanded perception creates an ability to exercise more choice.





The objective of EVOX and perception reframing is to identify the position of the Perception Index and then use VSIs for frequencies to facilitate a reframe or shift in perception.  This can be significant to the extent a person’s reality is created by his perception.  Filling in the biosurvey involves the process of stimulus (with the VSI) and response (expressed as a dR).  The EVOX expands that process by using the voice as a feedback loop in the process.  With EVOX, the Hand Cradle is used in the same way, but voice becomes the primary indicator of perception and the achievement of a subsequent shift or reframe of perception.






19





ZYTO.com





We anticipate that our website, www.ZYTO.com, will become the nexus for all ZYTO healthcare professionals and for those professionals and their clients as this will become the portal for all remote biosurvey scans.  Remote use of our technology over the Internet is available and has been for the last several years under the name of “Virtual Clinic.”  Information contained on, or available through, our website is not a part of, and is not incorporated by reference into, this Quarterly Report.





In addition to being the nexus between healthcare professionals and their clients as it relates to remote scans, we have recently launched the ‘ZYTO Store’ where healthcare professionals can share biosurveys and clinical applications using ZYTO technology.  A healthcare professional owning the Elite can now author a biosurvey and post that biosurvey for sale at The Store, and other healthcare professionals can benefit from their experience and knowledge.  The net effect is more robust sharing of intellectual power and experience.   We collect a portion of the revenue from each biosurvey sold through The Store.





Results of Operations





Three Months Ended June 30, 2012, compared to Three Months Ended June 30, 2011





For the Three Months EndedJune 30, 2012

(Unaudited)


June 30, 2011

(Unaudited)Statement of Operations Data:Revenues, net

$
1,397,785


$
1,175,176Cost of sales


115,737



54,014Gross profit


1,282,048



1,121,162Total operating expenses


1,162,658



1,105,582Other expense


(88,120
)


(81,818
)Net income (loss)


31,270



(66,238
)Net income (loss) per share


0.00



(0.00
)





Revenues





Total revenues for the three months ended June 30, 2012, were $1,397,785, compared to $1,175,176 for the three months ended June 30, 2011, reflecting an increase of $222,609, or 18.9 percent.





Healthcare Professional Product Line





Revenues generated through our Healthcare Professional product line for the three months ended June 30, 2012, were $717,651, compared to $697,742 for the three months ended June 30, 2011, reflecting an increase of $19,909, or 2.9 percent.





Our Select product sales for the three months ended June 30, 2012, were $157,470, compared to $46,025 for the three months ended June 30, 2011, reflecting an increase of $111,445, or 242.1 percent. This was a result of increased promotion of our Select product, as well as an increase in sales of the Select product at our Annual Conference held on May 4-5, 2012. Our Balance product sales for the three months ended June 30, 2012, were $9,770, compared to $45,420 for the three months ended June 30, 2011, reflecting a decrease of $35,650, or 78.5 percent. This was primarily due to a reduction in travel and expenses related to promoting our Balance product.





Our Elite product sales for the three months ended June 30, 2012, were $291,200, compared to $346,115 for the three months ended June 30, 2011, reflecting a decrease of $54,915, or 15.9 percent. The primary reason for the decrease in sales of our Elite product had to do with the Select product becoming more stable within past twelve months.  The Select price point is attractive to customers who want to implement ZYTO Technology into their practice, but cannot afford the Elite.  We often find customers will start with the Select product and then upgrade to the Elite product at a later date.  Our EVOX product sales for the three months ended June 30, 2012, were $132,250, compared to $211,200 for the three months ended June 30, 2011, reflecting a decrease of $78,950, or 37.4 percent.  The primary reason for the decrease in sales of the EVOX product had to do with a decrease in sales of our EVOX product during our Annual Conference held on May 4-5, 2012.




20





Our virtual clinic Hand Cradle sales for the three months ended June 30, 2012, increased $80,325, compared to the three months ended June 30, 2011. The increase was primarily due to being able to fulfill prior backorders from earlier in the year.





Professional subscription revenue for the three months ended June 30, 2012, increased $24,120, compared to the three months ended June 30, 2011.The increase in subscription revenues generated through our Healthcare Professional product line is attributable to our existing customers continuing to pay their monthly subscription fees and a steady increase of subscribers.





Compass Product Line





Revenues generated through our Compass product line for the three months ended June 30, 2012, were $483,874, compared to $429,669 for the three months ended June 30, 2011, reflecting an increase of $54,205, or 12.6 percent.





The increase in revenues generated through our Compass product line is primarily attributable to a volume increase in our Compass sales of $19,469, and by an increase in our monthly subscription fees of $36,416 for the three months ended June 30, 2012 when compared to the three months ended June 30, 2011.The increase in subscription revenues generated through our Compass product line is attributable to our existing customers continuing to pay their monthly subscription fees and a steady increase of subscribers.





Cost of Sales





Cost of sales for the three months ended June 30, 2012, were $115,737, compared to $54,014 for the three months ended June 30, 2011, reflecting an increase of $61,723, or 114.3 percent. This increase was primarily due to the fulfillment of backorders on the virtual Hand Cradle, which has a lower gross margin than our other professional products.





Selling and Marketing Expenses





Selling and marketing expenses for the three months ended June 30, 2012, were $559,039, compared to $631,977 for the three months ended June 30, 2011, reflecting a decrease of $72,938, or 11.5 percent.    This decrease was primarily attributable to a decrease in our expenses related to our Annual Conference, and a decrease in personnel costs.





General and Administrative Expenses





General and administrative expenses for the three months ended June 30, 2012, were $499,105, compared to $432,024 for the three months ended June 30, 2011, reflecting an increase of $67,081, or 15.5 percent.   The primary factors relating to the increase were an increase in salaries and wages, an increase of $31,837 in bad debt expenses resulting from our estimates of credit losses related to an increase in our accounts receivable balances, and an increase of $23,428 in legal and professional fees.





Research and Development





Research and development expenses for the three months ended June 30, 2012, were $104,514, compared to $41,581 for the three months ended June 30, 2011, reflecting an increase of $62,933, or 151.3 percent. Included in research and development expense is non-cash amortization of $44,474 and $25,346 for the three months ended June 30, 2012 and 2011. The remaning increase was primarily due to increased salaries and related costs due to hiring an additional programmer, and an increase in the time spent on improving our current software.





Other Income (Expense)





Interest expense for the three months ended June 30, 2012, was $88,120, compared to $81,818 for the three months ended June 30, 2011, reflecting an increase of $6,302, or 7.7 percent. Interest expense is comprised of the interest on our line of credit, notes payable and related party notes payable as discussed in Notes 5, 6 and 7.





Net Income/Loss





Our net income for the three months ended June 30, 2012, was $31,270, compared to a loss of $66,238 for the three months ended June 30, 2011, reflecting an increase of $97,508.  The net income for the three months ended June 30, 2012, is a direct result of the increase in revenues, as explained in the preceding paragraphs.




21




Six Months Ended June 30, 2012, compared to Six Months Ended June 30, 2011





For the Six Months EndedJune 30, 2012

(Unaudited)


June 30, 2011

(Unaudited)Statement of Operations Data:Revenues, net

$
2,484,126


$
1,983,290Cost of sales


156,918



123,850Gross profit


2,327,208



1,859,440Total operating expenses


2,117,774



2,088,836Other expense


(112,580
)


(167,994
)Net income (loss)


96,854



(397,390
)Net income (loss) per share


0.00



(0.01
)





Revenues





Total revenues for the six months ended June 30, 2012, were $2,484,126, compared to $1,983,290 for the six months ended June 30, 2011, reflecting an increase of $500,836, or 25.2 percent.





Healthcare Professional Product Line





Revenues generated through our Healthcare Professional product line for the six months ended June 30, 2012, were $1,255,946, compared to $1,020,089 for the six months ended June 30, 2011, reflecting an increase of $235,857, or 23.1 percent.





Our Elite product sales for the six months ended June 30, 2012, were $570,700, compared to $415,960 for the six months ended June 30, 2011, reflecting an increase of $154,740, or 37.2 percent. The increase in Elite product sales was primarily due to a special financing promotion during the month of February, 2012. Our EVOX product sales for the six months ended June 30, 2012, were $247,572, compared to $265,150 for the six months ended June 30, 2011, reflecting a decrease of $17,578, or 6.6 percent. The primary reason for the decrease in sales of the EVOX product had to do with a decrease in sales of our EVOX product during our Annual Conference held on May 4-5, 2012.





Our Select product sales for the six months ended June 30, 2012, were $229,303, compared to $46,025 for the six months ended June 30, 2011, reflecting an increase of $183,278, or 398.2%. This was a result of the introduction of our Select product in May 2011, increased promotion, as well as an increase in sales of the Select product at our Annual Conference held on May 4-5, 2012. Our Balance product sales for the six months ended June 30, 2012, were $30,254, compared to $98,118 for the six months ended June 30, 2011, reflecting a decrease of $67,864, or 69.2 percent. This was primarily due to a reduction in travel and expenses related to promoting our Balance product.





Our virtual clinic Hand Cradle sales for the six months ended June 30, 2012, increased $85,420, compared to the six months ended June 30, 2011. This was primarily due to a grace period we extended to customers to purchase virtual clinic Hand Cradles before implementing a price increase in June 2012.





Professional subscription revenue for the six months ended June 30, 2012, increased $71,456, compared to the six months ended June 30, 2011.The increase in subscription revenues generated through our Healthcare Professional product line is attributable to our existing customers continuing to pay their monthly subscription fees and a steady increase of subscribers.





Compass Product Line





Revenues generated through our Compass product line for the six months ended June 30, 2012, were $948,206, compared to $846,107 for the six months ended June 30, 2011, reflecting an increase of $102,099 or 12.1 percent.





The increase in revenues generated through our Compass product line is primarily attributable to a volume increase in our Compass sales of $51,384, and by an increase in our monthly subscription fees of $62,224.The increase in subscription revenues generated through our Compass product line is attributable to our existing customers continuing to pay their monthly subscription fees and a steady increase of subscribers.





22





Cost of Sales





Cost of sales for the six months ended June 30, 2012, were $156,918, compared to $123,850 for the six months ended June 30, 2011, reflecting an increase of $33,068, or 26.7 percent. This increase was primarily due to a volume increase in our virtual Hand Cradle sales, which has a lower gross margin than our other professional products.





Selling and Marketing Expenses





Selling and marketing expenses for the six months ended June 30, 2012, were $902,742, compared to $1,087,330 for the six months ended June 30, 2011, reflecting a decrease of $184,588, or 17.0 percent.    This decrease was primarily attributable to a decrease in our expenses related to our Annual Conference, and a decrease in personnel costs.





General and Administrative Expenses





General and administrative expenses for the six months ended June 30, 2012, were $1,051,634, compared to $921,528 for the six months ended June 30, 2011, reflecting an increase of $130,106, or 14.1 percent.   The primary factors relating to the increase were an increase in salaries and wages, bad debt expenses, and professional fees.





Research and Development





Research and development expenses for the six months ended June 30, 2012, were $163,398, compared to $79,978 for the six months ended June 30, 2011, reflecting an increase of $83,420, or 104.3 percent. Included in research and development expense is non-cash amortization of $83,545 and $46,537 for the three months ended June 30, 2012 and 2011.The increase was primarily due to hiring an additional programmer, an increase in amortization expenses, and an increase in the time spent on improving our current software.





Other Income (Expense)





Other expense for the six months ended June 30, 2012, is comprised of other income and interest expense.  Included in other income was $66,897 during the six months ended March 31, 2012, resulting from forgiveness of debt.





Interest expense was $179,477, compared to $167,994 for the six months ended June 30, 2011, reflecting an increase of $11,413, or 6.8 percent. Interest expense is comprised of the interest on our line of credit, notes payable and related party notes payable as discussed in Notes 5, 6 and 7.





Net Income/Loss





Our net income for the six months ended June 30, 2012, was $96,854, compared to a loss of $397,390 for the six months ended June 30, 2011, reflecting an increase of $494,244.  The net income for the six months ended June 30, 2012, is a direct result of the increase in revenues, as explained in the preceding paragraphs.




Liquidity and Capital Resources





Our sources of liquidity have historically been cash from operations, a working capital line of credit, and debt and equity financing.





As of June 30, 2012, we had cash and cash equivalents of $106,914, current liabilities of $1,350,274, and total current assets of $527,220, with our current liabilities exceeding current assets by $823,054.





Cash Flow





For the Six Months Ended June 30,Net cash provided by (used in):

2012


2011Operating activities

$
155,685


$
99,788Investing activities


(128,580
)


(107,930
)Financing activities


(7,555
)


48,151Net increase in cash


19,550



40,009




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Operating activities:





Cash provided by operating activities was $155,685 and $99,788 for the six months ended June 30, 2012 and 2011, respectively.





Net cash provided by operating activities during the six months ended June 30, 2012, consisted of our net income of $96,854, non-cash expenses for depreciation and amortization of $117,061, amortization of debt discount of $64,380, share-based compensation of $12,405, and provision of bad debt of $31,837,which was offset by a , changes in working capital items of ($89,648).





Net cash provided by operating activities during the six months ended June 30, 2011, consisted of our net loss of $397,390, which was offset by non-cash expenses of depreciation and amortization of $84,486, changes in amortization of debt discount of $64,379, provision of bad debt of $13,544, share-based compensation of $55,538, and a change in working capital of $279,231.





Investing activities:





Cash used in investing activities was $128,580 during the six months ended June 30, 2012, which included $7,752 for property, plant, and equipment purchases, and $120,828 for capitalizing costs relating to significant enhancements and upgrades to our proprietary software.





Cash used in investing activities was $107,930 during the six months ended June 30, 2011, which included $17,177 for property, plant, and equipment purchases, and $90,753 for capitalizing costs relating to significant enhancements and upgrades to our proprietary software.





Financing activities:





Cash used in financing activities was $7,555 during the six months ended June 30, 2012, which consisted of principal payments on our line of credit of $3,607 and principal payments on our notes payable of $3,948..





Cash provided by financing activities was $48,151 during the six months ended June 30, 2011, which included principal payments on notes payable of $1,849, and proceeds from notes payable of $50,000.





Contractual Obligations





As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide this information.





Off-Balance sheet arrangements





We do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt.





Critical Accounting Policies





Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  On an on-going basis, management evaluates estimates and judgments, including those related to revenue recognition, allowance for doubtful accounts, other intangible assets and going concern.





Revenue recognition





We recognize revenue from customers upon the delivery of the system hardware.  At the time payment is received, the system hardware is shipped and the customer receives an e-mail which includes a link to download the software.  Upon shipment, the customer has no right of return, and the transaction is final.  Thirty days from the date of purchase, the customer is required to pay a monthly subscription fee in order for the software to remain active.  Subscription revenue is recognized upon the performance of services.  In the event the customer cancels the monthly subscription or the monthly subscription fee is not received, the software automatically deactivates and the equipment is no longer functional.





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We recognize revenue when persuasive evidence of an arrangement exits, delivery has occurred, the customer no longer has the right of return, the fee is fixed or determinable, and collection has been made or is reasonably assured.





Revenues are shown net of any related sales or use taxes for sales transactions where applicable.




Allowance for doubtful accounts





We maintain an allowance for doubtful accounts from estimated losses resulting from the potential inability of certain customers to make required future payments on amounts due.  We determine the adequacy of this allowance by periodically evaluating the aging and past due nature of the individual customer accounts receivable balances and considering the customer’s current financial situation as well as the existing industry economic conditions and other relevant factors that would be useful towards assessing the risk of collectability.  If the future financial condition of our customers were to deteriorate, resulting in their inability to make specific required payments, additions to the allowance for doubtful accounts may be required.  In addition, if the financial condition of our customers improves and collections of amounts outstanding commence or are reasonably assured, then we may reverse previously established allowances for doubtful accounts.





Share-Based Compensation





We recognize compensation expense for stock-based awards expected to vest on a straight-line basis over the requisite service period of the award based on their grant date fair value.  We estimate the fair value of stock options using a Black-Scholes option pricing model which requires management to make estimates for certain assumptions regarding risk-free interest rate, expected life of options, expected volatility of stock and expected dividend yield of stock.





Going concern





Our independent auditors have issued a “going concern” qualification in its report on our consolidated financial statements for the year ended December 31, 2011, stating that we had an accumulated deficit and negative cash flows.





As of June 30, 2012, and December 31, 2011, we had accumulated deficits of $8,010,567 and $8,107,421 respectively.





During the six months ended June 30, 2012 and 2011, we recognized net income of $96,854 and a net loss of $397,390, respectively.





As of June 30, 2012, and December 31, 2011, our current liabilities exceeded our current assets by $823,054 and $1,016,852, respectively.





These factors raise substantial doubt about our ability to continue as a going concern.  The accompanying unaudited condensed consolidated financial statements do not include any adjustments that might result from the outcome of the uncertainty.  To increase revenue, we intend to focus on customer retention and expanding our customer base.





Technology





The ZYTO 5.0 platform is the 2010-2012 update to ZYTO Technology.  It is being released in phases.  The first product to be updated/released in 2010 was the EVOX 5.0.  The next product was a new version of the Balance called Balance 5.0.  This product was first shipped in June 2010.  The Elite 5.0 is the upgrade and replacement for the LSA Pro 4.0 and was released in January 2011.  A new product, Select 5.0 was released in May 2011.  We anticipate that our website, www.ZYTO.com, will become the nexus for all ZYTO healthcare professionals and for those professionals and their clients as this will become the portal for all remote biosurvey scans.  Remote use of our technology over the Internet is available and has been for the last several years under the name of “Virtual Clinic.” The ZYTO 5.0 platform has taken over three years to develop, and many of the concepts included in it were formulated as early as 2008.





In April 2012, we added the "ZYTO Store" to our Internet offering to increase the contact we have with our customers and to take us even more directly into the business of Internet transactions.  This new offering will facilitate the exchange of knowledge and experience among members of the ZYTO community.  Our expectation is that healthcare professionals who purchase our products will enhance each other’s clinical effectiveness through this sharing of information.  We collect a portion of the revenue generated through The Zyto Store.





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We capitalize all salaries and associated expenses relating to significant enhancements and upgrades to our proprietary software.  Each employee who is involved in the development process is required to maintain a detailed accounting of his or her time as it relates specifically to enhancements and upgrades to our proprietary software.  As of June 30, 2012, the total amount capitalized was $548,059, of which $193,195 has been amortized for a balance of  $354,864.





During the six months ended June 30, 2012 and 2011, we capitalized $120,828 and $90,753, respectively, of costs relating to significant enhancements and upgrades to our proprietary software. We capitalize certain software development costs incurred subsequent to the establishment of technological feasibility and amortize those costs over the estimated lives of the related products of three years. During the six months ended June 30, 2012 and 2011, amortization of these costs was $83,545 and $46,537, respectively.





These capitalized software development costs are classified as Technology on our balance sheet and considered a critical accounting estimate due to the fact that certain updates relating to the ZYTO 5.0 platform are still in the development phase.  Specifically, we have completed the entire planning stage of the ZYTO 5.0 platform and have determined that the ZYTO 5.0 platform has achieved technological feasibility.  We have not completed all the designing, coding or testing activities for various products that are required prior to release.   Technological feasibility will be established for these products once we have completed the designing, coding and testing activities mentioned above and we conclude that software meets its design specifications including functions, features, and technical performance requirements.  We have only capitalized costs for those components that have achieved technological feasibility.





We account for intangible assets under the applicable guidelines of Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 350, “Intangibles – Goodwill and Other” and FASB ASC 360, “Property, Plant, and Equipment.” Where intangible assets have finite lives, they are amortized over their useful life unless factors exist to indicate that the asset has been impaired. We evaluate if the assets are impaired annually or on an interim basis if an event occurs or circumstances change to suggest that the assets value has diminished. Under FASB ASC 360, when deemed necessary, we complete the evaluation of the recoverability of its long-lived assets by comparing the carrying amount of the assets against the estimated undiscounted future cash flows associated with them. If such evaluations indicate that the future undiscounted cash flows of long-lived assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their estimated fair values. Under FASB ASC 360 intangible assets with indefinite useful lives are required to be tested annually for impairment or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair value of the assets. As of June 30, 2012, we had not recognized any impairment.





Item 3.    Quantitative and Qualitative Disclosures about Market Risk





As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide this information.





Item 4.    Controls and Procedures





Evaluation of Disclosure Controls and Procedures





We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports under the Securities Exchange Act of 1934, as amended, is 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 Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.





As required by SEC Rule 13a-15(b), an evaluation was performed under the supervision and with the participation of management, including our principal executive officer and our principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, management, including the principal executive officer and principal financial officer, concluded that the design and operation of these disclosure controls and procedures were effective at the reasonable assurance level.





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Changes in Internal Control Over Financial Reporting





During the quarter ended June 30, 2012, there were no changes in our internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.




PART II – OTHER INFORMATION





Item 5.Legal Proceedings





From time to time, we may become involved in various lawsuits and legal proceedings, which arise, in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these, or other matters, may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition or operating results.





Item 6.     Exhibits





31. 1
Certification of Chief Executive Officer of ZYTO Corp, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31. 2
Certification of Chief Financial Officer of ZYTO Corp, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32. 1
Certification of Chief Executive Officer of ZYTO Corp, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32. 1
Certification of Chief Financial Officer of ZYTO Corp, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.101.INS*
XBRL Instance Document101.SCH*
XBRL Taxonomy Extension Schema Document101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document101.DEF*
XBRL Taxonomy Extension Definition Linkbase Document101.LAB*
XBRL Taxonomy Extension Label Linkbase Document101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document





* Furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise not subject to liability under these sections.











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SIGNATURES





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








ZYTO CORP(Registrant)By
/s/        Vaughn R CookChief Executive Officer(Principal Executive Officer)By
/s/        Brian E. HalladayChief Financial Officer

(Principal Financial Officer)





Date:  August 14, 2012








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