PINX:ZYTO Zyto Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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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 March 31, 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 of incorporation or organization)
 
(I.R.S. Employer Identification 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 May 15, 2012.

 

 
 

 


TABLE OF CONTENTS

 
PART I – FINANCIAL INFORMATION

   
Page
Item 1.
Financial Statements:
1
 
Condensed Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011 (Unaudited)
1
 
Condensed Consolidated Statements of Operations for the three months ended March 31, 2012 and 2011 (Unaudited)
2
 
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011 (Unaudited)
3
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
4
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
15
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
24
Item 4.
Controls and Procedures
25

PART II – OTHER INFORMATION

Item 1.
Legal Proceedings
25
Item 6.
Exhibits
26


 
 

 


PART I – FINANCIAL INFORMATION
 
Item 1.   Financial Statements

ZYTO CORP AND SUBSIDIARY
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
             
   
March 31,
   
December 31,
 
   
2012
   
2011
 
ASSETS
           
Current Assets:
           
Cash and cash equivalents
  $ 99,119     $ 87,364  
Accounts receivable, net of allowance for doubtful accounts  of $82,007 and $115,633, respectively
    255,688       217,712  
Prepaid expenses
    67,310       32,245  
Inventories
    30,840       17,558  
Other current assets
    7,525       7,525  
Total current assets
    460,482       362,404  
                 
Long-term accounts receivable, net of allowance for doubtful accounts of $46,696 and $13,071, respectively
    145,027       117,647  
Property and Equipment, net of accumulated depreciation  of $276,603 and $259,747, respectively
    121,667       132,693  
Technology, net of accumulated amortization of $148,721 and $109,650, respectively
    338,713       317,581  
Total assets
  $ 1,065,889     $ 930,325  
                 
LIABILITIES AND STOCKHOLDERS' DEFICIT
               
Current Liabilities:
               
Accounts payable
  $ 421,658     $ 488,967  
Accrued expenses
    199,954       178,121  
Accrued interest related party
    444,383       406,003  
Line of credit
    100,000       100,000  
Short-term notes payable
    96,942       96,942  
Deferred revenue
    143,419       104,927  
Current portion of capital lease
    4,296       4,296  
Total current liabilities
    1,410,652       1,379,256  
                 
Warranty Reserve
    8,476       8,476  
                 
Related Party Note Payable
    2,403,430       2,371,241  
                 
Capital lease, net of current portion
    6,854       9,522  
                 
Total liabilities
    3,829,412       3,768,495  
                 
STOCKHOLDERS' DEFICIT
               
Common stock, par value $.0001 per share, 200,000,000 shares authorized and 34,857,543 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively
    3,486       3,486  
Additional paid-in capital
    5,276,589       5,267,765  
Subscriptions receivable
    (2,000 )     (2,000 )
Accumulated deficit
    (8,041,598 )     (8,107,421 )
                 
Total stockholders' deficit
    (2,763,523 )     (2,838,170 )
                 
Total liabilities and stockholders' deficit
  $ 1,065,889     $ 930,325  

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


 
1

 

ZYTO CORP AND SUBSIDIARY
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
   
For the Three Months Ended March 31,
 
   
2012
   
2011
 
             
Revenues, net
  $ 1,086,580     $ 808,114  
Cost of sales
    41,181       69,836  
                 
Gross Profit
    1,045,399       738,278  
                 
Operating Expenses:
               
Selling and marketing expenses
    343,703       455,353  
General and administrative expenses
    552,529       489,504  
Research and development expenses
    58,884       38,397  
                 
Total operating expenses
    955,116       983,254  
                 
Income (Loss) from operations
    90,283       (244,976 )
                 
Other Income (Expense):
               
Other income
    66,897       -  
Interest expense
    (91,357 )     (86,176 )
                 
Total other income (expense)
    (24,460 )     (86,176 )
                 
Net Income (Loss)
  $ 65,823     $ (331,152 )
                 
Basic Income (Loss) Per Share
  $ 0.00     $ (0.01 )
                 
Basic Weighted Average Shares Outstanding
    34,857,543       34,547,170  
                 
Diluted Income (Loss) per Share:
               
  Net Income (Loss) per Common Share
  $ 0.00     $ (0.01 )
                 
Diluted Weighted-Average Shares Outstanding
    36,812,541       34,547,170  


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



 
2

 

ZYTO CORP AND SUBSIDIARY
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
   
Three Months Ended March 31,
 
   
2012
   
2011
 
Cash Flows from Operating Activities:
           
Net Income (Loss)
  $ 65,823     $ (331,152 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    55,927       39,795  
Amortization of debt discount
    32,190       32,190  
Provision for bad debt
    -       13,544  
Share-based compensation
    8,824       -  
Issuance of common stock for services
    -       41,789  
Issuance of common stock in connection with debt
    -       2,251  
Changes in operating assets and liabilities:
               
Accounts receivable
    (65,357 )     50,698  
Inventories
    (13,282 )     8,767  
Prepaid expenses
    (35,065 )     (10,710 )
Accounts payable
    (67,309 )     85,107  
Accrued expenses
    21,833       29,223  
Accrued interest related party
    38,380       7,774  
Deferred revenue
    38,492       10,734  
                 
Net cash provided by (used in) operating activities
    80,456       (19,990 )
                 
Cash Flows from Investing Activities:
               
Purchase of equipment
    (5,830 )     (12,575 )
Capitalization of software development costs
    (60,203 )     (45,260 )
                 
Net cash used in investing activities
    (66,033 )     (57,835 )
                 
Cash Flows from Financing Activities:
               
Principal payments on notes payable
    (2,668 )     (420 )
Principal payments on line of credit
    -       (11,000 )
Proceeds from notes payable
    -       50,000  
                 
Net cash provided by (used in) financing activities
    (2,668 )     38,580  
                 
Net Increase (Decrease) in Cash and Cash Equivalents
    11,755       (39,245 )
                 
Cash and Cash Equivalents, Beginning of Period
    87,364       39,360  
                 
Cash and Cash Equivalents, End of Period
  $ 99,119     $ 115  
                 
Supplemental Disclosure of Cash Flow Information
               
            Cash paid for interest
  $ 51,553     $ 75,834  

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.

Operating results for the three months ended March 31, 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, formerly known as Quiver Corporation (“Quiver”)) and its wholly owned subsidiary, ZYTO Technologies, Inc. (a Nevada corporation)(the “Subsidiary”).

Business Activity – Our Company’s 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 March 31, 2012, and December 31, 2011, we had an accumulated deficit of $8,041,598 and $8,107,421 respectively.

During the three months ended March 31, 2012 and 2011, we recognized net income of $65,823 and a net loss of $331,152, respectively.

As of March 31, 2012, and December 31, 2011, our current liabilities exceeded our current assets by $950,170 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.

 
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 of the Company is presented to assist in understanding the Company’s condensed consolidated financial statements.  The condensed consolidated financial statements and notes are representations of the Company’s 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 the Company has a controlling financial interest. The accompanying unaudited condensed consolidated financial statements of the Company and its subsidiary at March 31, 2012, and for the three months ended March 31, 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 feel 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 $128,703 and $128,704 at March 31, 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 realized when a customer signs a financing contract for purchases over $5,000, have a maturity of 3-5 years, and bear interest at an annual rate of 24% if the account remains in good standing. In the event the customer defaults, the annual long-term interest increases to 34%. 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 months ended March 31, 2012, other income included a gain on forgiveness of debt of $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
 
   
March 31,
 
   
2012
   
2011
 
Net Income (loss)
  $ 65,823     $ (331,152 )
                 
Basic Weighted-Average Common Shares Outstanding
    34,857,543       34,547,170  
 Effect of dilutive-securities Options
    1,954,998       -  
Diluted Weighted-Average Common Shares Outstanding
    36,812,541       34,547,170  
                 
 Basic Income (loss) Per Common Share Net Income (loss)
    0.00       (0.01 )
 Diluted Income (loss) Per Common Share Net Income (loss)
    0.00       (0.01 )

 
Note 3.  Inventory

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

   
March 31,
   
December 31,
 
   
2012
   
2011
 
Raw Materials
  $ 14,330     $ 4,631  
Finished Goods
    16,510       12,927  
    $ 30,840     $ 17,558  


 
7

 


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


Note 4.  Property and Equipment

Property and equipment consisted of the following as of March 31, 2012, and December 31, 2011:
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
Computer equipment
  $ 186,589     $ 182,678  
Furniture and fixtures
    98,966       98,966  
Production equipment
    62,681       62,681  
Software
    50,034       48,115  
      398,270       392,440  
Accumulated depreciation
    (276,603 )     (259,747 )
    $ 121,667     $ 132,693  
 
Depreciation expense for the three months ended March 31, 2012 and 2011, was $16,856 and $18,604, respectively.

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

   
Life
Computer equipment
 
2-3 years
Software
 
2-3 years
Furniture and fixtures
 
5-7 years
Production equipment
 
3-20  years


Note 5.  Line of Credit

On February 7, 2012, 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 April 5, 2012. As of March 31, 2012 and December 31, 2011, the amount drawn on the line totaled $100,000.  The interest rate to be applied to the unpaid principal balance during the term is 5.25% per annum as of March 31, 2012 and December 31, 2011.  
 
 

 
8

 


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


Borrowings under the line were collateralized by a security interest in all of our assets. The line of credit is personally guaranteed by one of our principal officers. As of May 15, 2012, we were in negotiations to extend the maturity date of the line of credit further.

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 March 31, 2012, the note payable was in default. As of March 31, 2012, the note payable balance was $46,942 and accrued interest totaled $7,792. 

On January 28, 2011, we received $50,000 in exchange for a promissory note.  The 18-month note matures 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 plan to make interest-only payments until the maturity date, at which time the full principal amount is payable.

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

   
2012
   
2011
 
             
Unsecured note payable to InteMedica, LLC,  interest at 12%, monthly payments of $8,000, in default
  $ 46,942     $ 46,942  
                 
Unsecured note payable to shareholder, interest at 10%,  interest payments due monthly, principal due at June 28, 2012
    50,000       50,000  
                 
Total notes payable
    96,942       96,942  
                 
Less current portion
    (96,942 )     (96,942 )
                 
Long-term portion
  $ -     $ -  


 
9

 


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


Note 7. Related Party Note Payable

On March 26, 2012, we executed an amended and restated promissory note with an officer for intellectual property and other related technologies, extending the maturity date to December 31, 2013, bearing interest at 7% per annum. During the three months ended March 31, 2012 and 2011, we recognized interest expense from the promissory note of $43,630 and $43,151, respectively. During the three months ended March 31, 2012 and 2011, we paid $5,251 and $37,870 in cash to the officer for interest expense from the promissory note, respectively.

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

   
March 31,
   
December 31,
 
   
2012
   
2011
 
             
Unsecured note payable to shareholder, interest at 7%, net of discount of $96,570 and $128,759, respectively
  $ 2,403,430     $ 2,371,241  
                 
Total related party notes payable
    2,403,430       2,371,241  
                 
Less current portion
    -       -  
                 
Long-term portion
  $ 2,403,430     $ 2,371,241  

Note 8. Research and Development

During the three months ended March 31, 2012 and 2011, we capitalized $60,203 and $45,260, 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 March 31, 2012 and 2011, amortization of these costs was $39,071 and $21,191, respectively.  During the three months ended March 31, 2012 and 2011, we expensed $58,884 and $38,397 of research and development costs, respectively. This is recorded in research and development expenses on our condensed consolidated statement of operations.



 
10

 


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


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.
 
Future amortization costs related to capitalized research and development are as follows:
 
2012
  $ 122,167  
2013
    162,478  
2014
    52,520  
2015
    1,548  
Total amortization costs
  $ 338,713  


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 March 31, 2012 and 2011, was $45,578 and $36,145, respectively.

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

2012
  $ 140,837  
2013
    192,477  
2014
    32,236  
Total minimum payments
  $ 365,550  

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.

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

 
11

 


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

For the nine months ended December 31, 2012
  $ 1,118  
For the year ended December 31, 2013
    4,296  
For the year ended December 31, 2014
    4,296  
For the year ended December 31, 2015
    2,809  
Total future minimum lease payments
    12,519  
Amount representing interest
    (1,369 )
Present value of future minimum lease payments
    11,150  
Current portion of capital lease
    (4,296 )
Capital lease, less current portion
  $ 6,854  

Note 11.  Equity

On June 15, 2010, we entered into an agreement with a public relations firm retained in 2009 and 2010 to provide public and financial communication services.  The agreement was for a period of twelve and one half months.  As compensation for services, we agreed to issue 1,200,000 shares of restricted common stock to the public relations firm.  We issued 1,100,000 shares of the 1,200,000 shares due under the contract, and mutually agreed to terminate the remainder of the contract.  The shares are valued based on the fair value of the shares on the date they were released from escrow. The total value of shares issued for the three months ended March 31, 2012 and 2011, was $0 and $41,789, of which the entire amount was expensed.

As discussed in Note 7, we received $50,000 in 2011 from a lender in exchange for a promissory note.  The 18-month note expires on June 28, 2012, bearing interest at 10% per annum. As part of the agreement we issued the lender 25,000 shares of common stock. The shares were valued at a grant date fair value of $0.09 per share. The total value of the shares issued was $2,251, which was determined by multiplying the number of shares granted by the closing market price of our common stock on the grant date.

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.

 
12

 


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


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, our consultants, all of our employees, and our subsidiary, as determined by the Board.

There were no issuances from the 2011 Plan for the three months ended March 31, 2012. As of March 31, 2012, there were 3,045,002 shares available for issuance under the 2011 Plan.

On August 16, 2011, we granted stock options to acquire 1,864,998 shares of common stock to our employees, valued at $54,589. These options are exercisable at $0.03 per share, based on the closing price of our common stock on the date of issue. These options vest yearly over three years starting August 16, 2012, and expire on August 16, 2021.

On August 16, 2011, we granted stock options to acquire 90,000 shares of common stock to certain non-employee directors, valued at $2,624. These options are exercisable at $0.03 a share, based on the closing price of our common stock on the date of issue. These options vest annually starting April 1, 2012, and expire August 16, 2021. These options vest over 2 years.

A summary of the status of stock options at March 31, 2012, and changes during the three months then ended, is presented in the following table:

               
Weighted
       
   
Shares
   
Weighted
   
Average
       
   
Under
   
Average
   
Remaining
   
Aggregate
 
   
Option
   
Exercise
   
Contractual
   
Intrinsic
 
   
or Warrant
   
Price
   
Life
   
Value
 
Outstanding at December 31, 2011
    1,954,998     $ 0.03       9.63     $ -  
Granted or issued
    -       -                  
Expired
    -       -                  
Outstanding at March 31, 2012
    1,954,998       0.03       9.38       19,550  
                                 
Exercisable at March 31, 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 the Company’s 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 March 31, 2012, closing price of $0.04 per share.


 
13

 


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

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, is measured based on the grant date fair value of the award, and requires 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 compensation cost has been capitalized in the accompanying condensed consolidated balance sheet.

As of March 31, 2012, there was approximately $35,101 of unrecognized compensation cost related to stock options that will be recognized over a weighted average period of approximately 1.97 years. For the three months ended March 31, 2012, we recorded compensation expense related to stock options of $8,824 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 months ended March 31, 2011.
 
Note 13. Concentrations

During the three months ended March 31, 2012, we purchased approximately 69% of our inventory from two separate 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.


 
14

 
 
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

On January 17, 2012, our patent application for “Methods and Devices for Analyzing and Comparing Physiological Parameter Measurements” (the “Patent”) was issued by the United States Patent and Trademark Office (“USPTO”) and given Patent No. 8,099,159.

The Patent covers the methods and devices that are capable of measuring physiological parameters of at least two contact points and determining whether the measured parameters reflect favorable or unfavorable physiological responses. As noted in the application for the Patent filed with the USPTO, the invention encompasses a method that can non-invasively monitor physiological parameters of at least two contact points before and after a stimulus is applied to a subject and compare the measured parameters to determine whether the physiological state of the subject is favorable or unfavorable.

We use this patented method of measuring the skin’s galvanic response to stimuli to provide information to healthcare professionals about an individual’s health and healthcare options.
 
The grant of the Patent follows the notification we received from the US Food and Drug Administration (the “FDA”) in August 2011 that our Premarket Notification (the “Notification”), submitted pursuant to Section 510(k) of the U.S. Food, Drug and Cosmetic Act (the “Act”), had been approved. We filed the Notification in May of 2011, and on August 30, 2011, the FDA issued its determination that the Hand Cradle was substantially equivalent to other Galvanic skin response measurement devices.


 
15

 
 
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. 

As of the date of this Report, we were in the process of adding 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.

Additionally, this new offering (accessible to our customers through www.ZYTO.com) will be the nexus for healthcare professionals using our technology to communicate with their clients.  All ZYTO applications that are sold exclusively to healthcare professionals have the ability to be used remotely over the Internet.  This allows a healthcare professional to “stay in touch” with his or her clients, even if the client is located a great distance from the healthcare professional’s clinic. 

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.
 

 
16

 
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.

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 of biosurveys.  The Compass is then offered for sale for 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.



 
17

 
 
The Compass biosurvey first records the body’s response to a number of VSIs referred to as biomarkers.  These VSIs are representative of 75 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 generated the most aggressive responses are plotted outside a range circle and are considered “out of range.”  Next, VSIs for a number of products are used to determine and rank their effect on coherence, or their ability to bring the biomarkers back in range.   The product with the highest positive dR is then used as the stimulating VSI as each of the out-of-range biomarkers are rescanned.  The stress profile will indicate which biomarkers move into range.  If all biomarkers do not move into range the VSI for the product with the next highest positive dR is used, along with the first, as the stimulating signal as the biomarkers are again rescanned.  This process is repeated, adding a new product each time, until the stress profile is resolved, i.e., until all biomarkers have moved into range.

The exercises involved with all of our products do not imply that “all your health issues will go away if you take these products.” However, these exercises provide information that is helpful when choosing what supplements to buy, and/or what prescriptions a healthcare professional should issue, and/or how a healthcare professional can further assist his or her client.

Healthcare Professional Product Line

Elite
 
The Elite (an upgrade to our previous product, the LSA Pro) 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. 
 
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 nutriceutical products.  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.
 

 
18

 
 
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.
 
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, Management plans for ZYTO.com to have a Store where healthcare professionals can share biosurveys and clinical applications using ZYTO technology.  A healthcare professional owning the Elite will be able to author a biosurvey and post that biosurvey for sale at “The Store,” and other healthcare professionals will be able to benefit from their experience and knowledge.  The net effect is expected to be a more robust sharing of intellectual power and experience. Once the Store is created, we anticipate making revenue from a portion of each sale.
 

 
19

 

Results of Operations
 
Three Months Ended March 31, 2012, compared to Three Months Ended March 31, 2011
 
   
For the Three Months Ended
 
   
March 31, 2012
(Unaudited)
   
March 31, 2011
(Unaudited)
 
Statement of Operations Data:
           
Revenues, net
  $ 1,086,580     $ 808,114  
Cost of sales
    41,181       69,836  
Gross profit
    1,045,399       738,278  
Total operating expenses
    955,116       983,254  
Other expense
    (24,460 )     (86,176 )
Net income (loss)
    65,823       (331,152 )
Net income (loss) per share
    0.00       (0.01 )
 
Revenues
 
Total revenues for the three months ended March 31, 2012, were $1,086,580, compared to $808,114 for the three months ended March 31, 2011, reflecting an increase of $278,466, or 34.4 percent.  
 
Healthcare Professional Product Line
 
Revenues generated through our Healthcare Professional product line for the three months ended March 31, 2012, were $592,458, compared to $382,380 for the three months ended March 31, 2011, reflecting an increase of $210,078, or 54.9 percent.  

Our Elite product sales for the three months ended March 31, 2012 were $231,045, compared to $150,460 for the three months ended March 31, 2011, reflecting an increase of $80,585, or 53.5 percent. Our EVOX product sales for the three months ended March 31, 2012 were $96,448, compared to $45,678 for the three months ended March 31, 2011, reflecting an increase of $50,770, or 111.1 percent. The primary reasons for increase in sales of the Elite and EVOX systems had to do with a special financing promotion during the month of February, where we offered twelve month financing interest-free.

Our Select product sales for the three months ended March 31, 2012 were $53,809. The Select system was released in May 2011 and replaced our prior version of the Balance, which had product sales during the three months ended March 31, 2011, of $8,500. Our Balance product sales for the three months ended March 31, 2012, were $20,434, compared to $44,198 for the three months ended March 31, 2011, reflecting a decrease of $23,764, or 53.7 percent. This was primarily due to a reduction in travel and expenses related to promoting our Balance product.

Our virtual clinic Hand Cradle sales increased $5,095 compared to the three months ended March 31, 2011, due to increased functionality and use of our remote clinics, which allow healthcare professionals to scan clients remotely.

Professional subscription revenue for the three months ended March 31, 2012, increased $47,335 compared to the three months ended March 31, 2011. The increase in 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 March 31, 2012, were $464,331 compared to $416,438 for the three months ended March 31, 2011, reflecting an increase of $47,893 or 11.5 percent.   The increase in revenues generated through our Compass product line is primarily attributable to a volume increase in our Compass sales of $31,915, and by an increase in our monthly subscription fees of $22,808.   
 

 
20

 
 
The increase in 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 March 31, 2012, were $41,181, compared to $69,836 for the three months ended March 31, 2011, reflecting a decrease of $28,655, or 41.0 percent. This decrease was primarily due to having our virtual hand cradles on backorder for much of the quarter, which has a lower gross margin than our professional line of products.

Selling and Marketing Expenses
 
Selling and marketing expenses for the three months ended March 31, 2012, were $343,703 compared to $455,353 for the three months ended March 31, 2011, reflecting a decrease of $111,650 or 24.5 percent.    This decrease was primarily attributable to a decrease in outside consulting costs, travel expenses, and salaries.

General and Administrative Expenses
   
General and administrative expenses for the three months ended March 31, 2012, were $552,529 compared to $489,504 for the three months ended March 31, 2011, reflecting an increase of $63,025 or 12.9 percent.   The primary factor relating to the increase was an increase in salaries and wages. Other factors relating to the increase included expanding our office space in 2011, which resulted in recognizing an additional $9,433 in office rent expense for the three months ended March 31, 2012, compared to the three months ended March 31, 2011.  These increases were partially offset by a $30,314 decrease in our investor relations expenses, as the engagement of our public relations firm ended in May 2011, and a decrease in legal fees of $42,980.

Research and Development

Research and development expenses for the three months ended March 31, 2012, were $58,884 compared to $38,397 for the three months ended March 31, 2011, reflecting an increase of $20,487 or 53.3 percent. The increase was primarily due to hiring an additional programmer, and an increase in the time spent on improving our current software.

Other Expense

Other expense for the three months ended March 31, 2012, was $24,460 compared to $86,176 for the three months ended March 31, 2011, reflecting a decrease of $61,716 or 71.6 percent. The decrease was primarily due to other income of $66,897 during the three months ended March 31, 2012, resulting from forgiveness of debt.

Net Income/Loss
 
Our net income for the three months ended March 31, 2012, was $65,823 compared to a loss of $331,152 for the three months ended March 31, 2011.  The net income for the three months ended March 31, 2012, is a direct result of the increase in revenues, and a reduction in operating expenses, 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 March 31, 2012, we had cash and cash equivalents of $99,119, current liabilities of $1,410,652, and total current assets of $460,482, with our current liabilities exceeding current assets by $950,170.
 

 
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Cash Flow

   
For the Three Months Ended March 31,
 
Net cash provided by (used in):
 
2012
   
2011
 
  Operating activities
  $ 80,456     $ (19,990 )
  Investing activities
    (66,003 )     (57,835 )
  Financing activities
    (2,688 )     38,580  
Net increase (decrease) in cash
    11,755       (39,245 )

Operating activities:

Cash provided by (used in) operating activities was $80,456 and ($19,990) for the three months ended March 31, 2012 and 2011, respectively. Net cash provided by operating activities during the three months ended March 31, 2012, consisted of our net income of $65,823, which was offset by non-cash expenses of depreciation and amortization of $55,927, changes in amortization of debt discount of $32,190, share-based compensation of $8,824 and a change in working capital of ($82,308).

Net cash used in operating activities during the three months ended March 31, 2011, consisted of our net loss of $331,152, which was offset by non-cash expenses of depreciation and amortization of $39,795, changes in amortization of debt discount of $32,190, provision of bad debt of $13,544, issuance of common stock for services of $41,789, issuance of common stock in connection with debt of $2,251 and a change in working capital of $181,593.

Investing activities:

Cash used in investing activities was $66,033 during the three months ended March 31, 2012, which included $5,830 for property, plant, and equipment purchases, and $60,203 for capitalizing costs relating to significant enhancements and upgrades to our proprietary software.

Cash used in investing activities was $57,835 during the three months ended March 31, 2011, which included $12,575 for property, plant, and equipment purchases, and $45,260 for capitalizing costs relating to significant enhancements and upgrades to our proprietary software.

Financing activities:

Cash used in financing activities was $2,668 during the three months ended March 31, 2012, which consisted of principal payments on notes payable of $2,668.

Cash provided by financing activities was $38,580 during the three months ended March 31, 2011, which included principal payments on notes of $420, principal payments on our line of credit of $11,000, 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.
 

 
 
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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.

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 March 31, 2012, and December 31, 2011, we had accumulated deficits of $8,041,598 and $8,107,421 respectively.

During the three months ended March 31, 2012 and 2011, we recognized net income of $65,823 and a net loss of $331,152, respectively.

As of March 31, 2012, and December 31, 2011, our current liabilities exceeded our current assets by $950,170 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.
 

 
23

 
 
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 as of the date of this Report 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 in 2008. 

In addition to being the nexus between healthcare professionals and their clients as it relates to remote scans, ZYTO.com will have a Store where healthcare professionals can share biosurveys and clinical applications using ZYTO technology.  A healthcare professional owning the Elite will be able to author libraries and biosurveys and post them for sale at “The Store.” In this way other healthcare professionals will be able to benefit from their experience and knowledge.  The net effect is expected to be a more robust sharing of intellectual power and experience.

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 March 31, 2012, the total capitalized amount was $487,434. 

During the three months ended March 31, 2012 and 2011, we capitalized $60,203 and $45,260, 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 March 31, 2012 and 2011, amortization of these costs was $39,071 and $21,191, 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” (formerly SFAS 142 “Goodwill and Other Intangible Assets”) and FASB ASC 360, “Property, Plant, and Equipment” (formerly SFAS 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”). 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 March 31, 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.

 
24

 
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.

Changes in Internal Control Over Financial Reporting

During the quarter ended March 31, 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 1.  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.
 
 
 
25

 
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. 2
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 Document*
   
101 SCH
XBRL Schema Document*
   
101 CAL
XBRL Calculation Linkbase Document*
   
101 DEF
XBRL Definition Linkbase Document*
   
101 LAB
XBRL Labels Linkbase Document*
   
101 PRE
XBRL Presentation Linkbase Document*

*           The XBRL related information in Exhibit 101 shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability of that section and shall not be incorporated by reference into any filing or other document pursuant to the Securities Act of 1933, as amended, except as shall be expressly set forth by specific reference in such filing or document.

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 Cook
   
Chief Executive Officer
   
(Principal Executive Officer)
     
 
By 
/s/ Brian E. Halladay
   
Chief Financial Officer
(Principal Financial Officer)
     
Date:  May 15, 2012
 
 
 
 
26

 

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