Form 10-QSB
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-QSB
 

[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2006

[   ] Transition report under Section 13 or 15(d) of the Exchange Act
For the transaction period from ______ to _______
 
 
Commission file number 333-62216

HEALTH DISCOVERY CORPORATION 
(Exact name of small business issuer as specified in its charter) 
 
 

Texas
 
74-3002154
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
 

5501 ½ Abercorn Street
Savannah, Georgia
 
 
31405
(Address of principal executive offices)
 
(Zip Code)
 
912-352-7488
(Issuer's telephone number, including area code)
 
 

 
(Former name, former address and former fiscal year,
if changed since the last report)
 
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]  
 
 
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
 
 
Check whether the registrant filed all documents and reports required to be filed by Section l2, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes [  ] No [  ]
 
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
 
State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 116,163,384 shares of common stock, no par value, were issued and outstanding as of May 11, 2006.
 
 
Transitional Small Business Disclosure Format (Check one): Yes [  ] No [X]


 

 

TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION
Page
     
Item 1.
Financial Statements
  
     
 
Balance Sheet
1
     
 
Statements of Operations
2
     
 
Statements of Cash Flows
3
     
 
Notes to Financial Statements
4-7
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
7-9
     
Item 4.
Controls and Procedures
9
     
PART II
OTHER INFORMATION
  
     
Item 1.
Legal Proceedings
10
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
10-11
     
Item 6.
Exhibits
12
     
 
Signatures
14




HEALTH DISCOVERY CORPORATION

Balance Sheet
(unaudited)

 

 Assets
     
   
March 31,
2006
  
       
Current Assets
      
Cash 
  
$
522,910
  
Prepaid Expenses and Other Assets
    
32,731
  
         
Total Current Assets
    
555,641
  
         
Equipment, Less Accumulated Depreciation of $8,407
    
11,808
  
         
Other Assets
        
Patents, Less Accumulated Amortization of $483,215
    
3,502,579
  
         
Total Assets
  
$
4,070,028
  
         
 Liabilities and Stockholders’ Equity
         
Current Liabilities
        
Accounts Payable - Trade
  
$
357,378
  
Accrued Liabilities
   
139,500
  
Current Portion of Long-Term Debt
   
26,780
  
         
Total Current Liabilities
    
523,658
  
         
Convertible Notes Payable
    
665,643
  
Long-Term Debt, Less Current Portion
    
321,911
  
         
Total Liabilities
    
1,511,212
  
         
Commitments
       
         
Stockholders’ Equity
        
Common Stock, No Par Value, 200,000,000 Shares Authorized
       
115,963,384 Shares Issued and Outstanding
    
10,180,002
  
Accumulated Deficit
    
(7,621,186
)
         
Total Stockholders' Equity
    
2,558,816
  
         
Total Liabilities and Stockholders' Equity
  
$
4,070,028
  








See accompanying notes to financial statements.

1

HEALTH DISCOVERY CORPORATION
Statements of Operations
(unaudited)
For the Three Months Ended March 31, 2006 and 2005

   
2006
  
2005
  
Revenues:
          
Licensing
 
$
105,000
    
-
  
Total Revenues
    
105,000
    
-
  
Cost of Sales:
              
Licensing
    
-
    
-
  
               
Total Cost of Sales
    
-
    
-
  
               
Gross Profit
    
105,000
    
-
  
Operating Expenses:
              
Amortization 
    
65,680
    
56,819
  
Professional and Consulting Fees
    
573,229
    
448,042
  
Compensation
    
359,298
    
199,543
  
Other General and Administrative Expenses
    
240,211
    
206,364
  
Total Operating Expenses
    
1,238,418
    
910,768
  
               
Loss From Operations
    
(1,133,418
)
  
(910,768
)
               
Other Income (Expense)
              
Interest Income
    
4,830
    
-
  
Gains on Restructuring of Accounts Payable
    
77,546
    
-
  
Interest Expense
    
(19,745
)
  
(17,152
)
Total Other Income (Expense)
    
62,631
    
(17,152
)
               
Net Loss
 
$
(1,070,787
)
  
(927,920
)
               
               
               
Weighted Average Outstanding Shares
    
115,063,384
    
85,237,154
  
               
Loss Per Share
  
$
(.01
)
  
(.01
)
               
               
               
               
               
               
               


       






See accompanying notes to financial statements.


2

HEALTH DISCOVERY CORPORATION

Statements of Cash Flows
(unaudited)
For the Three Months Ended March 31, 2006 and 2005

   
March 31,
2006
      
March 31,
2005
  
       
Cash Flows From Operating Activities:
              
Net Loss
  
$
(1,070,787
)
        
(927,920
)
Adjustments to Reconcile Net Loss to Net Cash
                    
Used by Operating Activities:
                    
Noncash Compensation
    
190,322
          
-
  
Securities Exchanged for Warrants
    
305,265
          
-
  
Services Exchanged for Common Stock
   
-
          
75,000
  
Gains on Restructuring of Accounts Payable
    
(77,546
)
        
-
  
Depreciation and Amortization
    
67,427
          
57,778
  
Increase in Employee Advances
    
-
          
(3,500
)
Increase in Prepaid Expenses and Other Assets
    
(15,023
)
        
(2,706
)
Increase (Decrease) in Accounts Payable - Trade
    
222,406
          
(109,761
)
Increase in Accrued Liabilities
   
76,181
          
24,049
  
                     
  Net Cash Used by Operating Activities
    
(301,755
)
        
(887,060
)
                     
Cash Flows From Investing Activities:
                    
Purchase of Equipment
    
(502
)
        
(5,882
)
Amounts Paid to Acquire Patents
    
-
          
(3,223
)
                     
  Net Cash Used by Investing Activities
    
(502
)
        
(9,105
)
                     
Cash Flows From Financing Activities:
                    
Repayments of Notes Payable
    
-
          
(62,500
)
Proceeds from Sales of Common Stock, Net
Proceeds from Exercise of Stock Options
    
100,000
6,000
          
1,926,000
-
  
                     
  Net Cash Provided by Financing Activities
    
106,000
          
1,863,500
  
                     
Net Increase (Decrease) in Cash
    
(196,257
)
        
967,335
  
                     
Cash, at Beginning of Period
    
719,167
          
163,477
  
                     
Cash, at End of Period
  
$
522,910
          
1,130,812
  
                     
Non-Cash Investing and Financing Transactions:
                    
Stock Issued for Professional and Consulting Services
  
$
-
          
75,000
  
Non-cash Compensation Warrants and Options
  
$
495,587
          
-
  
Non-cash Stock Issuance Costs
  
$
-
          
127,076
  
Warrants Issued in Restructuring of Accounts Payable
  
$
55,454
          
-
  
                     
Supplemental disclosures of cash flow information:
                    
Cash Paid for Interest
  
$
-
          
2,774
  
                     
 



See accompanying notes to financial statements.


3


HEALTH DISCOVERY CORPORATION

Notes to Financial Statements

Note A - BASIS OF PRESENTATION

Health Discovery Corporation (the “Company”) is a biotechnology-oriented company that has acquired certain rights to patents and has patent pending applications for certain machine learning tools used for diagnostic and drug discovery. The Company licenses the use of its patented protected technology or may develop specific learning tools to sell to third parties. The Company was reported on as a development stage corporation through December 31, 2004.

The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America (GAAP). In preparing financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from those estimates.

The interim financial statements included in this report are unaudited but reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the period ended March 31, 2006 are not necessarily indicative of the results of a full year’s operations. For further information, refer to the financial statements and footnotes included in the Company’s annual report on Form 10-KSB for the year ended December 31, 2005.

RECLASSIFICATIONS

Certain amounts from 2005 have been reclassified to conform to the presentation used in 2006.

Note B - NET LOSS PER SHARE

Basic Earnings Per Share (“EPS”) includes no dilution and is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings or losses of the entity. Due to the net loss in all periods presented, the calculation of diluted per share amounts would result in an anti-dilutive result and therefore is not presented.

Note C - STOCK-BASED COMPENSATION
 
Effective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment (“SFAS No. 123(R)”) using the modified prospective transition method provided for under the standard. SFAS 123(R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee’s requisite service period. We had previously applied Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations and provided the required pro forma disclosures of SFAS No. 123.
 
The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation for periods presented prior to the Company’s adoption of Statement 123(R):

4

 

HEALTH DISCOVERY CORPORATION

Notes to Financial Statements, continued

Note C - STOCK-BASED COMPENSATION, continued

   
Three months ended
  
   
March 31, 2005
  
       
Net loss as reported
  
$
(927,920
)
         
Deduct: Stock-based Expense
Determined Under Fair Value Based
Method for Employee Stock Options
    
-
  
         
Proforma Net Loss
  
$
(927,920
)
         
Stock-based Expense Included in Net Loss
  
$
75,000
  
         
Loss Per Share:
        
Basic - As Reported
  
$
(.01
)
Basic - Proforma
  
$
(.01
)
 
Stock-based expense included in our net loss for the three months ended March 31, 2006 consisted of $495,587 in compensatory warrants and options. Stock-based expense included in our net loss for the three months ended March 31, 2005 consisted of $75,000 for the issuance of common stock to consultants for services.

As of March 31, 2006, there was approximately $659,000 of unrecognized cost related to stock option and warrant grants. The cost is expected to be recognized over the remaining vesting period of approximately 2 years.

The Company granted 2,000,000 options during the first quarter of 2006. The fair value of each option granted in 2006 was $0.11 and was estimated on the date of grant using the Black-Scholes pricing model with the following assumptions: dividend yield at 0%, risk-free interest rate of 5.00%, an expected life of 10 years, and volatility of 133%. Expected option lives and volatilities used in the fair valuation calculations are based on historical data of the Company and the related expense is recognized on a straight-line basis over the vesting period. No options were granted in the first quarter of 2005.

The following schedule summarizes stock option activity for the first quarter of 2006:

   
 
Option
  
Weighted
Average
  
 
  
Shares
  
Exercise Price
  
           
Outstanding, December 31, 2005
    
2,500,000
  
$
0.08
  
Granted
    
2,000,000
    
0.11
  
Exercised
    
(600,000
)
  
0.01
  
Forfeited
    
(400,000
)
  
0.10
  
               
Outstanding, March 31, 2006
    
3,500,000
  
$
0.11
  

The weighted average remaining life of the outstanding options at March 31, 2006 is 10 years.

There were 1,500,000 options exercisable at March 31, 2006. The exercisable options have a weighted average exercise price of $0.11 and a weighted average remaining life of 10 years.

Information about warrants outstanding at March 31, 2006 is summarized below:

5


HEALTH DISCOVERY CORPORATION

Notes to Financial Statements, continued

Note C - STOCK-BASED COMPENSATION, continued


 
Exercise Prices
  
 
Number
Outstanding
  
Weighted-
Average
Remaining
Contractual Life (years)
  
 
 
 
 
Number
Exercisable
  
Weighted Average Remaining Contractual Life (years) of
Exercisable Warrants
  
$0.01
    
1,400,000
    
1
    
800,000
    
1
  
$0.08
    
600,000
    
1
    
600,000
    
1
  
$0.10
    
365,000
    
3
    
365,000
    
3
  
$0.11
    
500,000
    
3
    
500,000
    
3
  
$0.12
    
150,000
    
3
    
150,000
    
3
  
$0.13
    
5,500,000
    
5
    
2,500,000
    
3
  
$0.15
    
1,000,000
    
3
    
1,000,000
    
3
  
$0.20
    
500,000
    
2
    
500,000
    
2
  
$0.22
    
500,000
    
3
    
500,000
    
3
  
$0.24
    
32,546,250
    
3
    
32,546,250
    
3
  
$0.35
    
15,235,000
    
1
    
15,235,000
    
1
  
 
During 2006, the Company issued 2,600,000 warrants to consultants and others for services with a weighted-average exercise price of $0.13 per share. A total of $258,724 was recorded as Paid in Capital for Compensatory Warrants. The warrants became exercisable upon issuance.
 
The Company issued 3,000,000 warrants to two directors with an exercise price of $0.13 per share. A total of $29,625 was recorded as Paid in Capital for Compensatory Warrants. The warrants vest at a rate of 500,000 warrants (250,000 warrants for each director) after satisfactory completion of each 6 months of service until 3 years of service has been completed. The expense is being recorded over the service period.
 
The Company issued 1,000,000 warrants to a director with an exercise price of $0.15 per share in conjunction with a common stock sale. The Company has ascribed no value to the warrants associated with the common stock sale described in Note E.
 
The Company issued 765,000 warrants to three of its service providers with a weighted-average exercise price of $0.11 in settlement of certain accounts payable due to the service providers. The Company recorded a total of $55,454 as Paid in Capital for Compensatory Warrants and recognized total gains of $77,546 as a result of the restructuring the accounts payable amounts.
 
In addition, the Company recorded a total of $16,916 during 2006 as Paid in Capital for Compensatory Warrants associated with previous warrant grants that have not fully vested. The expense is being recorded over the service period.
 
Note D - PATENTS

The Company has acquired a group of patents related to biotechnology and certain machine learning tools used for diagnostic and drug discovery. Additionally, legal costs associated with patent acquisitions and the application process are also capitalized as a part of patents. The Company has recorded $3,502,579 in patents and patent related costs, net of accumulated amortization, at March 31, 2006.

Amortization charged to operations for the quarters ended March 31, 2006 and 2005 was $65,680 and $56,819, respectively. The weighted average amortization period for patents is 14 years. Estimated amortization expense for the next five years is $262,575 per year.
 
Note E - STOCKHOLDERS’ EQUITY

During the first quarter of 2006, the Company issued 600,000 shares of its common stock upon the exercise of stock options. Proceeds from the exercise totaled $6,000.


6

HEALTH DISCOVERY CORPORATION

Notes to Financial Statements, continued


 
Note E - STOCKHOLDERS’ EQUITY, continued

In addition, the Company sold 1,000,000 shares of its common stock to one of its directors for $100,000. The shares were sold for $.10 per share which was the closing price of the stock on the date of the sale. As part of the purchase, the director also received warrants to purchase an additional 100,000 shares of the Company’s common stock at a fixed price of $.15 per

share until December 2008. No portion of the proceeds was assigned to the value of the warrants because the exercise price of the warrants exceeded the market value of the underlying common stock on the date of purchase.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Corporate Overview
 
Our Company is uniquely positioned in the field of pattern recognition technology. Through the application of our patent protected technology, HDC is a biology-oriented biomarker and pathway discovery company providing all aspects of First-Phase Biomarker Discovery. Our primary business consists of licensing that intellectual property and working with prospective customers on the development of varied products that utilize pattern recognition tools. We also endeavor to develop our own product line of newly discovered biomarkers and pathways that include human genes and genetic variations, as well as gene, protein, and metabolite expression differences. In drug discovery, biomarkers can help elicit disease targets and pathways and validate mechanisms of drug action. They may also be pharmacodynamic indicators of drug activity, response and toxicity for use in clinical development.
 
We intend to provide pharmaceutical and diagnostic companies with all aspects of first phase diagnostic and drug discovery, from expert assessment of the clinical dilemma through proper selection and procurement of high quality specimens. We will then apply our proprietary analytical evaluation methods and state-of-the-art computational analysis to derive relevant and accurate clinical data, producing accurate biomarker and pathway discoveries, resulting in patent protection of our biomarker discoveries for future development.
 
First Phase Biomarker Discovery is based on the belief that in order to discover the most clinically relevant biomarkers, the computational component must begin at the inception of the clinical dilemma to be solved. This process includes several critical levels of decision-making - all of which are part of our business strategy.
 
We intend to produce more relevant and predictable biomarkers for drug discovery so that new and better medicines and diagnostic markers can be developed for patients worldwide.
 
Three Months Ended March 31, 2006 Compared with Three Months Ended March 31, 2005
 
Revenue
 
For the three months ended March 31, 2006, revenue was $105,000 compared with no revenue for the three months ended March 31, 2005, which was reported as a developmental stage company. Revenue was recognized for licensing and development fees.
 
Cost of Sales and Gross Margin
 
No expenses attributable to cost of sales was recorded for 2006. Cost of sales includes all direct costs associated with the acquisition and development of patents and processes sold. All direct costs, primarily professional fees associated with licensing negotiations, are also included in cost of sales. No such direct costs were incurred during the first quarter of 2006.
 

7

 
Operating and Other Expenses
 
Amortization expense was $65,680 for the first quarter of 2006 compared with $56,819 for the first quarter of 2005. This increase was due to amortization being charged in 2006 for intangibles acquired during 2005.
 
Professional and consulting fees totaled $573,229 for the first quarter of 2006 compared with $448,042 for the first quarter of 2005. These fees, related to legal, accounting and scientific activities, were higher in 2006 because of increased regulatory filing activity, patent protection efforts, and general corporate legal and accounting work. The amount for 2006 includes $275,641 in compensatory warrants issued to consultants for services.
 
Compensation of $359,298 for the first quarter of 2006 was higher than the $199,543 reported for the first quarter of 2005. This increase was due to the implementation of SFAS 123(R) favorably offset by a reduction of $17,000 in salaries due to reduced headcount.
 
Other general and administrative expenses increased from $206,364 for the first quarter of 2005 to $240,211 for the first quarter of 2006. This increase is largely due to the extensive sales, marketing, and promotional efforts expended throughout the first quarter of 2006.
 
Loss from Operations
 
The loss from operations for the first quarter of 2006 was $1,133,418 compared to $910,768 for the first quarter of 2005. The increased loss was due to the factors enumerated above.
 
Other Income and Expense
 
Interest income was $4,830 for the first quarter of 2006. No interest income was earned in 2005.
 
A gain on the restructuring of accounts payable of $77,546 was recorded in the first quarter of 2006 to reflect common stock warrants issued in payment of liabilities. No such amount was recorded in the comparable 2005 period.
 
Interest expense was $19,745 in 2006 compared with $17,152 in the first quarter of 2005. This increase was due to interest being charged in 2006 for the debt assumed in 2005, as well as the higher interest rate associated with the renegotiated promissory notes.
 
Net Loss
 
The net loss for the first quarter of 2006 was $1,070,787 compared to $927,920 for the first quarter of 2005. The increased loss was due to the higher loss from operations, offset favorably by the increased other income.

Net loss per share was $0.01 for the first quarter of 2006 and 2005. The larger net loss in 2006 compared to that in 2005 was offset by the increased average number of shares outstanding in 2006.
 
Liquidity and Capital Resources
 
At March 31, 2006, the Company had $522,910 in available cash. Cash used by operating activities was $301,775. This was due primarily to the net loss of $1,070,787; however non-cash charges of $563,014 favorably impacted the computation of the net cash used. Cash used by investment activities was $502 due to the acquisition of assets. Net cash provided by financing activities was $106,000 due to the proceeds from the sale of common stock and the exercise of stock options.
 
A portion of our cash will be used to satisfy the Company’s outstanding debt obligations related to the acquisition of the SVM assets and fees due to professionals for services performed. Scheduled payments of $26,780 on notes resulting from the acquisition of the SVM Portfolio were paid on May 11, 2006.
 

8

 
The following table summarizes the due dates of our contractual obligations. The Company has no long term lease agreements in effect as of March 31, 2006.
 

   
Total
  
Less than
1 Year
  
1-3
Years
  
Convertible Notes Payable
  
$
665,643
  
$
-
  
$
665,643
  
Term Debt
    
348,691
    
26,780
    
321,911
  
Total
  
$
1,014,334
  
$
26,780
  
$
987,554
  
 
 
The Company has relied primarily on equity funding plus debt financing for liquidity during its developmental phase that ended in 2005. The Company produced sales, licensing, and developmental revenue in 2005 and 2006 and must continue to do so in order to generate sufficient cash to continue operations. Our plan to have sufficient cash to support operations is comprised of generating revenue through licensing our significant patent portfolio, providing services related to those patents, and obtaining additional equity or debt financing. We have been and continue to be in meaningful discussions with a variety of parties, which if successful, will result in significant revenue. We have implemented a cash conservation plan that includes salary deferrals, reduction in consulting payments, negotiated settlements with creditors whereby we substituted equity instruments for amounts owed, and a heightened scrutiny of all potential expenditures.
 
Should it prove necessary, the Company may also consider such alternatives as raising additional equity through private placements and/or debt offerings. Although this raises doubt with respect to our ability to operate as a going concern, the Company believes that it has sufficient capability to operate through the next twelve months.
 
Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements that provide financing, liquidity, market or credit risk support or involve leasing, hedging or research and development services for our business or other similar arrangements that may expose us to liability that is not expressly reflected in the financial statements.

Forward-Looking Statement

This Report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements appear in a number of places in this Report and include all statements regarding the intent, belief or current expectations of the Company, its directors or its officers with respect to, among other things: (i) the Company’s financing plans; (ii) trends affecting the Company’s financial condition or results of operations; (iii) the Company’s growth strategy and operating strategy; and (iv) the declaration and payment of dividends. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those projected in the forward-looking statements as a result of various factors discussed herein and those factors discussed in detail in the Company’s other filings with the Securities and Exchange Commission.

Item 4. Controls and Procedures.

As of March 31, 2006 (the “Evaluation Date”), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and President and our Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon this evaluation, our Chief Executive Officer and our Principal Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective under Rule 13a-15.
 
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company to disclose material information otherwise required to be set forth in the Company’s periodic reports.
 

9

 
The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. As of the Evaluation Date, no changes in the Company’s internal control over financial reporting occurred, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

On May 25, 2004, we filed suit in the District Court of McLennan County, Texas, against Bill G. Williams, Shirley K. Williams, W. Steven Walker, Jerry W. Petermann and a company controlled by Mr. Williams. In this action we allege that an aggregate of 700,000 shares of our common stock (4,900,000 after a 7-1 stock split) issued to Mr. Williams, Mr. Walker, Mr. Braswell and Mr. Petermann were not issued in compliance with Texas law and we sought to restrain the defendants and persons acting on their behalf or in concert with them from selling any shares of our stock. We also requested that the Court declare we were permitted to cancel the shares issued to the defendants and sought monetary damages, attorney’s fees and costs of the action.
 
In June 2004, Jerry W. Petermann agreed to return to the Company 1,000,000 shares of the Company stock, which were canceled upon return to the Company as full and final settlement of the claims brought in the aforementioned lawsuit. In addition, in June 2004, Robert S. Braswell IV agreed to return to the Company 2,100,000 shares of the company stock, all of which were canceled upon return to the Company.
 
In July 2004, W. Steven Walker Esq., former general counsel, an officer and director of the Company, agreed to settle with the Company and return 366,036 shares of our common stock, which was all of the shares then owned by him, and he will no longer be a party to the suit. Accordingly, only the shares originally issued to Mr. Williams are subject to the suit, and the Company believes he controls approximately 2.1 million shares of our common stock.
 
After several rulings at the District Court, on August 25, 2004 the Court of Appeals for the Tenth District of the State of Texas granted our appeal and entered an order, remanding the case to the original trial judge with instructions to issue a temporary injunction to preserve the status quo. The injunction will remain until a judgment in the case becomes final or the court otherwise instructs. The injunction requires the remaining defendants, their agents, employees, affiliates, any person or entity they control, and any person acting in concert with them to (i) stop and refrain from selling or otherwise disposing of any share of our common stock, and (ii) deposit into the registry of the District Court all shares of our common stock they now own or hold. Costs of the appeal were assessed against the Respondents. The defendants have asserted several counter claims against the Company, including a derivative action, and have brought third-party claims against several current officers of the Company.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

On September 15, 2003 we completed the sale of 2,750,000 shares of restricted common stock to individual accredited investors at a price of $0.02 per share for a total of $55,000. The securities issued in the private placement were not registered under the Securities Act of 1933, as amended, and until they are registered the securities may not be offered or sold in the United States absent registration or the availability of an applicable exemption from registration. The shares were offered and sold in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended, and Regulation D promulgated thereunder. Based on the information provided by each of the investors, all investors qualify as accredited investors (as defined by Rule 501 under the Securities Act of 1933, as amended). The Company filed a registration statement on September 15, 2003 and agreed that should the Company, before September 15, 2005, propose for itself or any other person, the registration under the Act of any securities of the Company on Form S-1, S-2 or S-3, the Company shall include in any such Registration Statement and in any related underwriting agreements, if the investors so requests, such securities of the investors.
 

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In the fourth quarter of 2003, the Company issued 450,000 shares to consultants to the Company, including members of the Company’s scientific advisory board. In 2004, the Company issued 422,372 shares for services, including members of the Company’s scientific advisory board. In 2005, the Company issued 2,039,453 shares to consultants and members of the scientific advisory board, 308,133 shares in settlement of liabilities, 3,585,741 shares to noteholders who exchanged their notes for stock and 540,000 shares in accordance with the penalty provisions of the stock purchase agreement as amended February 25, 2005. In December 2005, two consultants who had previously received shares for work performed rescinded 1,580,532 shares. All of these issuances were made in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended.
 
On July 31, 2004, we completed the private sale of 15,235,000 shares of restricted common stock to individual accredited investors at an offering price of $ 0.10 per share for a total of $1,523,500. Under the terms of the sale, the Company issued 15,235,000 restricted common shares. In addition, each purchaser of common shares was granted a warrant to acquire an equal number of restricted common shares at a fixed price of $0.35 per share, exercisable until February 2007. This could result in the issuance of up to 15,235,000 additional restricted common shares upon exercise. We entered into purchase agreements with each of the investors, the form of which is attached as Exhibit 10.6. Neither the shares sold pursuant to the private placement nor the shares issuable upon the exercise of the warrants will be registered under either federal or state securities laws and must be held for at least one year from the time they are issued. The securities issued in the private placement were not registered under the Securities Act of 1933, as amended, and until they are registered the securities may not be offered or sold in the United States absent registration or the availability of an applicable exemption from registration. The shares and the warrants, the form of which is attached as Exhibit 10.7, were offered and sold in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended, and Regulation D promulgated thereunder. Based on the information provided by each of the investors, all investors qualify as accredited investors (as defined by Rule 501 under the Securities Act of 1933, as amended).
 
On March 9, 2005, we completed the private sale of 30,703,125 shares of restricted common stock to certain institutional investors and individual accredited investors at an offering price of $0.16 per share for a total of $4,912,500. For every share of common stock purchased, each investor received warrants to purchase one share of the Company’s common stock at $0.24 per share, exercisable until December 31, 2008. This could result in the issuance of up to 30,703,125 additional restricted common shares upon exercise. We entered into purchase agreements with each of the investors, the form of which is attached as Exhibit 10.8. Under each agreement, the Company agreed to use its best efforts to file a registration statement to register the shares of common stock and the shares underlying the warrants issued and sold to the investors by May 9, 2005, and to use its best efforts to cause the registration statement to be declared effective July 6, 2005. Shares totaling 540,000 were issued in the fourth quarter of 2005 under the penalty provisions of the agreement. The securities issued in the private placement were not registered under the Securities Act of 1933, as amended, and until they are registered the securities may not be offered or sold in the United States absent registration or the availability of an applicable exemption from registration. The shares and the warrants, the form of which is attached as Exhibit 10.9, were offered and sold in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended, and Regulation D promulgated there under. Based on the information provided by each of the investors, all investors qualify as accredited investors (as defined by Rule 501 under the Securities Act of 1933, as amended). Subsequently on March 10, 2005, we filed registration statement No. 333-124750 for 18,609,375 shares of restricted common stock and the equivalent number of warrants.
 
On December 14, 2005, the Company filed registration statement 333-124750 registering 31,622,749 shares of common stock and 32,638,436 shares of common stock underlying warrants with the Securities and Exchange Commission, and the Securities and Exchange Commission declared the registration statement effective on December 20, 2005.

In January 2006, Mr. David Cooper was issued 600,000 shares of the Company’s common stock in exchange for exercising his options, which had an exercise price of $0.01. On March 31, 2006, Mr. William Quirk purchased 1,000,000 shares of the Company’s common stock with accompanying warrants to acquire an equal number of shares. The purchase price for the common shares was $.10 per share, and the exercise price of the warrants is $0.15 per share. All of these issuances were made in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended.
 

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Item 6. Exhibits.

The following exhibits are attached hereto or incorporated by reference herein (numbered to correspond to Item 601(a) of Regulation S-B, as promulgated by the Securities and Exchange Commission) and are filed as part of this Form SB-2:
 

3.1
Articles of Incorporation. Registrant incorporates by reference Exhibit 3.1 to Registration Statement on Form SB-2,  filed June 4, 2001.
 
 
3.1 (a)
Articles of Amendment to Articles of Incorporation Registrant incorporates by reference Exhibit 2.2 to Form 10-QSB, filed November 14, 2001.
 
 
3.1(b)
 
Articles of Amendment to Articles of Incorporation changing Registrant name from Direct Wireless Communications, Inc., to Health Discovery Corporation. Registrant incorporates by reference Exhibit 3.1 (b) to form 10-KSB, filed March 3, 2004.
 
 
3.2
By-Laws. Registrant incorporates by reference Exhibit 3.2 to Registration Statement on Form SB-2, filed June 4, 2001.
 
 
4.1
Copy of Specimen Certificate for shares of common stock. Registrant incorporates by reference Exhibit 4.1 to Registration Statement on Form SB-2, filed June 4, 2001.
 
 
4.1 (b)
Copy of Specimen Certificate for shares of common stock. Registrant incorporates by reference Exhibit 4.1 (b) to Form 10-KSB, filed March 30, 2004.
 
 
4.2
Excerpt from By-Laws. Registrant incorporates by reference Exhibit 4.2 to Registration Statement on Form SB-2,  filed June 4, 2001.
 
 
4.2(A)
Corrected Article 3.02 of By-Laws. Registrant incorporates by reference Exhibit 4.2(A) to Amendment No. 2 to Registration Statement on Form SB-2, filed August 15, 2001.
 
 
4.3(a)
Non Qualified stock option agreements dated October 30, 2003 between registrant and David Cooper. Registrant incorporates by reference Exhibit 4.3(a) to form 10-KSB, filed March 30, 2004.
 
 
10.1
Asset purchase agreement between registrant dated September 15, 2003 and Barnhill Group LLC. Registrant incorporates by reference Exhibit 10.2 to form 10-KSB, filed March 30, 2004.
 
 
10.2
Asset purchase agreement between registrant dated December 30, 2003 and Fractal Genomics LLC. Registrant incorporates by reference Exhibit 10.3 to Form 10-KSB, File No. 333-62216, filed March 30, 2004.
 
 
10.3
Employment Agreement with Stephen Barnhill. Registrant incorporates by reference Exhibit 10.3 to form 10-KSB, filed April 19, 2005. *
 
 
10.4
Employment Agreement with David Cooper. Registrant incorporates by reference Exhibit 10.4 to form 10-KSB, filed April 19, 2005. *
 
 
10.5
Form of Asset Purchase agreement between the registrant and the sellers of the SVM Portfolio and related assets. Registrant incorporates by reference Exhibit 10.5 to form 10-KSB, filed March 30, 2004.
 
 
10.6
Form of Securities Purchase Agreement. Registrant incorporates by reference Exhibit 10.6 to form 10-KSB, filed April 19, 2005.
 
 
10.7
Form of Warrant. Registrant incorporates by reference Exhibit 10.7 to form 10-KSB, filed April 19, 2005.
 
 
10.8
Form of Securities Purchase Agreement. Registrant incorporates by reference Exhibit 10.8 to form 10-KSB, filed April 19, 2005.
   
10.9
Form of Warrant. Registrant incorporates by reference Exhibit 10.9 to form 10-KSB, filed April 19, 2005.
 
 
10.10
Form of Amendment to Securities Purchase Agreement. Registrant incorporates by reference Exhibit 10.10 to form SB-2/A, filed December 14, 2005.
 
 
10.11
Employment Agreement with David R. Furth, dated as of December 5, 2005. Registrant incorporates by reference Exhibit 10.11 to form SB-2/A, filed December 14, 2005.
 
 
10.12
Employment Agreement with Robert S. Braswell IV, dated as of January 1, 2006. Registrant incorporates by reference Exhibit 99.1 to form 8-K, filed February 2, 2006.
 
 
 

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10.13
Form of Amendment to Promissory Note. Registrant incorporates by reference Exhibit 99.1 to form 8-K, filed January 3, 2006.
 
 
31
Rule 13a-14(a)/15(d)-14(a) Certifications of Chief Executive Officer.
 
 
31.1
Rule 13a-14(a)/15(d)-14(a) Certifications of Principal Financial Officer.
 
 
32
Section 1350 Certification of Chief Executive Officer.
 
 
32.1
Section 1350 Certification of Principal Financial Officer.

 

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SIGNATURES

In accordance with the requirement of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

        Health Discovery Corporation
        Registrant

Date: May 15, 2006        /s/ Stephen D. Barnhill M.D.    
       Printed Name: Stephen D. Barnhill M.D.
       Title: Chief Executive Officer

Date: May 15, 2006           /s/ Daniel R. Furth   
       Printed Name: Daniel R. Furth
      Title: Chief Financial Officer / Secretary

 
 
 
 
 
 
 
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