Form 10-KSB
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-KSB
FOR
ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(D) OF
THE
SECURITIES
AND EXCHANGE ACT OF 1934
(Mark
One)
x |
ANNUAL
REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF
1934
|
For
the fiscal year ended December 31, 2006
OR
o |
TRANSITION
REPORT UNDER TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF
1934
|
For
the transition period from__________to__________
Commission
File No. 333-62216
HEALTH
DISCOVERY CORPORATION
(Name
of small business issuer in its charter)
Texas
|
|
74-3002154
|
(State
or other jurisdiction of incorporation or
organization)
|
|
(I.R.S.
Employer Identification No.)
|
5501
½
Abercorn
Street, Savannah,
GA
|
|
31405
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
(912)
352-7488
(Registrant’s
telephone number, including area code)
Securities
Registered Pursuant to Section 12 (b) of the Exchange Act:
None
Securities
Registered Pursuant to Section 12 (g) of the Act:
None
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 o
Check
if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained,
to
the best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12(b)-2 of the Exchange Act). o
State
issuer’s revenues for its most recent fiscal year. $203,889
The
aggregate market value of the voting common stock held by non-affiliates as
of
March 27, 2007 was approximately $8,895,135. There were 116,493,384 shares
of
common stock outstanding as of March 27, 2007.
Transitional
Small Business Disclosure Format (Check one): Yes o, No x
PART
I
ITEM
1. DESCRIPTION OF BUSINESS
Our
History
We
were
organized under the name Direct Wireless Communications, Inc., in April 2001
by
Direct Wireless Corporation, which licensed to us its technology for a wireless
telephone. In October 2001, Direct Wireless Corporation, then our sole
stockholder, pursuant to an effective registration statement under the
Securities Act of 1933, distributed its entire holdings of our common stock
as a
stock dividend to its stockholders. As a result of the dividend, Direct Wireless
Corporation ceased to own any of our equity securities. The negative events
that
occurred over the next several years in the communications industry made it
difficult for us to fund the advancement of our communication platform. As
a
result, we made the decision to strategically change the overall direction
of
our intended business activities.
On
August
26, 2003, we acquired all of the assets of The Barnhill Group, LLC, which was
owned by Stephen D. Barnhill, M.D. Dr.
Barnhill is a physician trained in laboratory medicine and clinical pathology.
He developed artificial intelligence and pattern recognition computational
techniques used in medicine, genomics, proteomics, diagnostics and drug
discovery. Following the acquisition, Dr. Barnhill became our Chief Executive
Officer and Chairman of our Board of Directors. Also, immediately following
our
acquisition of the assets of The Barnhill Group, LLC and the change in strategic
direction of the Company, our licensing rights to the telecommunications
technology previously granted by Direct Wireless Corporation were terminated
and
all payments due to Direct Wireless Corporation were terminated.
Subsequently,
we amended our charter to change our name to Health Discovery Corporation (“HDC”
or the “Company”). Direct Wireless Communications (DWCM) officially became
Health Discovery Corporation on November 6, 2003, at which time the new trading
symbol (HDVY) became effective.
On
September 30, 2003, we acquired the assets of Fractal Genomics, LLC, a company
with patented Fractal Genomics Modeling software, through the issuance of
3,825,000 common shares of the Company. In addition to the shares of common
stock of the Company issued for the acquisition of Fractal Genomics, LLC’s
assets, the Company agreed to execute a note for $500,000 payable in $62,500
quarterly installments to the seller beginning on January 1, 2004 with the
final
payment being made in October 2005. Fractal Genomics’ technology finds, links
and models patterns of similarity hidden in large amounts of information, such
as the clinical databases used for diagnostic and drug discovery. Fractal
Genomics has applied its technology to protein and pathway discovery in leukemia
and lung development, which could lead to the identification of novel proteins
that could be used to develop diagnostic markers and drug targets. Our
acquisition of Fractal Genomics’ assets was completed on December 30, 2003.
On
July
30, 2004, we began purchasing rights to a portfolio of 71 patents and pending
patent applications, including patents on the use of Support Vector Machines,
or
SVMs, and other machine learning tools useful for diagnostic and drug discovery
(the “SVM Portfolio”). On May 6, 2005, we acquired the remaining interest in the
SVM Portfolio from a group of unrelated third parties.
Effective
September 26, 2004, we were assigned a patent license agreement with Lucent
Technologies GRL Corporation (“Lucent”). The patent license agreement was
associated with the patents acquired July 30, 2004. We agreed to pay minimum
royalty fees to Lucent, which increases as a percentage of revenue based on
each
licensed product that is sold, leased, or put into use by the Company. The
license granted will continue for the entire unexpired term of Lucent’s patents.
Our
Company Overview
HDC
is a pattern recognition company that uses advanced mathematical techniques
to
analyze large amounts of data to uncover patterns that might otherwise be
undetectable. The Company operates primarily in the emerging field of molecular
diagnostics where such tools are critical to scientific discovery. The terms
artificial
intelligence
and machine
learning
are sometimes used to describe pattern recognition tools.
HDC’s
mission is to use its patents, intellectual prowess, and clinical partnerships
principally to identify patterns that can advance the science of medicine,
as
well as to advance the effective use of our technology in other diverse business
disciplines, including the high-tech, financial, and homeland security
markets.
Our
historical foundation lies in the molecular diagnostics field where we have
made
a number of important discoveries that may play a critical role in developing
more personalized approaches to the diagnosis and treatment of certain diseases.
However, our SVM assets in particular have broad applicability in many other
fields. Intelligently applied, HDC’s pattern recognition technology can be a
portal between enormous amounts of otherwise undecipherable data and truly
meaningful discovery.
Our
Company’s principal asset is its intellectual property which includes advanced
mathematical algorithms called Support
Vector Machines
(SVM) and Fractal
Genomic Modeling
(FGM), as well as biomarkers
that we discovered by applying our SVM and FGM techniques to complex genetic
and
proteomic data. Biomarkers are biological indicators or genetic expression
signatures of certain disease states. Our
intellectual property is protected by more than 50 patents that have been issued
or are currently pending around the world.
Our
business model has evolved over time to respond to business trends that
intersect with our technological expertise and our capacity to professionally
manage these opportunities. In the beginning, we sought only to use our SVMs
internally in order to discover and license our biomarker signatures to various
diagnostic and pharmaceutical companies. Today, our commercialization efforts
include: utilization of our discoveries and knowledge to help develop biomarkers
for use as companion diagnostics, surrogate biomarkers, and diagnostic and
prognostic predictive tests; licensure of the SVM and FGM technologies directly
to diagnostic and pharmaceutical companies; and, the formation of new ventures
with domain experts in other fields where our pattern recognition technology
holds commercial promise.
Our
Principal Market
The
principal healthcare market for our pattern recognition technology and biomarker
discoveries is the growing field of molecular diagnostics. Borrowing from the
two disciplines of genomics and proteomics, molecular diagnostics categorizes
cancer and other diseases using technology such as mass spectrometry and gene
chips. Genomics is the study of all the genes in a cell or organism, and
proteomics is the study of all the proteins. Molecular diagnostics determines
how these genes and proteins interact in patients by focusing on patterns -
gene
and protein patterns - in different types of healthy and diseased patient cells.
Molecular diagnostics uncovers these genomic and proteomic changes and captures
this information as expression patterns. Also called molecular
signatures,
these expression patterns are improving clinicians’ ability to diagnose cancer
earlier, predict which patients will respond to certain treatments, predict
cancer recurrence risk, and select appropriate treatment for individual
patients.
Molecular
diagnostics can provide early, accurate screening and prediction of diseases
in
their asymptomatic stages, years before symptoms manifest or diseases actually
begin. This allows intervention to begin at that early point, perhaps preventing
the disease entirely. Early intervention will allow the healthcare system to
encompass both reactive and preventive medicine, improving overall healthcare
efficiency and possibly reducing systemic healthcare expenditures.
The
molecular diagnostics industry is an increasingly powerful health care
participant with tremendous potential. It is characterized by a very diverse,
constantly changing technology base that continuously produces new opportunities
and applications. Advances in PCR (polymerase chain reaction), multiplexing,
sequencing and other technologies are propelling both new and old companies
forward with novel capabilities.
Similarly, a growing understanding of the molecular basis of cancer and other
chronic diseases has awakened new realms of medicine to the possibilities of
molecular diagnostic testing.
Clinicians
have discovered that molecular diagnostics have many uses beyond just the
creation of new screening and diagnostic tools. Expression patterns can also
provide information for the design of new cancer treatments, monitor the
treatment’s effectiveness as it is studied in a clinical trial, and even predict
the patient’s response to a new treatment. In addition to its importance in
addressing the many kinds of cancer, molecular diagnostics will likely become
an
important technology for detecting resistance to antibiotics, a major hazard
in
the hospital setting. In the future, molecular tests should be able to determine
within two to three hours not only the nature of an infection but also any
potential resistance.
Today,
the molecular diagnostics market represents about $18 billion in revenue per
year for both commercial and home-brew
molecular diagnostic tests, and it is expected to reach more than $92 billion
by
2016 according to a recent study. Primary market drivers include the addition
of
new diagnostic tests in high-volume testing areas coupled with the introduction
of new instrumentation that provide greater ease, speed, and quality in test
performance. Now growing at an average annual rate of more than 40%, the
potential for molecular diagnostics is particularly impressive in the U.S.
which
represents the largest market with the most favorable conditions for molecular
diagnostics entry and marketing.
From
a demographic standpoint, 12% of the U.S. population was 65 years old or older
in 2000. By 2030, that segment is anticipated to grow to 20% of the population,
burdening the healthcare system with increased numbers of cardiovascular,
neurological, and other age-related diseases. Age-related conditions are
expected to contribute to the health care market that will require greater
product development and marketing of assays, including molecular
tests.
Diagnostics
addressing the pharmacogenetic testing segment (i.e. companion diagnostics
and
surrogate biomarkers) are expected to drive market growth in the years ahead.
Pharmacogenetics broadly relates to the study of genetic variations and their
application to drug discovery to provide personalized therapy. Currently the
second largest market sector behind diagnostics for infectious diseases, the
pharmacogenetic sector of the molecular diagnostics market is projected to
increase from its current $3 plus billion in revenues to more than $60 billion
of the overall forecasted market over the next ten years.
Our
SVM technology offers pharmaceutical companies a key tool as they approach
drug
discovery in this new era of personalized medicine. Accordingly, our marketing
efforts are focused on utilizing our technology in partnership with many of
the
world’s leading pharmaceutical and life-sciences companies. Our primary
commercialization pathway for our technology and discoveries is to enter into
both licensing agreements and joint development opportunities that feature
up-front license fees, fee-for-service development revenue, milestone payments,
and royalty streams. The pharmaceutical industry is characterized by costly
R&D efforts to create new patent-protected products, fierce competition for
products that are not so protected, and ongoing consolidation as major companies
acquire smaller players to add new products to existing pipelines.
The
use of HDC’s SVM technology and our discovered biomarkers may help
pharmaceutical companies develop and evaluate new drugs and medical therapies
in
less time and at lower cost. According to the lobby group PhRMA, only 1 of
every
10,000 potential medicines investigated by America’s drug companies survives the
research and development process and is approved for patient use by the U.S.
Food and Drug Administration (FDA). On average, the drug developmental process
can take up to 15 years in research and development, with costs approaching
many
hundreds of millions of dollars. This extended timeframe and enormous expense
has led to an emphasis on the development of “blockbuster” drugs.
Within
the drug discovery R&D process, biomarkers like ours can help pharmaceutical
companies identify disease targets and pathways and validate mechanisms of
drug
action. They may also serve as pharmacodynamic
indicators of drug activity, drug response, and drug toxicity in clinical
development. Biomarkers may also be used to help avoid new drug failures in
late
stage trials, earlier detection of disease, and improved prognosis of
therapeutic outcome.
We
consistently work to influence the evolving relationship between diagnostics
and
monitoring patients for therapeutic outcome. With its February 2007 approval
of
MammoPrint,
Agendia’s multi-gene expression breast cancer prognosis test, the FDA signaled
its acceptance of the field of molecular diagnostics and highlighted the growing
importance of personalized medicine. In particular, the advent of molecular
diagnostics has led to the promise of a completely new paradigm in the care
of
patients suffering from cancer and other diseases.
Using
companion diagnostics in patient care can substantially improve patient outcomes
and pave the way for personalized, targeted medicine by reducing both
misdiagnoses and adverse reactions, and by eliminating unnecessary and expensive
downstream tests. Today, patient dosage levels are based on age, sex, and
weight, as determined by empirical studies. However, specific drug metabolism
may be as individualized as one’s fingerprint. In the future, molecular
diagnostics may be able to direct physicians to the right drugs for every
patient, no matter what the illness.
This
trend towards personalized medicine may lead to the reduction of overall
healthcare expenditures. What is known as a surrogate molecular
marker
may now be substituted for the lengthy process of comparing the effects of
a
prospective new drug versus a placebo on the ultimate outcome of a disease.
As a
result, a drug’s effectiveness against the disease process in question may be
monitored more efficiently by evaluating the presence or absence of a specific
biomarker, thereby avoiding failures late in the research and development
process as well as the threat of recalls. One example of the successful
application of biomarker data to therapeutic evaluation is the use of blood
cholesterol levels to evaluate the effectiveness of cholesterol lowering drugs.
This
approach has the potential for creating a revolutionary new paradigm in the
conduct of clinical trials worldwide.
Current
diagnostic tools, such as blood marker-based immunoassays, imaging techniques,
and biopsy analyses, provide valuable information and have played an important
role in increasing survival rates of cancer patients. However, these tools
have
inherent limitations in accuracy (i.e. sensitivity and specificity) and remain
quite expensive. There is a significant need for advanced diagnostic and
prognostic tests that can provide meaningful information, screen for cancer,
detect early recurrence, and monitor progression and therapeutic response in
real time. HDC’s pattern recognition technology can play a critical role in the
development of these tests because an advanced pattern recognition technique
is
required
for this type of discovery. SVM technology is recognized as a superior pattern
recognition tool available today as evidenced in hundreds of scientific papers
worldwide.
Working
with recognized diagnostic and pharmaceutical partners, our goal is to develop
a
product line of newly discovered biomarker signatures and pathways that can
be
found in human genes and genetic variations, as well as gene, protein and
metabolite expression differences. In addition, we market our expertise in
the
design of clinical trials for companion diagnostics to substantiate the clinical
validity and commercial utility of those biomarkers. We also market the potent
combination of our intellectual property and intellectual prowess to our
prospective collaborative partners. As inventors of the SVM technology, our
world renowned mathematicians offer these companies the strongest possible
development team for their drug discovery, diagnostic test, or other
applications.
Our
Technologies and Discoveries
HDC
owns a patent portfolio of machine learning technology, including certain
pioneer patents on SVM. We also have consulting arrangements with many of the
physicians, clinical specialists and mathematicians responsible for developing
and filing the pioneer neural network and SVM patents for the analysis of
clinical data.
The
Company’s SVM technology is commonly considered within the context of
artificial
intelligence.
This is a branch of computer science concerned with giving computers the ability
to perform functions normally associated with human intelligence, such as
reasoning and optimization through experience. Machine learning is a type of
artificial intelligence that enables the development of algorithms and
techniques that allow computers to learn. Pattern recognition is machine
learning with a wide spectrum of applications including medical diagnosis,
bioinformatics, classifying DNA sequences, detecting credit card fraud, stock
market analysis, object recognition in computer vision, and robot locomotion.
SVM
Overview
SVMs
are mathematical algorithms that allow computers to sift through large, complex
datasets to identify patterns. SVM’s are widely acknowledged for their ability
to discover hidden relationships in these complex datasets. With the ability
to
handle what is known as infinite
dimensional space,
SVMs are broadly considered to be superior to neural networks and other
mathematical techniques. SVM is a core machine learning technology with strong
theoretical foundations and excellent empirical successes.
Since
their introduction in 1992, SVMs marked the beginning of a new era in the
learning
from examples
paradigm in artificial intelligence. Rooted in the Statistical Learning Theory
developed by Professor Vladimir Vapnik, a member of HDC’s Scientific Advisory
Board, SVMs quickly gained attention from the math and science communities
due
to a number of theoretical and computational merits. This development advanced
a
new framework for modeling learning algorithms. Within this framework, the
fields of machine learning and statistics were merged introducing powerful
algorithms designed to handle the difficulties of prior computational
techniques.
The
new generation of learning algorithms that were developed based on this theory
have proved to be remarkably resistant to the problems imposed by noisy data
and
high dimensionality. They are computationally efficient, have an inherent
modular design that simplifies their implementation and analysis and allows
the
insertion of domain knowledge, and, more importantly, they have theoretical
guarantees about their generalization ability. SVMs have been validated in
hundreds of independent academic publications and presentations. In recognition
for his work, Professor Vapnik received the prestigious Alexander von Humboldt
Prize from the German government honoring foreign scientists and scholars for
lifetime achievement.
SVMs
have become widely established as one of the leading approaches to pattern
recognition and machine learning worldwide and are replacing neural networks
in
a variety of fields, including engineering, information retrieval and
bioinformatics. This technology has been incorporated into product and research
applications by many biomedical, pharmaceutical, software, computer and
financial companies. Educational and research institutions throughout the world
have successfully applied SVMs to a wide array of applications, including gene
and protein expression analysis, medical image analysis, flow cytometry, and
mass spectrometry.
Recursive
Feature Elimination - Support Vector Machine Overview
Recursive
Feature Elimination (RFE-SVM) is an application of SVM that was created by
members of HDC’s science team to find discriminate relationships within clinical
datasets, as well as within gene expression and proteomic datasets created
from
micro-arrays of tumor versus normal tissues. In general, SVMs identify patterns
- for instance, a biomarker/genetic expression signature of a disease. The
RFE-SVM utilizes this pattern recognition capability to identify and rank order
the data points that contribute most to the desired results based on specificity
or sensitivity. The Company believes that its two RFE-SVM patents are currently
the only RFE patents issued in the world.
Using
RFE-SVM, we have been able to access information in micro-array datasets that
the most advanced bioinformatics techniques missed. In one micro-array
experiment, RFE-SVMs were able to filter irrelevant tissue-specific genes from
those related to the malignancy. RFE-SVM has also been used to determine gene
expression patterns that correlate to the severity of a disease, not just its
existence. It has been shown to improve both diagnosis and prognosis by
providing physicians with an enhanced decision tool. HDC scientists believe
that
these analytic methods are effective for finding genes and proteins implicated
in several cancers, as well as in assisting with the pharmacogenetic and
toxicological profiling of patients. The RFE-SVM method is also capable of
finding those specific genes and proteins that are unhindered by ever-increasing
patent protection.
Fractal
Genomic Modeling Overview
On
September 30, 2003, we acquired the assets of Fractal Genomics, LLC, a company
with patented Fractal Genomic Modeling (“FGM”) software. The fractal technology
is used to find discriminate relationships within clinical datasets as well
as
within gene expression datasets created from micro-arrays of disease versus
normal tissues.
The
FGM data analysis technique has been shown to improve the mapping of genetic
pathways involved in the diagnosis and prevention of certain diseases. HDC
scientists feel that these analytic methods are effective for finding genes
implicated in several cancers, HIV infection, lymphedema, Down’s syndrome, and a
host of other diseases, as well as the pharmacogenetic profiling of
patients.
FGM
technology is designed to study complex networks. A complex network can be
made
up of genes inside a living organism, web pages on the Internet, stocks within
a
financial market, or any group of objects or processes that appear to be
connected together in some intricate way. FGM uses a new approach toward
modeling network behavior to rapidly generate diagrams and software simulations
that facilitate prediction and analysis of whatever process is your particular
object of study. Two important concepts behind FGM technology are the notions
of
scale-free networks and self-similarity.
The
FGM process begins by creating a special mathematical surface (the FGM surface)
where every point on the surface can be used to generate a network model with
varying degrees of scale-free and fractal properties. Utilizing user-supplied
data, models which best match the behavior of each node are selected and
represented by a point on the FGM surface. These point-models are then linked,
compared, and combined to generate diagrams that reflect the behavior of the
entire network.
The
end result of the modeling process is a diagram where circles represent nodes
in
the network and arrows represent directions of causality or “flow” through the
network. FGM-derived diagrams expedite forecasting, analysis, and study of
complex system behavior by clearly displaying all hubs, links, and flow in
the
network. These diagrams also serve as flow charts and schematics from which
to
build software simulations of the network. The FGM process can also be used
to
quickly search for networks and connections between processes and between
objects that appear to be unrelated.
Our
Scientific Achievements
HDC’s
world renowned scientific team is uniquely experienced in the design, analysis
and application of machine learning technology, having invented the concepts
and
many of the methodologies used to exploit domain knowledge. In addition, through
pattern recognition, our science team has identified and patent-protected
biomarkers as possible treatment advances for several diseases, including Benign
Prostatic Hyperplasia (BPH), prostate cancer, leukemia, colon cancer, and
AIDS.
Benign
Prostatic Hyperplasia
HDC
has identified and patent-protected
a subset of genes that separates BPH from prostate cancer with a high degree
of
accuracy. This same set of genes also separated BPH from normal tissue patterns,
indicating that BPH is a disease with molecular characteristics of its own.
This
discovery could be used to develop a new non-invasive diagnostic test for BPH,
which does not currently exist, as well as a completely new type of therapy
for
patients with this disease.
BPH
is a non-cancerous enlargement of the prostate gland that occurs as men age.
The
enlargement often leads to obstruction in the flow of urine through the urethra
that passes through the prostate gland. BPH is a common condition, representing
a global treatment market of almost $4 billion annually growing by 12% per
year
in fixed-rate US dollar terms. According to the National Institutes of Health
(NIH), BPH affects more than 50% of men over age 60 and as many as 90% of men
over the age of 70. While BPH does not cause prostate cancer, both may be found
together.
Prostate
Cancer
HDC
has identified and patent-protected
a genetic biomarker signature that identifies clinically significant high grade
prostate cancer based on analysis of tissue samples. A logical next step will
be
to determine whether this same biomarker signature and the protein products
of
these genes exist in urine and other fluids that can be obtained non-invasively
in order to develop non-tissue based diagnostics.
Prostate
cancer is the second-leading cause of cancer death in men, after lung cancer.
The National Cancer Institute (NCI) estimates that more than 218,000 new
cases
of prostate cancer will be diagnosed in the U.S. in 2007, with more than
27,000
deaths.
More
than one million men a year undergo biopsies of the prostate gland after a
cancer-screening test reveals moderately elevated levels of prostate specific
antigen (PSA) in the blood. Typically, a biopsy specimen is then used to
determine if the tissue is cancerous. If cancer is found, the Gleason scale
is
used to evaluate the patient’s prognosis. This scale ranges from 1 to 5, wherein
a higher Gleason score is given to cancer that is more aggressive.
Only
one in four such biopsies reveals evidence of cancer. Many experts now believe
that most of the prostate biopsies performed each year are unnecessary.
According to a group of urologists led by Stanford University’s Dr. Thomas
Stamey MD, a member of HDC’s Scientific Advisory Board, the PSA test is now all
but useless for predicting the risk of prostate cancer since it indicates
nothing more than whether the prostate gland is enlarged, a common condition
called benign prostatic hypertrophy which is associated with the normal aging
process for men. The PSA can also be raised by benign prostatic hyperplasia,
biopsy of the prostate, transurethral prostatectomy, acute urinary retention,
acute prostatitis, and ejaculation.
The
Stamey study noted that tumors encountered twenty years ago were generally
so
large they generated PSA levels high enough to provide a reasonably good measure
of cancer severity. Now that screening is more commonplace in this country,
many
cancers are being caught earlier and are usually smaller - not generating enough
PSA to be a good indicator of severity. Given the importance of determining
severity, there remains an urgent need for serum markers that reflect the size
and grade of this ubiquitous cancer. It is conceivable that developments flowing
from HDC’s recent discoveries may ultimately displace Gleason score as an
indicator of prostate cancer severity.
Leukemia
HDC
has identified and patent-protected
a set of leukemia genes that can separate ALL-T-cell leukemia from ALL-B-cell
leukemia with a high degree of accuracy. The Company collaborated with the
University of Texas M.D. Anderson Cancer Center to analyze a gene expression
database to identify new biomarkers and pathways involved in
leukemia.
Leukemia
is a type of cancer that originates in the bone marrow. The accumulation of
malignant cells interferes with the body’s production of healthy blood cells and
makes the body unable to protect itself against infections. The National Cancer
Institute (NCI) estimates that more than 44,000 new cases will be diagnosed
in
the U.S. in 2007, with almost 22,000 deaths.
Colon
Cancer
HDC
has identified and patent-protected
colon cancer-specific biomarkers that can be used in the development of
diagnostic assays for cancer detection, disease discrimination, and even a
potential vaccine. The aim of this early biomarker discovery project was to
define the gene expression patterns associated with colon cancer. Our RFE-SVM
served as an effective tool for sifting through the noise of thousands of
measurements to highlight only those genes that optimally contributed to the
study focus.
In
the United States, colorectal cancer is the third most common cancer in men
and
women. The National Cancer Institute (NCI) estimates that more than 112,000
new
cases of colon and rectal cancer will be diagnosed in the U.S. in 2007, with
more than 50,000 deaths.
When
colorectal cancer is detected early, survival rates are much higher. The
survival rate at five years is 91% for patients who receive early treatment.
When adjacent organs or lymph nodes are affected, the five-year survival rate
drops to 66%. In cases where the cancer spreads to other organs, the survival
rate drops to only 8%. Thus, it is essential that all patients undergo screening
for the early detection of pre-cancerous conditions.
Most
colon cancers can be detected early with routine colonoscopy, but only a small
percentage of the at-risk population has this procedure. Fear of the procedure
and its complications along with its high cost have limited the potential of
colonoscopy to be used as an acceptable screening tool for colon
cancer.
AIDS
HDC
has identified and patent-protected
an AIDS expression signature that can separate AIDS brain cells from non-AIDS
brain cells with a high degree of accuracy.
This
biomarker discovery was accomplished in conjunction with Dr. Paul Shapshak,
Director of the Dementia/HIV Laboratory at the University of Miami Medical
School, and a group of leading scientists using HDC’s proprietary FGM analysis
technique. HDC sold the biomarker discovery to the University of Miami in
November 2005.
HIV-related
dementia occurs in 40 to 60 percent of all cases of HIV infection that are
left
untreated. Even when treated, dementia occurs in 10 percent of all cases of
HIV
infection, with the number continuing to rise as the virus becomes resistant
to
treatment. The dementia is related to inflammation in the brain caused by HIV
infection, a problem whose underlying genetic causes are complex and largely
unknown.
Breast
Cancer
HDC
is developing two breast cancer diagnostic technologies; one for detecting
malignancy in mammograms (MammoSIGHT)
and another for identifying circulating tumor cells in the blood (MetastaSIGHT).
The detection component of these technologies finds the areas of particular
interest in the image and separates these objects from the background. The
feature extraction component formulates numerical values relevant to the
classification task from the segmented objects. HDC’s patented technology can be
used within all diagnostic imaging radiology techniques, including PET scans,
CT
scans, and MRIs.
For
women, breast cancer is the most common non-skin cancer and the second leading
cause of cancer-related death in the United States. However, death rates from
breast cancer have been declining since 1990, and these decreases are believed
to be the result, in part, of earlier detection and improved treatment.
Mammography remains the best method of early breast cancer detection. According
to studies cited by the National Cancer Institute, 10 to 20 percent of breast
cancers detected by a physical exam were missed by a film mammogram. For this
reason, there have been extensive research efforts to improve mammography.
The
FDA reports that there are about 33.5 million mammography procedures performed
each year in the United States. Data from 2000-2002 show that about 70 percent
of all mammograms that are performed annually are for screening purposes (to
detect cancer as opposed to following cancer once it has been diagnosed). This
translates to about 23.5 million screening procedures every year.
Studies
have shown that among newly diagnosed breast cancer cases in which the patients
have previous mammograms, 75% of the cases will have abnormality detectable
in
the old films. In fact, missed cancer reading in mammography is a major source
of lawsuits in radiology. Detecting malignancy in mammograms can be very
difficult. Individual mammograms are unique and there can be great variation
within “normal” images. Unlike CT and MRI, mammograms are not cross-sectional
images. Basically, a mammogram produces a two-dimensional picture of a
three-dimensional object. The projection from 3D to 2D and the resulting
overlaps on the images may interfere with the recognition of the distinguishing
features. The features are often very subtle. The rules for differentiating
the
benign and malignant cases are vague and not easily formulated.
One
way to reduce reading errors is to have two radiologists read the same
mammograms independently. However, in most health care systems, it is not
feasible to implement such a two-radiologist reading process. A
computer-assisted detection (CAD) system serving as a second reader is therefore
an attractive option and CAD is currently reimbursed by both insurance companies
and Medicare.
One
of the most recent advances in x-ray mammography
is
digital mammography. Digital (computerized) mammography is similar to standard
mammography in that x-rays are used to produce detailed images of the breast.
Digital mammography uses essentially the same mammography system as conventional
mammography, but the system is equipped with a digital receptor and a computer
instead of a film cassette. Several studies have demonstrated that digital
mammography is at least as accurate as standard mammography.
For
a
woman getting either a traditional film mammogram or the digital version, the
experience of the exam is the same: each breast is compressed by a machine
between square plates, while a very low dose of radiation
is
passed through the tissue. The major difference comes in how the image is viewed
and stored. Digital scans are stored in bits and bytes on a computer where,
theoretically, they can be enhanced for contrast if necessary, or otherwise
manipulated to improve the information provided.
Both
digital and film mammography use X-rays to produce an image of the breast.
In
film mammography, which has been used for over 35 years, the image is created
directly on a film. While standard film mammography is very good, it is less
sensitive for women who have dense breasts. A major limitation of film
mammography is the film itself. Once a film mammogram is obtained, it cannot
be
significantly altered; if the film is underexposed, for example, contrast is
lost and cannot be regained.
Digital
mammography takes an electronic image of the breast and stores it directly
in a
computer. Digital mammography uses less radiation than film mammography and
allows for improvement in image storage and transmission because images can
be
stored and sent electronically. Radiologists can use software to help interpret
digital mammograms.
In
September 2006, digital mammograms received heightened attention when the
National Cancer Institute released details of the Digital Mammographic Imaging
Screening Trial (DMIST), a $26 million study of 49,528 women at 33 sites in
the
United States. DMIST showed that, for the entire population of women studied,
digital and film mammography had very similar screening accuracy. However,
the
study concluded that the new digital technology was found to be better than
film
mammograms at detecting cancer among three groups of women: (1) those with
very
dense breasts, as determined by their doctors; (2) women under 50, whatever
their breast density; and, (3) women of any age who were premenopausal or who
had had at least one menstrual period within 12 months of the last mammogram.
These results suggest that for women who fall into the three subgroups, digital
mammography may be better at detecting breast cancer than traditional film
mammography. Approximately 65% of the women in DMIST fit into one of the three
subsets that showed a benefit with digital mammography. Today, approximately
8%
of breast imaging units provide digital mammography.
MammoSIGHT
HDC’s
MammoSIGHT
technology introduces the use of SVMs in detecting malignancy in mammograms.
The
SVM classifier produces an index discriminating between the benign and malignant
cases. The individual components can be developed in parallel because of the
modular structure. In developing the calcification segmentation component,
a
selected set of malignant, benign and normal cases representing a wide range
of
images was used to guide and test the design in order to produce a general,
robust and accurate algorithm. At the same time, the SVM classifier was
developed and tested with manually prepared input data. A set of 300 images
(150
benign and 150 malignant cases) was used in training the SVM. An independent
set
of 328 images was used for testing. High dimensional input features were used
to
ensure a sufficient capacity for automatically extracted features.
Clusters
of micro calcifications are characterized by their relatively small sizes and
high densities. The algorithm combines a recursive peak seeking technique with
morphological operations to achieve a highly accurate calcification detection
and segmentation.
MetastaSIGHT
Cancer
cells have the ability to migrate from the organ of its origin to any distant
organ throughout the body. This is known as metastasis, the hallmark of
malignant cancers. During metastasis, cancerous cells break through barriers
to
travel through the body’s circulatory system to invade other organs. These cells
form new cells in vital organs throughout the body, becoming secondary tumors
that destroy normal cells by depriving them of nutrition.
Even
with today’s best treatment when the cancer is forced into remission, metastasis
will not necessarily leave the body. Metastasis cannot be eliminated by surgery.
Often, malignant cells circulate in the blood before
detection by clinical examination. MetastaSIGHT
uses an SVM-based approach to introduce new cellular imaging technology that
identifies circulating tumor cells in the blood.
Employees
On
December 31, 2006, we had 5 full time employees. We do not expect any
significant change in the number of employees over the next 12 months. We
consider our employee relations to be good, and we have no collective bargaining
agreements with any employees.
Website
Address
Our
corporate website address is www.HealthDiscoveryCorp.com. To view our public
filings from the home page, select the “Display SEC Filings” tab followed by
“SEC Filings.” This is a direct link to our filings with the Securities and
Exchange Commission (“SEC”), including but not limited to our Annual Report of
Form 10-KSB, quarterly reports on Form 10-QSB and current reports on Form 8-K,
and any amendments to these reports. These reports are accessible soon after
we
file them with the SEC.
Governmental
Regulation
Our
business plan involves First
Phase Biomarker Discovery in
the
field of molecular diagnostics. This early discovery process does not involve
any governmental regulations or approvals. If we are successful in licensing
our
discoveries to other companies, FDA approvals may be required before the
ultimate product may be sold to consumers. Companies licensing our discoveries
or technologies will be responsible for all costs involved in such approvals.
If
we are not successful in licensing these discoveries and choose to take these
discoveries to market ourselves, we may then be subject to applicable FDA
regulations and would then bear the costs of such approvals.
We
know
of no governmental regulations that will affect the Company’s current operations
or products.
Intellectual
Property
In
connection with the SVM Acquisition, we obtained rights to the intellectual
property within the “SVM portfolio” that currently consists of twenty patents
which were or have since issued as well as 35 other patent applications that
are
pending in the U.S. and elsewhere in the world. The issued patents and pending
applications in the SVM portfolio to date, including new applications that
we
have filed since acquiring the original IP, HDC are:
Patent/Application
No.
|
|
Title
|
|
Expiration
Date
|
U.S.
Patent No. 6,128,608
|
|
Enhancing
Knowledge Discovery Using Multiple Support Vector Machines
|
|
05/01/2019
|
|
|
|
|
|
U.S.
Patent No. 6,157,921
|
|
Enhancing
Knowledge Discovery Using Support Vector Machines in a Distributed
Network
Environment
|
|
05/01/2019
|
|
|
|
|
|
U.S.
Patent No. 6,427,141
|
|
Enhancing
Knowledge Discovery Using Multiple Support Vector
Machines.
|
|
05/01/2019
|
|
|
|
|
|
U.S.
Patent No. 6,658,395
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines.
|
|
05/01/2019
|
|
|
|
|
|
U.S.
Patent No. 6,714,925
|
|
System
for Identifying Patterns in Biological Data Using a Distributed
Network.
|
|
05/01/2019
|
|
|
|
|
|
U.S.
Patent No. 6,760,715
|
|
Enhancing
Biological Knowledge Discovery Using Multiple Support Vector
Machines.
|
|
05/01/2019
|
|
|
|
|
|
U.S.
Patent No. 6,789,069
|
|
Method
of Identifying Patterns in Biological Systems and Method of
Uses.
|
|
05/01/2019
|
|
|
|
|
|
U.S.
Patent No. 6,882,990
|
|
Method
of Identifying Biological Patterns Using Multiple Data
Sets.
|
|
05/01/2019
|
|
|
|
|
|
U.S.
Patent No. 6,944,602
|
|
Spectral
Kernels for Learning Machines
|
|
02/19/2023
|
|
|
|
|
|
U.S.
Patent No. 6,996,542
|
|
Computer-Aided
Image Analysis
|
|
04/21/2021
|
|
|
|
|
|
U.S.
Patent No. 7,117,188
|
|
Methods
of Identifying Patterns in Biological Systems and Uses
Thereof
|
|
05/01/2019
|
|
|
|
|
|
Australian
Patent No. AU 764897
|
|
Pre-processing
and Post-processing for Enhancing Knowledge Discovery Using Support
Vector
Machines.
|
|
05/01/2019
|
|
|
|
|
|
South
African Patent No. ZA 00/7122
|
|
Pre-processing
and Post-processing for Enhancing Knowledge Discovery Using Support
Vector
Machines.
|
|
05/01/2019
|
|
|
|
|
|
Australian
Patent No. AU 780050
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines.
|
|
05/24/2020
|
|
|
|
|
|
Chinese
Patent No. ZL00808062.3
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines.
|
|
05/24/2020
|
|
|
|
|
|
European
Patent No. 1192595
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines.
|
|
05/24/2020
|
|
|
|
|
|
German
Patent No. DE60024452.0-08
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines.
|
|
05/24/2020
|
|
|
|
|
|
Israeli
Patent No. 146705
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines
|
|
05/24/2020
|
|
|
|
|
|
Norwegian
Patent No. 319,838
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines.
|
|
05/24/2020
|
|
|
|
|
|
Australian
Patent No. AU 779635
|
|
Method
of Identifying Patterns in Biological Systems and Method of
Uses.
|
|
10/27/2020
|
Canadian
Application No. 2,330,878
|
|
Pre-Processing
and Post-Processing for Enhancing Knowledge Discovery Using Support
Vector
Machines
|
|
05/01/2019
|
|
|
|
|
|
European
Publication No. 1082646
|
|
Pre-Processing
and Post-Processing for Enhancing Knowledge Discovery Using Support
Vector
Machines
|
|
05/01/2019
|
|
|
|
|
|
Hong
Kong Application No. 011065063
|
|
Pre-Processing
and Post-Processing for Enhancing Knowledge Discovery Using Support
Vector
Machines
|
|
05/01/2019
|
|
|
|
|
|
Indian
Application No. 2000/00580
|
|
Pre-Processing
and Post-Processing for Enhancing Knowledge Discovery Using Support
Vector
Machines
|
|
05/01/2019
|
|
|
|
|
|
Canadian
Application No. 2,371,240
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines
|
|
05/24/2020
|
|
|
|
|
|
Indian
Application No. 2001/01329
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines
|
|
05/24/2020
|
|
|
|
|
|
Japanese
Application No. 2000-620577
|
|
Enhancing
Knowledge Discovery from Multiple Data Sets Using Multiple Support
Vector
Machines
|
|
05/24/2020
|
|
|
|
|
|
South
Korean Application No. 7015064/2001
|
|
Enhancing
Knowledge Discovery from Data Sets Using Multiple Support Vector
Machines
|
|
05/24/2020
|
|
|
|
|
|
Canadian
Application No. 2,388,595
|
|
Method
of Identifying Patterns in Biological Systems and Method of
Uses
|
|
08/07/2020
|
|
|
|
|
|
European
Publication No. 1236173
|
|
Method
of Identifying Patterns in Biological Systems and Method of
Uses
|
|
08/07/2020
|
|
|
|
|
|
Japanese
Application No. 2001-534088
|
|
Method
of Identifying Patterns in Biological Systems and Methods of Uses
|
|
08/07/2020
|
|
|
|
|
|
U.S.
Patent Publication No. 2005/0165556
|
|
Colon
Cancer-Specific Markers
|
|
05/01/2019
|
|
|
|
|
|
U.S.
Application No. 11/274,931
|
|
Biomarkers
for Screening, Predicting, and Monitoring Prostate Disease
|
|
05/01/2019
|
|
|
|
|
|
PCT
Application No. PCT/US2005/041442
|
|
Biomarkers
for Screening, Predicting, and Monitoring Prostate Disease
|
|
11/14/2025
|
|
|
|
|
|
Australian
Application No. 2002253879
|
|
Methods
of Identifying Patterns in Biological Systems and Uses
Thereof
|
|
01/24/2022
|
|
|
|
|
|
Canadian
Application No. 2,435,254
|
|
Methods
of Identifying Patterns in Biological Systems and Uses
Thereof
|
|
01/24/2022
|
|
|
|
|
|
European
Publication No. 1459235
|
|
Methods
of Identifying Patterns in Biological Systems and Uses
Thereof
|
|
01/24/2022
|
|
|
|
|
|
Japanese
Application No. 2002-560076
|
|
Methods
of Identifying Patterns in Biological Systems and Uses
Thereof
|
|
01/24/2022
|
|
|
|
|
|
U.S.
Patent Publication No. 2006/0074821
|
|
Spectral
Kernels for Learning Machines
|
|
02/19/2023
|
|
|
|
|
|
European
Publication No. 1384155
|
|
Spectral
Kernels for Learning Machines
|
|
02/19/2023
|
|
|
|
|
|
U.S.
Patent Publication No. 2005/0071300
|
|
Kernels
and Methods for Selecting Kernels for Use in a Learning
Machine
|
|
05/07/2022
|
|
|
|
|
|
European
Publication No. 1393196:
|
|
Kernels
and Methods for Selecting Kernels for Use in a Learning
Machine
|
|
05/07/2022
|
|
|
|
|
|
U.S.
Application No. 11/349,542
|
|
Computer-Aided
Image Analysis
|
|
05/01/2019
|
Australian
Application No. 2002243783
|
|
Computer
Aided Image Analysis
|
|
01/23/2022
|
|
|
|
|
|
Canadian
Application No. 2,435,290
|
|
Computer
Aided Image Analysis
|
|
01/23/2022
|
|
|
|
|
|
European
Publication No. 1356421
|
|
Computer
Aided Image Analysis
|
|
01/23/2022
|
|
|
|
|
|
Japanese
Application No. 2002-560082
|
|
Computer
Aided Image Analysis
|
|
01/23/2022
|
|
|
|
|
|
U.S.
Patent Publication No. 2005/0216426
|
|
Methods
for Feature Selection in a Learning Machine
|
|
08/07/2020
|
|
|
|
|
|
U.S.
Patent Publication No. 2005/0071140
|
|
Model
Selection for Cluster Data Analysis
|
|
05/17/2022
|
|
|
|
|
|
U.S.
Application No. 10/481,068
|
|
Data
Mining Platform for Bioinformatics
|
|
08/07/2020
|
|
|
|
|
|
U.S.
Patent Publication No. 2005/0228591
|
|
Kernels
and Kernel Methods for Spectral Data
|
|
08/07/2020
|
|
|
|
|
|
U.S.
Patent Publication No. 2005/0131847
|
|
Pre-Processed
Feature Ranking for a Support Vector Machine
|
|
08/07/2020
|
|
|
|
|
|
European
Publication No. 1449108
|
|
Pre-Processed
Feature Ranking for a Support Vector Machine
|
|
11/07/2022
|
|
|
|
|
|
U.S.
Provisional Application No. 60/833,644
|
|
Biomarkers
for Screening, Predicting, and Monitoring Benign Prostate
Hyperplasia
|
|
N/A
|
|
|
|
|
|
U.S.
Provisional Application No. 60/888,070
|
|
Biomarkers
for Screening, Predicting, and Monitoring Prostate Disease
|
|
N/A
|
HDC
also
owns intellectual property rights in U.S. and foreign patents and pending patent
applications covering the FGM technology. The FGM portfolio includes 1 issued
patent and 6 pending patent applications, which are:
Patent/Application
No.
|
|
Title
|
|
Expiration
Date
|
U.S.
Patent No. 6,920,451
|
|
Method
for the Manipulation, Storage, Modeling, Visualization and Quantification
of Datasets.
|
|
01/19/2021
|
U.S.
Patent Publication No. 2005/026199
|
|
Method
for Identifying Biomarkers Using Fractal Genomics
Modeling.
|
|
01/19/2021
|
U.S.
Patent Publication No.: 2005/0026199
|
|
Method
for Identifying Biomarkers Using Fractal Genomics
Modeling.
|
|
01/19/2021
|
U.S.
Patent Publication No.: 2005/0158735
|
|
Method
for Studying Cellular Chronomics and Causal Relationships of Genes
Using
Fractal Genomics Modeling.
|
|
01/19/2021
|
U.S.
Patent Publication No.: 2005/0076190
|
|
Method
for the Manipulation, Storage, Modeling, Visualization and Quantification
of Datasets.
|
|
01/19/2021
|
WIPO
Publication No.
WO
2006/083330
|
|
Method
for the Manipulation, Storage, Modeling, Visualization and Quantification
of Datasets.
|
|
05/05/2007
|
European
Publication No.: 1252588
|
|
Method
for the Manipulation, Storage, Modeling, Visualization and Quantification
of Datasets.
|
|
01/19/2021
|
Our
Competition
HDC’s
main service/product is First-Phase
Biomarker Discovery.
While there are numerous companies that perform individual steps in this
process, we know of no other company that performs all steps in First-Phase
Biomarker Discovery.
Competing companies in the biomarker discovery arena have made numerous
promising discoveries but have failed to bring fully validated biomarkers to
market. We feel that by performing and controlling all steps of this process,
we
can eliminate the problems these companies have had in validating their
findings, and thus, produce fully validated, marketable biomarkers.
Our
SVM and FGM technologies give us a distinct advantage over competing
technologies. Neither classical statistical analysis nor neural networks (the
two competing technologies) can handle the large amounts of inputs necessary
to
produce fully validated biomarkers.
Research
and Development
Our
past Research and Development costs have been minimal due to the unique
relationships we have maintained with the members of our scientific team and
their institutions. Our total R&D costs have consisted solely of the
consultant fees paid to Dr. Stamey, Dr. Vapnik, and Dr. Guyon. These fees
consisted of $70,734 in cash for 2006 and $404,421 in cash for
2005.
RISK
FACTORS
This
document contains certain forward-looking statements within the meaning of
the
Private Securities Litigation Reform Act of 1995 including, without limitation,
all
statements, other than statements of historical facts, that address activities,
events or developments that we expect or anticipate will or may occur in the
future, including the successful implementation of our services, business
strategies and measures to implement such strategies, competitive strengths,
expansion and growth of our business and operations, references to future
success and other such matters are forward-looking statements and are based
on
the beliefs of, assumptions made by and information currently available to
our
management. The words “expect,” “estimate,” “anticipate,” “believe,” “intend,”
“plan” and similar expressions and variations thereof are intended to identify
forward-looking statements. Such forward-looking statements may involve
uncertainties and other factors that may cause the actual results and
performance of our company to be materially different from future results or
performance expressed or implied by such statements.
The
cautionary statements set forth in this “Risk Factors” section and elsewhere in
this annual report identify important factors with respect to such
forward-looking statements, including certain risks and uncertainties, which
could cause actual results to differ materially from those expressed in or
implied by such forward-looking statements. Among others, factors that could
adversely affect actual results and performance include failure to successfully
develop a profitable business, delays in identifying and enrolling customers,
and the inability to retain a significant number of customers. All written
or
oral forward-looking statements attributable to us are expressly qualified
in
their entirety by the foregoing
cautionary statement.
Risks
Related to Our Business
We
are a developing business and a high-risk company.
We
are a high-risk company in a volatile industry. In
September 2003, we completely changed the focus of our business from wireless
telecommunications to biotechnology. Consequently, we
have no history on which to base an evaluation of our business and prospects.
Thus, investors should recognize that an investment in our company is risky
and
highly speculative. We are a developing business, and our prospects must be
considered in light of the risks, uncertainties, expenses and difficulties
frequently encountered by companies in their early stages of development.
Failure to implement and execute our business and marketing strategy
successfully, to provide superior customer service, to respond to competitive
developments and to integrate, retain and motivate qualified personnel could
have a material adverse effect on our business, results of operations and
financial condition. We must successfully overcome these and other business
risks. If our efforts are unsuccessful or other unexpected events occur,
purchasers of the common stock offered hereby could lose their entire
investment.
We
expect to incur future losses, and we may never achieve or sustain
profitability.
We
expect
to continue to incur net losses and have negative cash flows in the future
due
in part to high research and development expenses, including enhancements to
our
technologies and investments in new technologies. We cannot assure you that
we
will ever achieve profitability. Even if we do achieve profitability, we may
not
be able to sustain or increase profitability.
Our
business is difficult to evaluate because we have a limited history of
operations.
Since
reorganizing in 2003, our focus and our business model have been continually
evolving. Accordingly, we have a history of operations in which there is
insufficient information to identify any historical pattern. Even if we could
discern such a pattern, the rapidly evolving nature of the biotechnology and
pharmaceutical industries would make it very difficult to identify any
meaningful information in such short a history. Therefore, it is also difficult
to make any projections about the future of our operations. This difficulty
may
result in our shares trading below their value.
We
will have negative
operating income and may never become profitable.
Our
operating expenses are expected to exceed our income for the next six to nine
months and thus our capital will be decreased to pay these operating expenses.
If we ever become profitable, of which there is no assurance that we can, from
time to time our operating expenses could exceed our income and thus our capital
will be decreased to pay these operating expenses.
We
may need additional financing.
Additional
proceeds may be required to finance our activities. We
cannot
assure prospective investors that we will not need to raise additional capital
or that we would be able to raise sufficient additional capital on favorable
terms, if at all. No
binding arrangements have been made to secure such financing, and there can
be
no assurance that such additional financing will be available when required
on
terms acceptable to us. If
we
fail to raise sufficient funds, we may have to cease operations, which would
materially harm our business and financial results. If we raise additional
capital by issuing equity securities, our stockholders may experience dilution.
If we raise additional funds through collaboration and licensing arrangements,
we may be required to relinquish some rights to our technologies or product
candidates, or grant licenses on terms that are not favorable to us.
Our
operating results are unpredictable and may fluctuate significantly from period
to period, which may cause our stock price to decline and result in losses
to
investors.
Our
operating results may vary from period to period due to numerous factors, many
of which are outside our control, including the number, timing and acceptance
of
our services. Factors that may cause our results to vary by period include:
|
§
|
changes
in the demand for our products and
services;
|
|
§
|
the
nature, pricing and timing of products and services provided to our
collaborators;
|
|
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acquisition,
licensing and other costs related to the expansion of our operations,
including operating losses of acquired businesses;
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reduced
capital investment for extended
periods;
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losses
and expenses related to our investments in joint ventures and
businesses;
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regulatory
developments or changes in public perceptions relating to the use
of
genetic information and the diagnosis and treatment of disease based
on
genetic information;
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changes
in intellectual property laws that affect our rights in genetic
information that we sell; and
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payments
of milestones, license fees or research payments under the terms
of our
increasing number of external
alliances.
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Research
and development costs associated with our technologies and services, as well
as
personnel costs, marketing programs and overhead, account for a substantial
portion of our operating expenses. These expenses cannot be adjusted quickly
in
the short term. If revenues of the business decline or do not grow as
anticipated, we may not be able to reduce our operating expenses accordingly.
Failure to achieve anticipated levels of revenue could therefore significantly
harm our operating results for a particular period.
We
may fail to meet our debt obligations.
If
our cash flow and capital resources are insufficient to fund our debt
obligations incurred in connection with recent acquisitions, we may be forced
to
sell assets, seek additional equity or debt capital or restructure our debt.
In
addition, any failure to make scheduled payment of interest and principal on
our
outstanding notes or any other indebtedness could result in our creditors
exercising remedies on the notes and taking some or all of our assets or could
otherwise harm our ability to incur additional indebtedness on acceptable terms.
We cannot assure you that our cash flow and capital resources will be sufficient
for payment of interest and principal on our debt in the future, including
payments on any outstanding notes, or that any alternative methods would be
successful or would permit us to meet our debt obligations.
Our
stock price has been, and is likely to continue to be, highly
volatile.
Our
stock
price has, since September 1, 2003, traded as high as $0.60 and as low as $0.06.
Our stock price could fluctuate significantly due to a number of factors beyond
our control, including:
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variations
in our actual or anticipated operating results;
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sales
of substantial amounts of our
stock;
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announcements
about us or about our competitors, including technological innovation
or
new products or services;
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litigation
and other developments related to our patents or other proprietary
rights
or those of our competitors;
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conditions
in the life sciences, pharmaceuticals or genomics industries;
and
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governmental
regulation and legislation.
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In
addition, the stock market in general, and the market for life sciences and
technology companies in particular, have experienced extreme price and volume
fluctuations recently. These fluctuations often have been unrelated or
disproportionate to the operating performance of these companies. These broad
market and industry factors may decrease the market price of our common stock,
regardless of our actual operating performance.
In
the
past, companies that have experienced volatility in the market prices of their
stock have been the objects of securities class action litigation. If we became
the object of securities class action litigation, it could result in substantial
costs and a diversion of management’s attention and resources, which could
affect our profitability.
Our
approach of incorporating ideas and methods from mathematics, computer science
and physics into the disciplines of biology, organic chemistry and medicine
is
novel and may not be accepted by our potential customers or
collaborators.
We
intend to create a fully integrated biomarker discovery company to provide
pharmaceutical and diagnostic companies worldwide with new, clinically relevant
and economically significant biomarkers. We
are a
drug and diagnostic discovery company, which incorporates ideas and methods
from
mathematics, computer science and physics into the disciplines of biology,
organic chemistry and medicine. Our objective is to significantly increase
the
probability of success of drug discovery and diagnostic development. Our
approach and the products and technologies derived from our approach are novel.
Our
potential customers and
collaborators
may be reluctant to accept our new, unproven technologies, and our customers
may
prefer to use traditional services. In addition, our approach may
prove
to be ineffective or not as effective as other methods. Our products and
technologies may prove to be ineffective if, for instance, they fail to account
for the complexity of the life processes that we are now attempting to model.
If
our customers or collaborators do not accept our products or technologies and/or
if our technologies prove to be ineffective our business may fail or we may
never become profitable.
Even
if our computational technologies are effective as research tools, our customers
or we may be unable to develop or commercialize new drugs, therapies or other
products based on them.
Even
if
our computational technologies perform their intended functions as research
tools, our customers may be unable to use the discoveries resulting from them
to
produce new drugs, therapies, diagnostic products or other life science
products. Despite recent scientific advances in the life sciences and our
improved understanding of biology, the roles of genes and proteins and their
involvement in diseases and in other life processes is not well understood.
Only
a few therapeutic products based on the study of and discoveries relating to
genes or proteins have been developed and commercialized. If our customers
are
unable to use our discoveries to make new drugs or other life science products,
our business may fail or we may never become profitable.
Our
acquired SVM Portfolio utilizes technology covered by an earlier-issued
patent, and if we lose the rights to use that patent, our ability to exploit
certain aspects of our SVM technology will be impaired.
Our
acquired SVM Portfolio utilizes technology covered by the original hyperplane
patent (Pat. No. 5,649,068) invented by members of our Scientific Advisory
Board
and owned by Lucent Technologies, Inc. - GRL Corp. (“Lucent”). We have
obtained an assignment of a pre-existing patent license from Lucent.
If Lucent were to terminate the license, it is possible that we would not
be able to use portions of the Support Vector Machine technology.
The
industries in which we are active are evolving rapidly, and we may be unable
to
keep pace with changes in technology.
The
pharmaceutical and biotechnology industries are characterized by rapid
technological change. This is especially true of the data-intensive areas of
such technologies. Our future success will largely depend on maintaining a
competitive position in the field of drug, therapeutics and diagnostic products
discovery. If we fail to keep pace with changes in technology, our business
will
be materially harmed. Rapid technological development may result in our products
or technologies becoming obsolete. This may occur even before we recover the
expenses that we incurred in connection with developing those products and
technologies. Products or services offered by us could become obsolete due
to
the development of less expensive or more effective drug or diagnostics
discovery technologies. We may not be able to make the necessary enhancements
to
our technologies to compete successfully with newly emerging technologies.
We
face intense competition and if we are unable to compete successfully we may
never achieve profitability.
The
markets for our products and services are very competitive, and we expect our
competition to increase in the future. Although
we have not identified one company that provides the full suite of services
that
we do, we
compete
with entities in the U.S. and elsewhere that provide products and services
for
the analysis of genomic information and information relating to the study of
proteins (proteomic information) or that commercializes novel genes and
proteins. These include genomics, pharmaceutical and biotechnology companies,
academic and research institutions and government and other publicly funded
agencies. We may not be able to successfully compete with current and future
competitors. Many of our competitors have substantially greater capital
resources, research and development staffs, facilities, manufacturing and
marketing experience, distribution channels and human resources than we do.
This
may allow these competitors to discover or to develop products in advance of
us
or of our customers.
Some
of
our competitors, especially academic and research institutions and government
and other publicly funded agencies, may provide for free services or data
similar to the services and data that we provide for a fee. Moreover, our
competitors may obtain patent and other intellectual property protection that
would limit our rights or our customers’ and partners’ ability to use or
commercialize our discoveries, products and services. If we are unable to
compete successfully against existing or potential competitors, we may never
achieve profitability.
Our
management may be unable to address our potential growth.
We
anticipate that once operations commence, a period of significant expansion
will
be required to address potential growth in our customer base and market
opportunities. This expansion will place a significant strain on our management,
operational and financial resources. To manage the expected growth of our
operations, we will be required to improve existing and implement new
operational systems, procedures and controls, and to expand, train and manage
our employee base. There can be no assurance that our current and planned
personnel, systems, procedures and controls will be adequate to support our
future operations, that management will be able to hire, train, retain, motivate
and manage the required personnel or that we will be able to identify, manage
and exploit existing and potential strategic relationships and market
opportunities. Our failure to manage growth effectively could have a material
adverse effect on our business, results of operations and financial
condition.
If
our business does not keep up with rapid technological change or continue to
introduce new products, we may be unable to maintain market share or recover
investments in our technologies.
Technologies
in the biomarker industry have undergone, and are expected to continue to
undergo, rapid and significant change. We may not be able to keep pace with
the
rapid rate of change and introduce new products that will adequately meet the
requirements of the marketplace or achieve market acceptance. If we fail to
introduce new and innovative products, we could lose market share to our
competitors and experience a reduction in our growth rate and damage to our
reputation and business.
The
future success of our business will depend in large part on our ability to
maintain a competitive position with respect to these technologies. We believe
that successful new product introductions provide a significant competitive
advantage because customers make an investment of time in selecting and learning
to use a new product, and are reluctant to switch to a competing product after
making their initial selection. However, our business or others may make rapid
technological developments, which could result in our technologies, products
or
services becoming obsolete before we are able to recover the expenses incurred
to develop them.
If
our business cannot enter into strategic alliances or licensing agreements,
we
may be unable to develop and commercialize our technologies into new products
and services or continue to commercialize existing products or
services.
We
may be unable to maintain or expand existing strategic alliances or establish
additional alliances or licensing arrangements necessary to continue to develop
and commercialize products, and any of those arrangements may not be on terms
favorable to the business. In addition, current or any future arrangements
may
be unsuccessful. If we are unable to obtain or maintain any third party license
required to sell or develop our products or product enhancements, we may choose
to obtain substitute technology either through licensing from another third
party or by developing the necessary technology ourselves. Any substitute
technology may be of lower quality or may involve increased cost, either of
which could adversely affect our ability to provide our products competitively
and harm our business.
We
also depend on collaborators for the development and manufacture of complex
instrument systems and chemicals and other materials that are used in laboratory
experiments. We cannot control the amount and timing of resources our
collaborators devote to our products. We may not be able to enter into or
satisfactorily retain these research, development and manufacturing
collaborations and licensing agreements, which could reduce our growth and
harm
our competitive position.
We
may not be able to find business partners to develop and commercialize product
candidates deriving from our discovery activities.
Our
strategy for the development and commercialization of diagnostic markers and
therapeutic proteins depends on the formation of collaborations or licensing
relationships with third parties that have complementary capabilities in
relevant fields. Potential third parties include pharmaceutical and
biotechnology companies, diagnostic companies, academic institutions and other
entities. We cannot assure you that we will be able to form these collaborations
or license our discoveries or that these collaborations and licenses will be
successful.
Our
dependence on licensing and other collaboration agreements with third parties
subjects us to a number of risks.
We
may
not be able to enter into licensing or other collaboration agreements on terms
favorable to us. Collaborators may typically be afforded significant discretion
in electing whether to pursue any of the planned activities. In most cases,
our
collaborators or licensees will have responsibility for formulating and
implementing key strategic or operational plans. Decisions by our collaborators
or licensees on these key plans, which may include development, clinical,
regulatory, marketing (including pricing), inventory management and other
issues, may prevent successful commercialization of the product or otherwise
affect our profitability.
In
addition, we may not be able to control the amount and timing of resources
our
collaborators devote to the product candidates, and collaborators may not
perform their obligations as expected. Additionally, business combinations
or
changes in a collaborator’s or a licensee’s business strategy may negatively
affect its willingness or ability to complete its obligations under the
arrangement with us. Furthermore, our rights in any intellectual property or
products that may result from our collaborations may depend on additional
investment of money that we may not be able or willing to make.
Potential
or future collaborators may also pursue alternative technologies, including
those of our competitors. Disputes may arise with respect to the ownership
of
rights to any technology or product developed with any future collaborator.
Lengthy negotiations with potential collaborators or disagreements between
us
and our collaborators may lead to delays or termination in the research,
development or commercialization of product candidates or result in
time-consuming and expensive litigation or arbitration. If our collaborators
pursue alternative technologies or fail to develop or commercialize successfully
any product candidate to which they have obtained rights from us, our business,
financial condition and results of operations may be significantly harmed.
If
we
are unable to hire or retain key personnel or sufficient qualified employees,
we
may be unable to successfully operate our business.
Our
business is highly dependent upon the continued services of our Chief
Executive Officer, Board of Directors, and Scientific Advisory Board.
While
members of our senior management are parties to employment or consulting
agreements and non-competition and non-disclosure agreements, we cannot assure
you that these key personnel and others will not leave us or compete with us,
which could materially harm our financial results and our ability to compete.
The
loss, incapacity or unavailability for any reason of any of these individuals
could have a material adverse effect upon our business, as well as our
relationships with our potential customers. We
do not
carry key person life insurance on any member of our senior management.
Furthermore, competition for highly qualified personnel in our industry and
geographic locations is intense. Our business would be seriously harmed if
we
were unable to retain our key employees, or to attract, integrate or retain
other highly qualified personnel in the future.
We
may not be able to employ and retain experienced scientists, mathematicians
and
management.
Technologies
in our industry have undergone, and are expected to continue to undergo, rapid
and significant change. A highly skilled staff is integral to developing,
marketing and supporting new products that will meet or exceed the expectations
of the marketplace and achieve market acceptance. Without experienced staff,
our
business may be unable to maintain or grow market share, which could result
in
lower than expected revenues and earnings.
We
may acquire or make strategic investments in other businesses and technologies
in the future, and these could prove difficult to integrate, disrupt our
business, dilute stockholder value and adversely affect our operating
results.
If
opportunities arise, we may consider making acquisitions of businesses,
technologies, services or products. Acquisitions
may involve significant cash expenditures, debt incurrence, additional operating
losses and expenses that may have a material adverse effect on the operating
results of our business. Moreover,
even if we acquire complementary businesses or technologies, we may be unable
to
successfully integrate any additional personnel, operations or acquired
technologies into our business. Difficulties in integrating an acquired business
could disrupt our business, distract our management and employees and increase
our expenses. Future
acquisitions could expose us to unforeseen liabilities and result in significant
charges relating to intangible assets. Sizable acquisitions may also divert
senior management from focusing on our existing business plan. Finally,
if we make acquisitions using convertible debt or equity securities, existing
stockholders may be diluted, which could affect the market price of our
stock.
If
our access to tissue samples or to genomic data or other information is
restricted, or if this data is faulty, our business may suffer.
To
continue to build our technologies and related products and services, we need
access to third parties’ scientific and other data and information. We also need
access to normal and diseased human and other tissue samples and biological
materials. We may not be able to obtain or maintain such access on commercially
acceptable terms. Some of our suppliers could become our competitors and
discontinue selling supplies to us. Information and data from these suppliers
could contain errors or defects that could corrupt our databases or the results
of our analysis of the information and data. In addition, government regulation
in the United States and other countries could result in restricted access
to,
or use of, human and other tissue samples. Although currently we do not face
significant problems in obtaining access to tissues, if we lose access to
sufficient numbers or sources of tissue samples, or if tighter restrictions
are
imposed on our use of the information generated from tissue samples, our
business may suffer.
The
sales cycle for some of our products and services is lengthy. We expend
substantial funds and management effort with no assurance of successfully
selling our products or services.
Our
ability to obtain customers for our platforms, tools and services depends in
large upon the perception that our technologies can help accelerate their
efforts in drug and diagnostics discovery. Our ability to obtain customers
for
our therapeutic or diagnostic product candidates significantly depends on our
ability to validate and prove that each such product candidate is suitable
for
our claimed therapeutic or diagnostic purposes. Our ability to obtain customers
will also depend on our ability to successfully negotiate terms and conditions
for such arrangements. The sales cycle for our therapeutic and diagnostic
product candidates is typically lengthy and may take more than 12 months.
An
inability to protect our proprietary data, technology or products may harm
our
competitive position.
If
we do
not adequately protect the intellectual property underlying our products and
services, competitors may be able to develop and market the same or similar
products and services. This would erode our competitive advantage. In addition,
the laws of some countries do not protect or enable the enforcement of
intellectual property to the same extent as the laws of the United
States.
We
use
contractual obligations to protect a significant portion of our confidential
and
proprietary information and know-how. This includes a substantial portion of
the
knowledge base from which we develop a large portion of our proprietary products
and services. However, these measures may not provide adequate protection for
our trade secrets or other proprietary information and know-how. Customers,
employees, scientific advisors, collaborators or consultants may still disclose
our proprietary information in violation of their agreements with us, and we
may
not be able to meaningfully protect our trade secrets against this
disclosure.
In
addition, we have applied for patents covering some aspects of some of our
technologies and predicted genes and proteins we have discovered using these
technologies. We plan to continue to apply for patents covering parts of our
technologies and discoveries as we deem appropriate, but cannot assure you
that
we will be able to obtain any patents. The patent positions of biotechnology
companies are generally uncertain and involve complex legal and factual
questions. Legislative changes and/or changes in the examination guidelines
of
governmental patents offices may negatively affect our ability to obtain patent
protection for certain aspects of our intellectual property, especially with
respect to genetic discoveries.
Our
success depends in large part on our ability to patent our discoveries.
Our
success depends, in large part, on our ability to obtain patents on biomarkers
and pathways that we have discovered and are attempting to commercialize. We
face intense competition from other biotechnology and pharmaceutical companies.
These include customers who use our products and technologies and are pursuing
patent protection for discoveries, which may be similar or identical to our
discoveries. We cannot assure you that other parties have not sought patent
protection relating to the biomarkers and pathways that we discovered or may
discover in the future. Our patent applications may conflict with prior
applications of third parties or with prior publications. They may not result
in
issued patents and, even if issued, our patents could be invalidated or may
not
be sufficiently broad to provide us with any competitive advantages. U.S. and
other patent applications ordinarily remain confidential for 18 months from
the
date of filing. As a result, patent applications that we file which we believe
are novel at the time of filing, may be determined at a later stage to be
inconsistent with earlier applications. Any of these events could materially
harm our business or financial results.
Litigation
or other proceedings or third party claims of intellectual property infringement
could prevent us, or our customers or collaborators, from using our discoveries
or require us to spend time and money to modify our operations.
If
we
infringe patents or proprietary rights of third parties, or breach licenses
that
we have entered into with regard to our technologies and products, we could
experience serious harm. If litigation is commenced against us for intellectual
property rights infringement, we may incur significant costs in litigating,
whether or not we prevail in such litigation. These costs would also include
diversion of management and technical personnel to defend us against third
parties or to enforce our patents (once issued) or other rights against others.
In addition, parties making claims against us may be able to obtain injunctive
or other equitable relief that could prevent us from being able to further
develop or commercialize. This could also result in the award of substantial
damages against us. In the event of a successful claim of infringement against
us, we may be required to pay damages and obtain one or more licenses from
third
parties. If we are not able to obtain these licenses at a reasonable cost,
if at
all, we could encounter delays in product introductions while we attempt to
develop alternative methods or products. Defense of any lawsuit or failure
to
obtain any of these licenses could prevent us from commercializing available
products.
The
technology that we use to develop our products, and the technology that we
incorporate in our products, may be subject to claims that they infringe the
patents or proprietary rights of others. The risk of this occurring will tend
to
increase as the genomics, biotechnology and software industries expand, more
patents are issued and other companies engage in other genomic-related
businesses.
As
is
typical in the genomics, biotechnology and software industries, we will probably
receive in the future notices from third parties alleging patent infringement.
We believe that we are not infringing the patent rights of any third parties.
No
third party has filed a patent lawsuit against us. We may, however, be involved
in future lawsuits alleging patent infringement or other intellectual property
rights violations. In addition, litigation may be necessary to:
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assert
claims of infringement;
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enforce
our patents as they are granted;
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protect
our trade secrets or know-how; or
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determine
the enforceability, scope and validity of the proprietary rights
of
others.
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We
may be
unsuccessful in defending or pursuing these lawsuits. Regardless of the outcome,
litigation can be very costly and can divert management’s efforts. An adverse
determination may subject us to significant liabilities or require us to seek
licenses to other parties’ patents or proprietary rights. We may also be
restricted or prevented from licensing or selling our products and services.
Further, we may not be able to obtain any necessary licenses on acceptable
terms, if at all.
The
scope of patents we receive may not provide us with adequate protection of
our
intellectual property, which would harm our competitive position.
Any
issued patents that cover our proprietary technologies may not provide us with
substantial protection or be commercially beneficial to the business. The
issuance of a patent is not conclusive as to its validity or its enforceability.
Federal courts may invalidate these patents or find them unenforceable.
Competitors may also be able to design around our patents. If we are unable
to
protect our patented technologies, we may not be able to commercialize our
technologies, products or services and our competitors could commercialize
our
technologies.
Our
business also relies on a combination of trade secrets, copyrights and
trademarks, non-disclosure agreements and other contractual provisions and
technical measures to protect our intellectual property rights. While we
generally require employees, collaborators, consultants and other third parties
to enter into confidentiality agreements where appropriate, it is not always
possible to enforce these arrangements.
Monitoring
the unauthorized use of our technology is difficult, and the steps we have
taken
may not prevent unauthorized use of our technology. The disclosure or
misappropriation of our intellectual property for any of the above reasons
could
harm our ability to protect our rights and our competitive position.
We
may become involved in disputes regarding our patents and other intellectual
property rights, which could result in the forfeiture of these rights, expose
the business to significant liability and divert management’s
focus.
In
order to protect or enforce our patent rights, our business may need to initiate
patent litigation against third parties. In addition, we may be sued by third
parties alleging that we are infringing their intellectual property rights.
These lawsuits are expensive, take significant time and divert management’s
focus from other business concerns. These lawsuits could result in the
invalidation or limitation of the scope of our patents, forfeiture of the rights
associated with these patents or an injunction preventing Health Discovery
from
selling any allegedly infringing product. In addition, we may not prevail or
a
court may find damages or award other remedies in favor of the opposing party
in
any of these suits. During the course of these suits, there may be public
announcements of the results of hearings, motions and other interim proceedings
or developments in the litigation. Securities analysts or investors may perceive
these announcements to be negative, which could cause the market price of our
common stock to decline.
Many
of our services will be based on complex, rapidly developing technologies.
Although we will try to identify all relevant third party patents, these
products could be developed by the business without knowledge of published
or
unpublished patent applications that cover some aspect of these technologies.
The biomarker industry has experienced intensive enforcement of intellectual
property rights by litigation and licensing. If we are found to be infringing
the intellectual property of others, we could be required to stop the infringing
activity, or we may be required to design around or license the intellectual
property in question. If we are unable to obtain a required license on
acceptable terms, or are unable to design around any third party patent, we
may
be unable to sell some of our services, which could
result in reduced revenue.
Risks
Related to Our Industry
There
are many risks of failure in the development of drugs, therapies, diagnostic
products and other life science products. These risks are inherent to the
development and commercialization of these types of products.
Risks
of
failure are inseparable from the process of developing and commercializing
drugs, therapies, diagnostic products and other life science products. These
risks include the possibility that any of these products will:
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be
found to be toxic or ineffective;
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fail
to receive necessary regulatory
approvals;
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be
difficult or impossible to manufacture on a large scale;
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be
uneconomical to market;
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fail
to be developed prior to the successful marketing of similar products
by
competitors; or
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be
impossible to market because they infringe on the proprietary rights
of
third parties or compete with superior products marketed by third
parties.
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We
are
dependent on our customers’ commercialization of our discoveries. Any of these
risks could materially harm our business and financial results.
The
trend towards consolidation in the pharmaceutical and biotechnology industries
may adversely affect us.
The
trend
towards consolidation in the pharmaceutical and biotechnology industries may
negatively affect us in several ways. These consolidations usually involve
larger companies acquiring smaller companies, which results in the remaining
companies having greater financial resources and technological capabilities,
thus strengthening competition in the industry. In addition, continued
consolidation may result in fewer customers for our products and services.
We
may be subject to product liability claims if products derived from our products
or services harm people.
We
may be
held liable if any product that is made with the use, or incorporation of,
any
of our technologies or data causes harm or is found otherwise unsuitable. These
risks are inherent in the development of genomics, functional genomics and
pharmaceutical products. If we are sued for any harm or injury caused by
products derived from our services or products, our liability could exceed
our
total assets. In addition, such claims could cause us to incur substantial
costs
and subject us to negative publicity even if we prevail in our defense of such
claims.
Our
business and the products developed by our collaborators and licensees may
be
subject to governmental regulation.
Any
new
therapy or diagnostic product that may be developed by our collaborators or
by
our licensees will have to undergo a lengthy and expensive regulatory review
process in the United States and other countries before it can be marketed.
It
may be several years, or longer, before any therapy or diagnostic product that
is developed by using our technologies, will be sold or will provide us with
any
revenues. This may delay or prevent us from becoming profitable. Changes in
policies of regulatory bodies in the United States and in other countries could
increase the delay for each new therapy and diagnostic product. Even if
regulatory approval is obtained, a product on the market and its manufacturer
are subject to continuing review. Discovery of previously unknown problems
with
a product may result in withdrawal of the product from the market.
Although
we intend to become involved in the clinical phases in the future, we still
expect to rely mainly on collaborators or licensees of our discovery activities
to file regulatory approval applications and generally direct the regulatory
review process. We cannot be certain whether they will be able to obtain
marketing clearance for any product that may be developed on a timely basis,
if
at all. If they fail to obtain required governmental clearances, it will prevent
them from marketing therapeutic or diagnostic products until clearance can
be
obtained, if at all. This will in turn reduce our chances of receiving various
forms of payments, including those relating to sales of marketed therapeutic
or
diagnostic products by them.
The
law applicable to us may change in a manner that negatively affects our
prospects.
We
must comply with various legal requirements, including requirements imposed
by
federal and state securities and tax laws. Should any of those laws change
over
the term of our existence, the legal requirements to which we may be subject
could differ materially from current requirements, which could increase the
cost
of doing business or preclude us from undertaking certain parts of our business
plan, would result in adverse consequences.
If
ethical and other concerns surrounding the use of genetic information become
widespread, there may be less demand for our products and services.
Genetic
testing has raised ethical issues regarding confidentiality and the appropriate
uses of the resulting information. For these reasons, governmental authorities
may call for limits on or regulation of the use of genetic testing or prohibit
testing for genetic predisposition to various conditions, particularly for
those
that have no known cure. Any of these scenarios could reduce the potential
markets for our technologies in the field of predictive drug response, which
could materially harm our business and financial results.
ITEM
2. DESCRIPTION
OF PROPERTY
We
do not
own any real property. We lease 1,554 square feet of office space in Savannah,
Georgia, on a month-to-month basis for a cost of $1,036 per month. Our principal
executive office is located at 5501 ½ Abercorn Street, Savannah, Georgia 31405,
and our telephone number is (912) 352-7488. Our principal executive office
is
well maintained and suitable for the business conducted in it.
ITEM
3. 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 award 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 cancelled upon return to the Company. 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 cancelled upon return to the
Company. Cancellation of the returned stock certificates was considered full
and
final settlement of the claims brought against Mr. Petermann and Mr. Braswell
in
this lawsuit.
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 were all of the shares then owned by him, and he will no
longer be a party to the suit. At this time, only the shares originally issued
to Mr. Williams are subject to the suit, and the Company believes he controls
approximately 1.6 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.
On
June
26, 2006, we originally filed suit in the United States District Court for
the
Eastern District of Texas against Ciphergen Biosystems, Inc. (“Ciphergen”),
alleging claims for infringment of three patents related to support vector
machine technology and seeking monetary and injunctive relief. Ciphergen denied
infringement, challenged the validity of the patents, and alleged counterclaims
against us. We deny liability to Ciphergen under the alleged counterclaims.
Pursuant to a motion filed by Ciphergen, the litigation has been transferred
to
the United States District Court for the Northern District of
California.
On
June
26, 2006, we also filed suit in the United States District Court for the Eastern
District of Texas against Equbits LLC (“Equbits”), alleging claims for
infringement of three of our patents related to Support Vector Machine
technology and seeking monetary and injunctive relief. On November 27, 2006,
the
court entered a Consent Final Judgment permanently enjoining Equbits from
making, using, selling, renting, leasing, or offering to sell in the United
States, or from importing into the United States, any product that utilizes
support vector machine technology, with certain limited exceptions related
to
technical support for previously sold products to two third
parties.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No
matter
was submitted during the fourth quarter of the fiscal year ended December 31,
2006 to a vote of shareholders of Health Discovery Corporation, through the
solicitation of proxies or otherwise.
PART
II
ITEM
5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND SMALL BUSINESS
ISSUER PURCHASES OF EQUITY SECURITIES.
Our
common stock is traded on the OTC Bulletin Board under the symbol HDVY. The
range of closing prices for our common stock, as reported on Bloomberg.com
during each quarter of the last two fiscal years was as follows. These
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not represent actual transactions.
|
High
|
|
Low
|
First
Quarter 2005
|
$0.40
|
|
$0.20
|
Second
Quarter 2005
|
$0.41
|
|
$0.21
|
Third
Quarter 2005
|
$0.25
|
|
$0.20
|
Fourth
Quarter 2005
|
$0.24
|
|
$0.07
|
|
|
|
|
First
Quarter 2006
|
$0.15
|
|
$0.10
|
Second
Quarter 2006
|
$0.12
|
|
$0.06
|
Third
Quarter 2006
|
$0.13
|
|
$0.07
|
Fourth
Quarter 2006
|
$0.17
|
|
$0.08
|
At
December 31, 2006, there were approximately 386 holders of record of our common
stock.
We
have
not paid any cash dividends since inception, and we do not anticipate paying
any
in the foreseeable future. We intend to retain future earnings, if any, to
support the development and growth or our business. Payment of future dividends,
if any, will be at the discretion of our board of directors and will depend
upon
our earnings, our financial condition, and opportunities for growth and
expansion.
|
|
Number
of securities to be issued upon exercise of outstanding options,
warrants
and rights (a)
|
|
Weighted-average
exercise price of outstanding options, warrants and rights
(b)
|
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column (a))
(c)
|
|
Equity
compensation plans approved by security holders
|
|
|
0
|
|
|
0
|
|
|
0
|
|
Equity
compensation plans not approved by security holders
|
|
|
72,296,250
|
|
$
|
0.228
|
|
|
0
|
|
Total
|
|
|
72,296,250
|
|
$
|
0.228
|
|
|
0
|
|
Private
Placements
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. The Company 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 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 were registered
the
securities could 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 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 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 wherein
31,622,749 shares of stock and 32,638,436 warrants were registered with the
Securities and Exchange Commission.
We
paid a cash fee of approximately $356,250, agreed to issue warrants to acquire
1,303,121 shares of common stock and agreed to issue 50,132 shares of common
stock to placement agents for assisting us in these two private
sales.
Additional
Issuance of Securities
Two
members of the Company’s Scientific Advisory Board, Drs. Vapnik and Stamey, were
each issued our common stock, no par value, equal to $10,000 per month beginning
in August 2004 and ending in the second quarter of 2006. For 2005, Drs. Vapnik
and Stamey were each contractually entitled to stock grants equivalent to
$140,000. Drs. Vapnik and Stamey forfeited 1,580,532
shares
in December 2005, and any shares issued pursuant to their agreements were
rescinded. No further shares have been issued in connection with these
agreements. 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.
During
the first quarter of 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 F. Quirk, Jr. 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.
During
the second quarter of 2006, the Company issued 500,000 warrants to two members
of its Scientific Advisory Board. These warrants vest over a one-year period
and
have an exercise price of $0.11. The Company also issued 200,000 warrants to
a
service provider in exchange for professional services. These warrants vest
over
a two-year period and have an exercise price of $0.10. During
the second quarter of 2006, the Company issued 200,000 shares of stock for
warrants exercised at $0.01 each. Proceeds of $2,000 were recorded in capital
stock.
During
the third quarter of 2006, the Company issued 10,000,000 warrants to purchase
an
equal number of shares of the Company’s common stock to Mr. Quirk in connection
with the loan Mr. Quirk made to the Company. These warrants vest over a period
of nine months and have an exercise price of $0.16 per share. During the third
quarter of 2006, the Company also issued 300,000 warrants to purchase an equal
number of shares of the Company’s common stock in exchange for legal services
provided to the Company. These warrants vest immediately and have an exercise
price of $0.10 per share.
In
addition, during the third quarter of 2006, the Company issued 500,000 warrants
to purchase an equal number of shares of the Company’s common stock to a member
of the Company’s Scientific Advisory Board for providing advisory services to
the Company beyond which was expected in his capacity as a Scientific Advisory
Board member. These warrants vest immediately and have an exercise price of
$0.10 per share.
During
the third quarter of 2006, the Company issued 230,000 shares of stock for
warrants exercised at $0.08 each. Proceeds of $18,400 were recorded in capital
stock.
All
of
these issuances of equity securities in 2006 were made in reliance upon
exemptions from registration pursuant to Section 4(2) under the Securities
Act
of 1933, as amended.
ITEM
6. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
Corporate
Overview
Our
Company is a pattern recognition company that uses advanced mathematical
techniques to analyze large amounts of data to uncover patterns that might
otherwise be undetectable. Our Company operates primarily in the emerging field
of molecular diagnostics where such tools are critical to scientific discovery.
Our primary business consists of licensing our 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.
Our
business 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. With the completion of the acquisition of the SVM portfolio of
patents we plan to begin to license the use of this technology.
Year
Ended December 31, 2006 Compared with Year Ended December 31,
2005
Revenue
For
the
year ended December 31, 2006, revenue was $203,889 compared with $224,000 in
revenue for the year ended December 31, 2005. Revenue is recognized for
licensing and development fees over the period earned. As of December 31, 2006,
the Company had received cash of $101,111 which was not recognized as revenue
and is reported as deferred revenue. No such amount was recorded as of December
31, 2005.
Cost
of Sales and Gross Margin
Cost
of
sales for 2006 was $28,671.
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.
Cost
of sales was $33,536 in 2005.
Operating
and Other Expenses
Amortization
expense was $262,719 for the twelve months ended December 31, 2006 compared
with
$251,097 for the comparable period in 2005. This increase was due to
amortization being charged throughout all of 2006 for intangibles acquired
during 2005.
Professional
and consulting fees totaled $1,123,498 for 2006 compared with $1,567,500 for
2005. These fees, related to legal, accounting and scientific activities, were
reduced by 28.3% in 2006 because of continued efforts to control costs related
to regulatory filing activity, patent protection efforts, and general corporate
legal and accounting work along with benefits achieved in restructuring accounts
payable.
Compensation
of $770,000 for the twelve months ended December 31, 2006 was lower than the
$822,261 reported for the comparable period of 2005. Compensation year to date
benefited from implementation of a salary reduction plan in the third quarter
of
2006. However, this benefit was offset by increased expense for compensation
of
$279,896 for warrants and options charged as a result of the implementation
of
SFAS 123(R) effective January 1, 2006.
Other
general and administrative expenses decreased from $656,214 in 2005 to $542,710
in 2006. This decrease was largely due to expense reduction efforts throughout
the entire 2006 period.
Loss
from Operations
The
loss
from operations for the twelve months ended December 31, 2006 was $2,523,709
compared to $3,106,608 for the prior year. The decreased loss was due to the
factors enumerated above.
Other
Income and Expense
Interest
income was $21,008 for the twelve months ended December 31, 2006 compared to
$2,998 in 2005. Increased interest income was due to the higher average cash
available to invest throughout 2006.
A
gain on
the restructuring of accounts payable of $97,864 was recorded in 2006 to reflect
common stock warrants issued in payment of liabilities. No such amount was
recorded in the comparable 2005 period.
Interest
expense was $190,922 in 2006 compared with $55,406 in 2005. This increase was
due to the higher interest rate associated with the renegotiated promissory
notes, and interest related to the promissory note executed in the third quarter
of 2006.
Net
Loss
The
net
loss for the twelve months ended December 31, 2006 was $2,595,759 compared
to
$3,159,016 for the twelve months ended December 31, 2005. The reduced loss
was
due to the smaller loss from operations offset by increased net other expense,
as previously discussed.
Net
loss
per share was $0.02 and $0.03 for the twelve months ended December 31, 2006
and
2005, respectively. The smaller net loss per share in 2006 compared to 2005
was
due to the smaller net loss and the increased average number of shares
outstanding in 2006.
Liquidity
and Capital Resources
At
December 31, 2006, the Company had $674,366 in available cash. Cash used by
operating activities was $1,135,134. This was due primarily to the net loss
of
$2,595,759; however, net non-cash charges and adjustments of $1,460,625
favorably impacted the computation of the net cash used. Cash used by investment
activities was $9,287 due to the acquisition of assets. Net cash provided by
financing activities was $1,099,620 due to the cash received from the promissory
note, sale of common stock, and the exercise of stock options and warrants
offset by the repayment of debt totaling $26,780.
The
following table summarizes the due dates of our contractual obligations. The
Company has no long term lease agreements in effect as of December 31,
2006.
|
|
Total
|
|
Less
than
1
Year
|
|
1-3
Years
|
|
Accounts
Payable Deferred
|
|
$
|
170,966
|
|
$
|
170,966
|
|
$
|
—
|
|
Deferred
Compensation
|
|
|
30,000
|
|
|
30,000
|
|
|
—
|
|
Accrued
Interest
|
|
|
140,875
|
|
|
—
|
|
|
140,875
|
|
Convertible
Notes Payable
|
|
|
665,643
|
|
|
—
|
|
|
665,643
|
|
Term
Debt
|
|
|
321,911
|
|
|
—
|
|
|
321,911
|
|
Promissory
Note
|
|
|
1,000,000
|
|
|
—
|
|
|
1,000,000
|
|
Total
|
|
$
|
2,329,395
|
|
$
|
200,966
|
|
$
|
2,128,429
|
|
On
September 1, 2006 the Company issued a promissory note in the amount of
$1,000,000 to one of our directors. The annual interest rate is 5%, and the
entire amount including accrued interest is due 2 years from the date of
execution. The note may be repaid at any time prior to the due date with no
penalty or additional fees. The Company intends to use the proceeds to fund
general working capital requirements.
The
Company also issued 10,000,000 common stock warrants with an exercise price
of
$0.16 in connection with the promissory note. The warrants fully vest over
ten
months if the promissory note remains unpaid during that period. The estimated
value of these warrants of $554,000 was
recorded as additional paid in capital and debt discount and will be accreted
as
interest expense over the term of the promissory note.
On
September 1, 2006, the Company and an officer of the Company and an employee
of
the Company entered into amendments to each of the employment agreements whereby
both will waive receipt of compensation aggregating $143,200 deferred pursuant
to such amended employment agreements in exchange for a one-time payment of
$6,000 and $1,460, respectively. The Company will also reimburse the officer
and
the employee for any adverse tax consequences associated therewith. As
a
result, the Company recorded a reduction in compensation expense during the
quarter of $143,200. The amount had previously been accrued as compensation
to
the officers with deferred payment terms. Prior to the renegotiation, the
officers were receiving a portion of their salary in cash and deferring the
remainder to be paid at a later date but agreed to
forfeit
$143,200 in their deferred salary for a one-time payment of $7,460.
Additionally, the officers received an increase of 25% of their current salary
amount paid in cash beginning in November 2006.
On
September 1, 2006, the Company and certain holders of promissory notes
previously issued by the Company entered into amendments to extend deferral
of
all remaining payments due under the notes until September 1, 2008. The notes
were issued by the Company in July 2004 as consideration for the purchase of
interests in the support vector machine patent portfolio. As of September 1,
2006, the notes had aggregate remaining principal of approximately $321,911
due
in October 2007, with accrued interest of approximately $38,000. The deferred
amounts will continue to accrue interest at a rate of 18%, which will be paid
in
shares of the Company’s common stock valued at $0.24 per share.
The
Company, in an effort to preserve cash, to enable the Company to continue its
operations, and as a condition to the loan from the director, negotiated a
restructuring of certain of its accounts payable with selected vendors,
primarily its legal and professional vendors. Two vendors reduced their
outstanding balances by $37,190, or 50%, in settlement of the full liability
for
a cash payment of $37,190. This settlement was recorded as a gain on
restructuring. Several other vendors agreed to extend the payment terms and
defer collection on outstanding amounts for an indefinite period of time. The
Company currently expects to pay such amounts in six to eight months upon
increases in revenues and or additional equity or debt financing, although
none
of those events is certain. The total amount of accounts payable deferred was
$170,966. The Company also issued 300,000 warrants to these vendors with an
exercise price of $0.10 per share. The fair value of these warrants on the
grant
date was $16,872 and was recorded as an expense in connection with the
restructuring. The amount was charged to expense in the quarter as the warrants
vested immediately. The deferred payments to the vendors has not been discounted
as the date of payment is not certain.
The
Company has relied primarily on equity funding plus debt financing for liquidity
during its developmental phase that ended in 2004. 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. The Company’s plan
to have sufficient cash to support operations is comprised of generating revenue
through licensing its significant patent portfolio, providing services related
to those patents, and obtaining additional equity or debt financing. The Company
has been and continues to be in meaningful discussions with a variety of
parties, which if successful, will result in significant revenue. The Company
has implemented a cash conservation plan that includes salary deferrals and
reductions, reduction in consulting payments, negotiated settlements with
creditors whereby the Company 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.
Critical
Accounting Policies, Estimates and Assumptions
We
consider our accounting policies related to revenue recognition, impairment
of
intangible assets and stock based compensation to be critical accounting
policies. A number of significant estimates, assumptions, and judgments are
inherent in our determination of when to recognize revenue, how to evaluate
our
intangible assets, and stock-based compensation expense. These estimates,
assumptions and judgments include deciding whether the elements required to
recognize revenue from a particular arrangement are present, estimating the
fair
value of an intangible asset, which represents the future undiscounted cash
flows to be derived from the intangible asset, and estimating the useful life
and volatility of stock awards granted. We base our estimates and judgments
on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances. Actual results could differ materially
from
these estimates.
Valuation
of intangible and other long-lived assets.
We
assess the carrying value of intangible and other long-lived assets at least
annually, which requires us to make assumptions and judgments regarding the
future cash flows of these assets. The assets are considered to be impaired
if
we determine that the carrying value may not be recoverable based upon our
assessment of the following events or changes in circumstances such
as:
|
§ |
the
asset’s ability to continue to generate income from operations and
positive cash flow in future
periods;
|
|
§ |
loss
of legal ownership or title to the
asset;
|
|
§ |
significant
changes in our strategic business objectives and utilization
of the
asset(s); and
|
|
§ |
the
impact of significant negative industry or economic
trends.
|
If
the assets are considered to be impaired, the impairment we recognize is the
amount by which the carrying value of the assets exceeds the fair value of
the
assets. In addition, we base the useful lives and related amortization or
depreciation expense on our estimate of the period that the assets will generate
revenues or otherwise be used by us. We also periodically review the lives
assigned to our intangible assets to ensure that our initial estimates do not
exceed any revised estimated periods from which we expect to realize cash flows
from the technologies. If a change were to occur in any of the above-mentioned
factors or estimates, the likelihood of a material change in our reported
results would increase.
Revenue
Recognition
We
recognize revenue principally from license and royalty fees for intellectual
property and from development agreements with research partners. Each element
of
revenue recognition requires a certain amount of judgment to determine if the
following criteria have been met: i) persuasive evidence of an arrangement
exists; ii) delivery has occurred or services have been rendered; iii) the
seller’s price to the buyer is fixed or determinable; iv) collectibility is
reasonably assured, and v) both title and the risks and rewards of ownership
are
transferred to the buyer. We are required to make more significant estimates
involving our recognition of revenue from license and royalty fees. Our license
and royalty fees revenue estimates depend upon on our interpretation of the
specific terms of each individual arrangement and our judgment to determine
if
the arrangement has more than one deliverable and how each of these deliverables
should be measured and allocated to revenue. In addition, we have to make
significant estimates about the useful life of the technology transferred to
determine when the risk and rewards of ownership have transferred to the buyer
to decide the period of time to recognize revenue. In certain circumstances
we
are required to make judgments about the reliability of third party sales
information and recognition of royalty revenue before actual cash payments
for
these royalties have been received.
Share-Based
Compensation
Share-based
compensation expense is significant to our financial position and results of
operations, even though no cash is used for such expense. In determining the
period expense associated with unvested options, we estimate the fair value
of
each option at the date of grant. We believe it is important for investors
to be
aware of the high degree of subjectivity involved when using option pricing
models to estimate share-based compensation under SFAS No. 123R. The
determination of the fair value of share-based payment awards on the date of
grant using an option-pricing model is affected by our stock price as well
as
assumptions regarding a number of complex and subjective variables. These
variables include, but are not limited to, our valuation methodology, the
expected term, expected stock price volatility over the term of the awards,
the
risk-free interest rate, expected dividends and pre-vesting forfeitures. If
any
one of these factors changes and we employ different assumptions in the
application of SFAS No. 123R in future periods, the compensation expense
that we record under SFAS No. 123R will differ significantly from what we
have recorded in the current period.
For
share-based awards issued during the year ended December 31, 2006, we
estimated the expected term by considering various factors including the vesting
period of options granted, employees’ historical exercise and post-employment
termination behavior, however due to the limited history of our Company, such
data is limited. We estimated the expected life will be substantially
longer than the vesting period given the sart-up nature of our operations and
accordingly have used the contractual life as the expected term. Our estimated
volatility was derived using our historical stock price volatility. We have
never declared or paid any cash dividends on our common stock and currently
do
not anticipate paying such cash dividends. The risk-free interest rate is based
upon U.S. Treasury securities with remaining terms similar to the expected
term
of the share-based awards.
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.
ITEM
7. FINANCIAL STATEMENTS.
Financial
statements appear beginning on page F1 of this Report.
ITEM
8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
On
September 21, 2006, Porter Keadle Moore LLP, Health Discovery Corporation’s
principal accountant, resigned. The Company engaged Hancock Askew LLP (“Hancock
Askew”) on September 21, 2006 as its new principal accountant to audit the
Company’s financial statements.
Porter
Keadle Moore’s report on the financial statements of the Company as of and for
the fiscal years ended December 31, 2005 and 2004 contained an unqualified
opinion, except the opinion included an explanatory paragraph referring to
the
Company’s ability to continue as a going concern. During the fiscal years ended
December 31, 2005 and 2004 and through September 20, 2006, there were no
disagreements with Porter Keadle Moore LLP on any matter of accounting
principles or practices, financial statement disclosures, or auditing scope
or
procedure, which disagreements, if not resolved to the satisfaction of Porter
Keadle Moore LLP would have caused it to make reference thereto in, or in
connection with, its reports on financial statements for the periods covered
by
its audit.
During
the fiscal years ended December 31, 2005 and 2004 and through September 21,
2006, the Company did not consult Hancock Askew with respect to the application
of accounting principles to a specified transaction, either contemplated or
proposed, or the type of audit opinion that might be rendered on the Company’s
consolidated financial statements, or any other matters or reportable events
as
set forth in Items 304(a)(2)(i) and (ii) of Regulation S-B.
We
have
had no disagreements with our former certifying accountants on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure.
ITEM
8A. DISCLOSURE CONTROLS AND PROCEDURES.
As
of the end of the period covered by this report (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.
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
III
ITEM
9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Our
executive officers, directors and significant employees are:
Name
|
|
Age
|
|
Position
|
Stephen
D. Barnhill, M.D.
|
|
48
|
|
Chief
Executive Officer and Chairman of the Board
|
Daniel
R. Furth
|
|
43
|
|
Principal
Financial Officer, Executive Vice President
|
Robert
S. Braswell IV
|
|
51
|
|
Senior
Vice President
|
Hong
Zhang, Ph.D.
|
|
45
|
|
Senior
Vice President
|
William
F. Quirk, Jr.
|
|
64
|
|
Director
|
William
M. Goldstein
|
|
71
|
|
Director
|
Stephen
D. Barnhill, M.D., is
currently our Chief Executive Officer and Chairman of the Board. He has been
a
member of the Board of Directors since November 2003. He is a physician trained
in laboratory medicine and clinical pathology. He has developed and used
artificial intelligence, pattern-recognition, and computational techniques
in
Medicine, Genomics, Proteomics, Diagnostics and Drug Discovery.
Dr.
Barnhill is or has been a Fellow of the American College of Physician Inventors,
the American College of International Physicians, the American Medical
Association, the American College of Physician Executives, the American
Association of Artificial Intelligence, the American College of Managed Care
Medicine, the Association of Clinical Scientists, the American Society of
Contemporary Medicine and Surgery, the American Society of Law, Medicine and
Ethics, the Southern Medical Society,
the American Federation for Clinical Research, and the National Federation
of
Catholic Physicians.
Dr.
Barnhill founded the Barnhill Clinical Laboratories in 1988 and served as
Chairman, CEO, President and Medical Director. This laboratory was later
acquired by Corning-Metpath in 1989 and after the acquisition he served as
Medical Director of this clinical laboratory until 1992. This clinical
laboratory, now owned by Quest Diagnostics, continues to be the largest and
busiest clinical laboratory in the Savannah, Georgia area.
In
1992,
Dr. Barnhill founded National Medical Specialty Laboratories and served as
Chairman, CEO, President, and Medical Director. This research laboratory was
founded to utilize pattern-recognition mathematics and artificial intelligence
techniques in cancer diagnosis. Dr. Barnhill is an inventor on the very first
patents issued by the United States Patent and Trademark Office for the use
of
neural networks in medicine. This company was acquired by Horus Therapeutics,
a
New York based pharmaceutical company. Dr. Barnhill served as Executive
Vice-President and Chairman of the Scientific Advisory Board for Horus
Therapeutics until 1998. Johnson & Johnson later acquired the Horus patents
invented by Dr. Barnhill.
In
1999, Dr. Barnhill founded and served as Chairman, President and CEO of Barnhill
BioInformatics, Inc. Barnhill BioInformatics, Inc. later became Barnhill
Genomics, Inc. and BioWulf Technologies, LLC and raised over $13.5 million
in
private placement funding. The primary focus of these companies was to utilize
the next generation of artificial intelligence and pattern-recognition
techniques, known as support vector machines, to identify genes that cause
cancer. Dr. Barnhill is the sole inventor on the very first patents issued
by
the United States Patent and Trademark Office for the use of support vector
machines in medicine. From the summer of 2000 until he organized The Barnhill
Group L.L.C. in the summer of 2003, Dr. Barnhill was not engaged in any
professional activities as the result of a non-compete agreement signed by
Dr.
Barnhill when he left the employment of Barnhill Genomics, Inc.
Daniel
R. Furth is
our
Principal Financial Officer, Executive Vice President, Secretary and Treasurer.
Mr. Furth is an experienced executive with a proven track record in diverse
industries for both private and public corporations. Since October 2000, he
served as a corporate communications consultant for several private clients.
During that same period, he also served as a managing member and equity partner
of Purple Shamrock LLC, a privately held investment group. From 1994 to 2000,
he
served as Senior Director of Marketing & Communications for Quality
Distribution, Inc., North America’s largest bulk transportation services
company, where he managed corporate communications, marketing communications,
investor relations, and public affairs. During that time, he was chief of staff
to QD’s Chairman/CEO and played an instrumental role in the QD’s initial public
offering in 1994 and its subsequent leveraged buyout in 1998. From 1986 to
1994,
Mr. Furth held varied executive positions in both the public and private sectors
including particular experience with early stage ventures. He earned his BA
degree in government from Georgetown University in Washington, DC.
Robert
S. Braswell IV
is our
Senior Vice President. Mr. Braswell served as our President from April 2001
until the acquisition of The Barnhill Group LLC, when he assumed his current
position. As President, he guided the creation of Direct Wireless Communications
Inc. (DWCI) and oversaw all administrative functions for both DWCI and Direct
Wireless Corporation (DWC). Mr. Braswell served as President of DWC since
December 1999 and a member of its Board of Directors since January 1999. Prior
to holding these positions, Mr. Braswell was an independent businessman engaged
in business evaluations, real estate development, and home construction while
running a working ranch operation. His administrative experience comes from
18
years experience in the common carrier freight business, working for Central
Freight Lines, Inc. from 1974-1992. Mr. Braswell graduated from the University
of Houston in 1983 with a Bachelor of Business Administration in Organizational
Behavior Management.
Hong
Zhang, Ph.D. is
our Senior
Vice President, Computational Medicine. As visiting faculty at Johns Hopkins
University, Dr. Zhang lectured at the Center for Biomarker Discovery on
Bioinformatics: Peak Detection Methods for Mass Spectral Data. Currently a
Yamacraw Associate Professor at Armstrong Atlantic University, Dr. Zhang was
the
Vice President and CIO for a neural network and computer assisted medical
diagnostic systems company that employs neural network and
mathematical/statistical preprocessing techniques. In this position, Dr. Zhang
was involved in digital image processing and pattern recognition for medical
image processing as well as software design and programming for support vector
machine applications. Dr. Zhang was a professor in the Department of
Mathematical Sciences at Purdue University from 1989 to 1996. He has held
numerous academic positions, including Adjunct Associate Professor, Associate
Professor with Tenure, and Assistant Professor. He was a visiting Associate
Professor in 1995 in the Department of Biometry at the Medical University of
South Carolina.
Throughout
his academic career, Dr. Zhang has consulted on many software and analytical
development projects for Union Switch and Signal, Inc., General Electric
Company, and the Department of Pharmacology at the University of Pittsburgh.
Dr.
Zhang has published numerous articles on the use of neural networks in the
detection of cancers. He has been published in more than twenty medical and
technical journals. Dr. Zhang received a Ph.D., Mathematics at the University
of
Pittsburgh, 1989, M.A., Mathematics, University of Pittsburgh, 1986, M.S.E.E.,
Electrical Engineering, University of Pittsburgh, 1984, B.S., Computer Science,
Fudan University, 1982. Dr. Zhang’s numerous awards and honors include: National
Cancer Institute SBIR Grant, 1999, 2000; Purdue Research Foundation Summer
Faculty Grant, 1993; IPFW Summer Research Grant, 1992; Andrew Mellon Fellowship,
1986-1987; Andrew Mellon Fellowship, 1985-1986; First Place, Fudan University
Mathematics Competition, 1979.
William
F. Quirk, Jr. is
a
member of the Board of Directors and has been a director since October 25,
2005.
Mr. Quirk is the first outside director to join our board, succeeding Dr. David
Cooper, the Company’s former president and chief medical officer who recently
resigned his positions to pursue other interests. Mr. Quirk is a private
investor who purchased a significant equity stake in the company in its
successful private placement in July 2005. Prior
to his retirement in 1996, he held a variety of senior executive positions
in
finance and management including: Fidelity Management & Research in the
mutual fund industry; the investment banking firm Peterson, Diehl, Quirk &
Company; leveraged buyout firm Kelso & Company; and auto parts supplier
Inline Brake Manufacturing. Mr. Quirk earned his B.S. from the U.S. Naval
Academy and an MBA from the Harvard Business School.
William
M. Goldstein is
a member of the Board of Directors and has been a director since January 28,
2006. Mr. Goldstein is currently a partner with
Philadelphia-based Drinker Biddle & Reath LLP. He succeeded Robert Braswell
IV, who resigned his Board seat, but remains a senior executive with the
Company. Since
1982, Mr. Goldstein has been a senior partner with Drinker Biddle & Reath
LLP and has served the firm as a managing partner, chairman of the firm’s
managing partners, and the chair of the Tax Practice Group. In the mid-70’s, Mr.
Goldstein served as Deputy Assistant Secretary for Tax Policy at the U.S.
Treasury Department where he worked directly with Secretary William E. Simon
in
determining the Treasury’s position on various tax and economic issues. He was
also a finalist candidate for Commissioner of the Internal Revenue Service.
Mr.
Goldstein earned his A.B. from Princeton University and his J.D. from Harvard
Law School.
The
directors named above will serve until the next annual meeting of our
stockholders. Absent an employment agreement, officers hold their positions
at
the pleasure of the Board of Directors.
Audit
Committee
We
do not
have a separately designated standing audit committee. The entire board of
directors is acting as our audit committee, and no individual on our Board
of
Directors possesses all of the attributes of an “audit committee
expert.” In
forming our Board of Directors, we sought out individuals who
would
be able to guide our operations based on their business experience, both
past
and present, or their education. Responsibility for our operations
is centralized
within management, which is comprised of five people.
The
Board
of Directors does not have a policy with regard to the consideration of
candidates to the Board recommended by stockholders. The Board has made no
determination as to whether or not such a policy should be adopted. The Board
of
Directors will consider candidates recommended by stockholders. To be considered
for
nomination by the Board of Directors at the next annual meeting of stockholders,
Chairman of the Board must receive stockholder recommendations at least 120
calendar days before the anniversary date of the Company’s proxy statement for
the previous year’s annual meeting. To recommend a candidate, a stockholder
should send the candidate’s name, age, credentials (including principal
occupation and employment), contact information and the candidate’s consent to
be considered to the Chairman of the Board in care of the Company at its
principal executive office address. The stockholder should also provide the
stockholder’s contact information, describe the stockholder’s relationship with
the candidate, and include a statement as to the number of Common Shares owned
by the stockholder and the length of time such Common Shares have been owned.
Code
of Ethics
The
Company has adopted a Code of Ethics applicable to its Chief Executive Officer
and Executive Vice President. This Code of Ethics is posted on our website
at
www.HealthDiscoveryCorp.com. These codes are also available without charge
upon
request directed to Investor Relations, Health Discovery Corporation, 5501
½
Abercorn Street, Savannah, GA 31405. The Company intends to disclose amendments
or waivers of the Code of Ethics required to be disclosed by posting such
information on its website.
ITEM
10. EXECUTIVE COMPENSATION.
Summary
Compensation Table
The
following table sets forth various elements of compensation for our Named
Executive Officers for each of the last three calendar years:
Name
and Principal Position
|
|
Year
|
|
Salary
($)
|
|
Option
Awards ($)
|
|
All
Other Compensation
($)
|
|
Total
|
|
Stephen
D. Barnhill, M.D.
|
|
|
2006
|
|
$
|
125,000
|
|
|
__
|
|
$
|
6,000
|
|
$
|
131,000
|
|
Chief
Executive Officer
|
|
|
2005
|
|
$
|
300,000
|
|
|
__
|
|
|
__
|
|
$
|
300,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Daniel
R. Furth
|
|
|
2006
|
|
$
|
71,000
|
|
|
__
|
|
$
|
5,069
|
(1)
|
$
|
76,069
|
|
Executive
Vice President
|
|
|
2005
|
|
$
|
22,500
|
|
$
|
278,027
|
|
|
__
|
|
$
|
300,527
|
|
(1) |
health
insurance premiums
|
Outstanding
Equity Awards at Fiscal Year-end
|
|
Option
Awards
|
|
Name
|
|
Number
of Securities
Underlying
Unexercised
Options
(#)
Exercisable
|
|
Number
of Securities
Underlying
Unexercised
Options
(#)
Unexercisable
|
|
Option
Exercise
Price
|
|
Option
Expiration
Date
|
|
Daniel
R. Furth
|
|
|
500,000
|
|
|
1,000,000
|
|
$0.10
|
|
|
December
5, 2015
|
|
Director
Compensation
Outside
directors are paid $1.00 each year.
Name
|
Fees
Earned
or
Paid
in Cash
($)
|
Total
($)
|
Stephen
D. Barnhill, M.D.
|
$0.00
|
$0.00
|
William
F. Quirk, Jr.
|
$1.00
|
$1.00
|
William
M. Goldstein
|
$1.00
|
$1.00
|
Employment
Agreements
We
entered into a five-year employment agreement with Dr. Stephen Barnhill on
September 15, 2003, regarding Dr. Barnhill’s employment as President and Medical
Director. The agreement will automatically renew for successive one-year terms
unless either party gives notice to the other party of its intent not to renew
within a thirty-day period prior to the end of the then current term. Under
the
terms of the agreement, Dr. Barnhill receives an initial base salary of $25,000
per month. Dr. Barnhill is eligible to be reimbursed monthly for reasonable
and
necessary business expenses, to participate in an Incentive Stock Option Plan
(as defined in the agreement) and for other benefits maintained by us. Dr.
Barnhill will be entitled to 10 paid vacation days during the calendar year.
Dr.
Barnhill’s employment may be terminated without prior written notice for cause,
in which case we will make a lump sum payment equal to the sum of (i) accrued
unpaid wages, (ii) unreimbursed expenses properly incurred prior to the date
of
termination and (iii) the value of all accrued unpaid vacation pay, less any
amounts he owes to us. If Dr. Barnhill terminates the Barnhill Agreement, then
he will receive the same benefits as if he was terminated for cause. If Dr.
Barnhill terminates the Barnhill Agreement, other than for cause, then we will
give two (2) weeks notice of termination, or in our sole discretion, two (2)
weeks wages in lieu of notice. The agreement also generally provides that Dr.
Barnhill will keep confidential information confidential and that he will not
compete with us in our business nor solicit our customers or employees for
a
period of 12 months following termination of employment. Effective December
30,
2005, we entered into an amendment to the employment agreement with Dr.
Barnhill, under which Dr. Barnhill agreed to defer 60% of his gross annual
pay
until January 1, 2008, representing total deferred payments of $360,000. The
agreement with Dr. Barnhill was further amended on September 1, 2006, whereby
Dr. Barnhill’s salary was changed to $10,000 per month, and he agreed to waive
the receipt of his deferred compensation for a one-time payment of $6,000 plus
the reimbursement for any negative tax consequences related to the
amendment.
We
entered into an employment agreement with Mr. Daniel R. Furth effective November
18, 2005 regarding Mr. Furth’s employment as Executive Vice President. The term
of the employment is for three years, with compensation of $60,000, which is
to
be reviewed after the first year for potential increase. Effective as of
September 1, 2006, Mr. Furth’s annual salary was increased to $84,000. Mr. Furth
will also receive options to acquire 1,500,000 shares of our common stock.
Mr.
Furth is eligible to be reimbursed monthly for reasonable and necessary business
expenses and for other benefits maintained by us. If the Company terminates
the
employment agreement for cause or if the agreement is terminated by Mr. Furth
without cause, Mr. Furth will be entitled to receive his salary only through
the
date such termination is effective. If Mr. Furth terminates the employment
agreement for cause or, if the employment agreement is terminated without cause,
he will be entitled to receive his salary for a period of three months from
the
date such termination is effective. The agreement also generally provides that
Mr. Furth will keep confidential information confidential and that he will
not
compete with us in our business nor solicit our customers or employees for
a
period of 12 months following termination of employment.
We
entered into an employment agreement with Mr. Robert Braswell IV effective
as of
January 1, 2006 regarding Mr. Braswell’s employment as Senior Vice President.
Pursuant to his employment agreement, Mr. Braswell will be employed as Senior
Vice President for a term of three years at an annual salary of $70,000, fifty
percent of which will be deferred until January 1, 2008. In addition, we awarded
Mr. Braswell options to acquire 1,500,000 shares of our common stock at an
exercise price of $0.11 (which was the closing price of the common stock on
the
preceding day) that vested upon issuance, and options to acquire 500,000 shares
of our common stock at an exercise price of $0.11, which vest semi-annually
over
the next two years. Mr. Braswell’s compensation and all other rights under Mr.
Braswell’s employment agreement will terminate (a) upon the death of Mr.
Braswell, (b) upon the disability of Mr. Braswell, (c) for cause, or (d) without
cause upon ninety days prior notice from either us or Mr. Braswell. If we or
Mr.
Braswell terminates his agreement for cause, Mr. Braswell will be entitled
to
receive his salary for a period of three months from the date such termination
is effective, and all outstanding options to acquire shares of our common stock
shall vest immediately. If the employment agreement is terminated as a result
of
Mr. Braswell’s disability, we will pay Mr. Braswell’s salary through the date on
which such termination is effective and all outstanding options to acquire
shares of our common stock shall vest immediately. If the employment agreement
is terminated because of Mr. Braswell’s death, Mr. Braswell’s estate will be
entitled to receive his salary though the date on which such termination is
effective. If the employment agreement is terminated by us without cause, Mr.
Braswell will be entitled to receive, in a lump sum payment within 15 days
of
termination, his salary for the entire remaining term of the employment
agreement. In addition, all outstanding options to acquire shares of our common
stock shall vest immediately, and Mr. Braswell will be awarded options to
purchase additional 300,000 shares of our common stock with an exercise price
of
$0.11, fully vested. If the employment agreement is terminated by Mr. Braswell
without cause, Mr. Braswell will be entitled to receive his salary only through
the date of such termination is effective, and all outstanding options to
acquire shares of our common stock shall vest immediately. On September 1,
2006,
we and Mr. Braswell entered into an amendment of Mr. Braswell’s employment
agreement. Pursuant to the amendment, Mr. Braswell agreed to a decrease in
his
annual salary to $35,000 and to waive all deferred compensation for a one-time
payment of $1,460.
We
entered into an employment agreement with Dr. David Cooper on November 1, 2003
regarding Dr. Cooper’s employment as President and Chief Medical Officer. The
employment commenced at signing and terminated on October 24, 2005, when Dr.
Cooper resigned. As compensation for his employment, Dr. Cooper was issued
non-qualified stock options to acquire 3,000,000 shares of our common stock,
of
which options to acquired 600,000 shares of our common stock vested immediately
while options to acquire the remaining 2,400,000 shares vested over time or
upon
certain accomplishments of Dr. Cooper. At the time of Dr. Cooper’s resignation,
options to acquire 400,000 shares had vested and the remaining options
terminated. Upon termination of his employment, Dr. Cooper agreed to observe
all
post-employment covenants set forth in his agreement. Dr. Cooper’s agreement
also generally provided that he will not compete with us in our business nor
solicit our customers or employees for a period of one year following
termination of his employment.
Scientific
Advisory Board
The
Company continues to perform under an oral agreement with three members of
its
Scientific Advisory Board wherein they are entitled to receive 100,000 shares
each of the Company’s common stock upon satisfactory completion of one year of
service. The arrangement with the Scientific Advisory Board members can be
terminated at any time by either party.
ITEM
11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.
The
following table sets forth information concerning the beneficial ownership
of
our common stock as of March 27, 2007 by (i) each of our directors, (ii) each
of
our executive officers, (iii) each person who is known to us to be the
beneficial owner of more than five percent of our common stock, and (iv) all
of
our executive officers and directors as a group. At March 27, 2007, there were
116,493,384 shares outstanding.
Title
of Class
|
|
Name
and Address of Beneficial Owner
|
|
Amount
and
Nature
of
Beneficial
Owner
|
|
Percent
of
Class
(1)
|
Common
Stock
|
|
Dr.
Stephen D. Barnhill
Chairman
of the Board, Chief Executive Officer
and
Chief Medical Officer, Director
5501
½ Abercorn Street
Savannah,
GA 31405
|
|
27,380,722
(2)
|
|
20.38%
|
|
|
|
|
|
|
|
Common
Stock
|
|
Daniel
R. Furth
Executive
Vice President
5501
½ Abercorn Street
Savannah,
GA 31405
|
|
750,000
(3)
|
|
0.56%
|
|
|
|
|
|
|
|
Common
Stock
|
|
William
Quirk
Director
5501
½ Abercorn Street
Savannah,
GA 31405
|
|
21,778,335
(4)
|
|
16.21%
|
|
|
|
|
|
|
|
Common
Stock
|
|
William
Goldstein
Director
One
Logan Square
18th
and Cherry Streets
Philadelphia,
PA 19103-6996
|
|
1,333,335
(5)
|
|
0.99%
|
|
|
|
|
|
|
|
Common
Stock
|
|
All
executive officers and directors as a group
(four
persons)
|
|
51,242,392
|
|
40.58%
|
(1)
|
The
percentage of our common stock beneficially owned was calculated
based on
116,493,384 shares of common stock issued and outstanding as of March
27,
2007, plus 17,879,170 warrants and options exercisable by the executive
officers and directors group. The percentage assumes the exercise
by the
stockholder or group named in each row of all options or warrants
for the
purchase of our common stock held by such stockholder or group and
exercisable within 60 days as of March 29,
2006.
|
(2)
|
These
shares are held by Barnhill Group LLC, which is wholly owned by Dr.
Barnhill.
|
(3)
|
Consists
of vested options.
|
(4)
|
Includes
16,108,335 vested warrants.
|
(5)
|
Includes
1,020,835 vested warrants.
|
ITEM
12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
On
May 6, 2005, we acquired the remaining 7% of the SVM Patent Portfolio from
unaffiliated third parties for an aggregate cash payment of approximately
$270,863, the issuance of the promissory notes totaling $37,872 and convertible
notes totaling $147,401, which were converted by the holders immediately upon
issuance in exchange for 867,065 shares of our common stock. Approximately
$175,000 of the purchase price was used by the sellers to repay an outstanding
obligation of a limited liability company of which our chief executive officer
was a member.
We
currently sub-lease our principle executive office space from a company owned
by
the wife of Dr. Stephen D. Barnhill. Our rent on this 1,554 sq. ft. office
is
$1,036.00 per month and is rented on a month-to-month basis.
On
September 1, 2006, we issued a note (the “Promissory Note”) to William F. Quirk,
Jr., a director of the Company, for $1,000,000. The Promissory Note contains
a
5% annual interest rate and is due on September 1, 2008. The proceeds of the
Promissory Note will be used for general working capital purposes. The
Promissory Note is completely repayable by the Company at any time without
any
related fees or penalties. In connection with the issuance of the Promissory
Note, Mr. Quirk was granted warrants to purchase 10,000,000 shares of Company
common stock at $0.16 per share. The warrants vest over the next ten months
based on the length of time the Promissory Note is outstanding, as
follows:
Total
Vested
|
|
Number
of Days to Vest
|
1
Million
|
|
Immediately
|
2
Million
|
|
46
days
|
3
Million
|
|
91
days
|
4
Million
|
|
121
days
|
5
Million
|
|
151
days
|
6
Million
|
|
181
days
|
7
Million
|
|
211
days
|
8
Million
|
|
241
days
|
9
Million
|
|
271
days
|
10
Million
|
|
300
days
|
ITEM
13. 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
10-KSB:
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 Form10-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, 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.
*
|
10.3(a) |
Amendment
to Employment Agreement with Stephen Barnhill. Registrant incorporates
by
reference Exhibit 99.3 to Form 8-K, filed September 1,
2006.
|
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 Daniel 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.
|
10.13
|
Form
of Amendment to Promissory Note. Registrant incorporates by reference
Exhibit 99.1 to Form 8-K, filed January 3,
2006.
|
10.14
|
Form
of Second Amendment to Promissory Note. Registrant incorporates
by
reference Exhibit 99.4 to Form 8-K, filed September 5,
2006.
|
10.15
|
Promissory
Note issued by Registrant on September 1, 2006 in favor of William
F.
Quirk, Jr. Registrant incorporates by reference Exhibit 99.1 to
Form 8-K,
filed September 5, 2006.
|
10.16
|
Warrant
Agreement by and between Registrant and William F. Quirk, Jr.,
dated as of
September 1, 2006. Registrant incorporates by reference Exhibit
99.2 to
Form 8-K, filed September 5, 2006.
|
16.1
|
Letter
from Porter Keadle Moore LLP regarding change in certifying accountant.
Registrant incorporates by reference3 Exhibit 16.1 to Form 8-K,
filed
September 27, 2006.
|
31.1
|
Rule
13a-14(a)/15(d)-14(a) Certifications of Chief Executive
Officer.
|
31.2
|
Rule
13a-14(a)/15(d)-14(a) Certifications of Principal Financial
Officer.
|
32.1
|
Section
1350 Certification of Chief Executive
Officer.
|
32.2
|
Section
1350 Certification of Principal Financial
Officer.
|
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The
Company changed its independent auditors from Porter Keadle Moore LLP to Hancock
Askew & Co., LLP during 2006. The following table sets forth the fees billed
by Hancock Askew & Co. LLP for 2006, along with fees billed by Porter Keadle
Moore LLP in 2005 and 2006.
|
|
2006
|
|
2005
|
|
Audit
Fees
|
|
$
|
56,347
|
|
$
|
103,737
|
|
Audit-Related
Fees
|
|
|
—
|
|
|
—
|
|
Tax
Fees
|
|
|
—
|
|
|
—
|
|
Sub-Total
|
|
$
|
56,347
|
|
$
|
103,737
|
|
All
Other Fees
|
|
|
—
|
|
|
—
|
|
Total
Fees
|
|
$
|
56,347
|
|
$
|
103,737
|
|
Audit
Fees.
This category includes aggregate fees billed for professional services rendered
by for the audit of the Company’s annual financial statements for the year ended
December 31, 2006 and 2005, review for the annual report on Form 10-KSB and
for
the limited reviews of quarterly condensed financial statements (Forms 10-QSB)
included in periodic reports filed with the SEC during 2006 and 2005, including
out of pocket expenses. Porter Keadle Moore LLP billed $17,690 for 2006. Hancock
Askew & Co. LLP has billed $38,657 for 2006.
Audit-Related
Fees.
This category includes fees billed for professional services associated with
consultation concerning financial accounting and reporting standards. No such
fees were billed in 2005 or 2006.
Tax
Fees.
This category includes the aggregate fees billed or to be billed for tax
services for the years ended December 31, 2005 and 2006. No such fees were
billed in 2005 or 2006.
All
Other Fees.
This category includes the aggregate fees billed for all other services,
exclusive of the fees disclosed above, rendered to the Company. No such services
were provided.
The
services provided by the independent auditors were pre-approved by the Board
of
Directors of the company to the extent required under applicable law. The Board
of Directors of the company requires pre-approval of all audit and allowable
non-audit services.
SIGNATURES
In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
|
|
|
|
HEALTH
DISCOVERY
CORPORATION |
|
|
|
|
By: |
/s/ Stephen
D. Barnhill, M.D., Chief Executive Officer |
|
|
|
Date: |
March 30, 2007 |
In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on
the
dates indicated.
Name
|
|
Title
|
|
Date
|
|
|
|
|
|
/s/
Stephen D. Barnhill M.D.
Stephen
D. Barnhill M.D.
|
|
Chief
Executive Officer, Chairman
|
|
March
30, 2007
|
|
|
|
|
|
/s/
Daniel R. Furth
Daniel
R. Furth
|
|
Principal
Financial Officer
Executive
Vice President
|
|
March
30, 2007
|
|
|
|
|
|
/s/
William F. Quirk, Jr.
William
F. Quirk, Jr.
|
|
Director
|
|
March
30, 2007
|
|
|
|
|
|
/s/
William M. Goldstein
William
M. Goldstein
|
|
Director
|
|
March
30, 2007
|
Hancock
Askew & Co LLP
100
Riverview Drive
Savannah,
GA 31404
Report
of Independent Registered Public Accounting Firm
Board
of Directors
Health
Discovery Corporation
Savannah,
Georgia
We
have audited the accompanying balance sheet of Health Discovery Corporation
as
of December 31, 2006 and the related statements of operations, changes in
stockholders’ deficit, and cash flows for the year ended December 31, 2006.
These financial statements are the responsibility of the management of
Health Discovery Corporation. Our responsibility is to express an opinion
on these financial statements based on our audit. The consolidated financial
statements as of December 31, 2005 and for the year then ended were audited
by
other auditors whose report dated March 30, 2006 included an explanatory
paragraph regarding substantial doubt about the Company’s ability to continue as
a going concern.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audits to obtain reasonable assurance about whether
the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose
of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we expressed no such opinion.
An audit also includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management as well as
evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
In
our opinion, the financial statements referred to above present fairly, in
all
material respects, the financial position of Health Discovery Corporation
as of
December 31, 2006 and the results of its operations and its cash flows for
the
year ended December 31, 2006 in conformity with accounting principles generally
accepted in the United States of America.
As
discussed in Note 1 to Financial Statements and in accordance with guidance
provided in Statement of Financial Accounting Standards No. 123R,
Share-Based Payment, in fiscal 2006 Health Discovery Corporation changed
its
method of accounting for stock-based compensation.
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note L, the Company has
had limited revenue since inception, has incurred recurring losses from
operations, and has had to extend the maturity of debt instruments. These
factors, among others, raise substantial doubt about the Company’s ability to
continue as a going concern. Management’s plans in regard to these matters
are also described in Note L. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/
Hancock Askew & Co., LLP
Savannah,
Georgia
March
20, 2007
Porter
Keadle Moore, LLP
Report
of Independent Registered Public Accounting Firm
To
the Board of Directors and Stockholders
Health
Discovery Corporation
We
have audited the accompanying balance sheet of Health Discovery Corporation
as
of December 31, 2005, and the related statements of operations, changes in
stockholders’ equity, and the cash flows for the year then ended. These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based
on
our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In
our opinion, the 2005 financial statements referred to above present fairly,
in
all material respects, the financial position of the Company as of December
31,
2005 and the results of its operations and its cash flows for the year then
ended in conformity with accounting principles generally accepted in the
United
States of America.
The
accompanying financial statements have been prepared assuming the Company
will
continue as a going concern. The Company has suffered recurring losses from
operations and negative working capital that raise substantial doubt about
its
ability to continue as a going concern. Management’s plans in regard to these
matters are described in Note L. The financial statements do not include
any
adjustments relating to the recoverability of reported asset amounts or the
amount of liabilities that might result from the outcome of this uncertainty.
/s/
Porter Keadle
Moore, LLP
Atlanta,
Georgia
March
30,
2006
HEALTH
DISCOVERY CORPORATION
Balance
Sheets
December
31, 2006 and 2005
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
2005
|
|
Current
Assets
|
|
|
|
|
|
Cash
|
|
$
|
674,366
|
|
|
719,167
|
|
Accounts
Receivable
|
|
|
20,000
|
|
|
—
|
|
Prepaid
Expense and Other Current Assets
|
|
|
55,188
|
|
|
17,708
|
|
Total
Current Assets
|
|
|
749,554
|
|
|
736,875
|
|
Equipment,
Less Accumulated Depreciation of $14,257 and $6,660
|
|
|
14,743
|
|
|
13,053
|
|
Other
Assets
|
|
|
|
|
|
|
|
Patents,
Less Accumulated Amortization of $680,255 and $417,535
|
|
|
3,305,540
|
|
|
3,568,259
|
|
Total
Assets
|
|
$
|
4,069,837
|
|
|
4,318,187
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
Liabilities
|
|
|
|
|
|
|
|
Accounts
Payable - Trade
|
|
$
|
237,928
|
|
|
267,972
|
|
Accrued
Liabilities
|
|
|
150,520
|
|
|
63,319
|
|
Deferred
Revenue
|
|
|
101,111
|
|
|
—
|
|
Current
Portion of Long-Term Debt
|
|
|
—
|
|
|
26,780
|
|
Total
Current Liabilities
|
|
|
489,559
|
|
|
358,071
|
|
Accrued
Interest Payable
|
|
|
140,875
|
|
|
—
|
|
Convertible
Notes Payable
|
|
|
665,643
|
|
|
665,643
|
|
Long-Term
Debt, Less Current Portion
|
|
|
321,911
|
|
|
321,911
|
|
Notes
Payable, net of unamortized discount of $461,667
|
|
|
538,333
|
|
|
—
|
|
Total
Liabilities
|
|
|
2,156,321
|
|
|
1,345,625
|
|
Commitments
and Contingencies
|
|
|
|
|
|
|
|
Stockholders’
Equity
|
|
|
|
|
|
|
|
Common
Stock, No Par Value, 200,000,000 Shares Authorized
|
|
|
|
|
|
|
|
Issued
and Outstanding 116,393,384 and 114,363,384 Shares,
Respectively
|
|
|
11,059,674
|
|
|
9,522,961
|
|
Accumulated
Deficit
|
|
|
(9,146,158
|
)
|
|
(6,550,399
|
)
|
Total
Stockholders’ Equity
|
|
|
1,913,516
|
|
|
2,972,562
|
|
Total
Liabilities and Stockholders’ Equity
|
|
$
|
4,069,837
|
|
|
4,318,187
|
|
See
accompanying notes to financial statements.
HEALTH
DISCOVERY CORPORATION
Statements
of Operations
For
the
Years Ended December 31, 2006 and 2005
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
Licensing
and Development
|
|
$
|
203,889
|
|
|
135,000
|
|
Patent
Sales
|
|
|
—
|
|
|
89,000
|
|
Total
Revenues
|
|
|
203,889
|
|
|
224,000
|
|
|
|
|
|
|
|
|
|
Cost
of Sales
|
|
|
|
|
|
|
|
Licensing
and Development
|
|
|
28,671
|
|
|
30,573
|
|
Patent
Sales
|
|
|
—
|
|
|
2,963
|
|
Total
Cost of Sales
|
|
|
28,671
|
|
|
33,536
|
|
Gross
Profit
|
|
|
175,218
|
|
|
190,464
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
Amortization
|
|
|
262,719
|
|
|
251,097
|
|
Professional
and Consulting Fees
|
|
|
1,123,498
|
|
|
1,567,500
|
|
Compensation
|
|
|
770,000
|
|
|
822,261
|
|
Other
General and Administrative Expenses
|
|
|
542,710
|
|
|
656,214
|
|
Total
Expenses
|
|
|
2,698,927
|
|
|
3,297,072
|
|
Net
Loss from Operations
|
|
|
(2,523,709
|
)
|
|
(3,106,608
|
)
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
Interest
Income
|
|
|
21,008
|
|
|
2,998
|
|
Gains
on Restructuring of Accounts Payable
|
|
|
97,864
|
|
|
—
|
|
Interest
Expense
|
|
|
(190,922
|
)
|
|
(55,406
|
)
|
Total
Other Income (Expense)
|
|
|
(72,050
|
)
|
|
(52,408
|
)
|
Net
Loss
|
|
$
|
(2,595,759
|
)
|
|
(3,159,016
|
)
|
|
|
|
|
|
|
|
|
Weighted
Average Outstanding Shares
|
|
|
115,895,692
|
|
|
103,566,777
|
|
|
|
|
|
|
|
|
|
Loss
Per Share
|
|
$
|
(.02
|
)
|
|
(.03
|
)
|
See
accompanying notes to financial statements.
HEALTH
DISCOVERY CORPORATION
Statements
of Changes in Stockholders’ Equity
For
the
Year Ended December 31, 2006 and 2005
|
|
Common
Stock
|
|
|
|
|
|
|
|
Issued
and Outstanding
|
|
Paid
for but Not Issued
|
|
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
|
Accumulated
Deficit
|
|
Total
Stockholders’
Equity
|
|
Balance
- January 1, 2005
|
|
|
78,767,464
|
|
$
|
3,788,442
|
|
|
5,434,375
|
|
$
|
695,761
|
|
$
|
(3,391,383
|
)
|
$
|
1,092,820
|
|
Stock
Issued for Cash
|
|
|
25,268,750
|
|
|
3,842,375
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
3,842,375
|
|
Issuance
of Shares Previously Paid-for but not Issued
|
|
|
5,434,375
|
|
|
695,761
|
|
|
(5,434,375
|
)
|
|
(695,761
|
)
|
|
—
|
|
|
—
|
|
Stock
Issued for Services
|
|
|
2,039,453
|
|
|
381,876
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
381,876
|
|
Stock
Issued in Settlement of Liability
|
|
|
308,133
|
|
|
78,746
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
78,746
|
|
Shares
Issued for Debt Conversion
|
|
|
3,585,741
|
|
|
609,576
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
609,576
|
|
Stock
Compensation Expense for Compensatory Options and Warrants
|
|
|
—
|
|
|
426,185
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
426,185
|
|
Shares
Issued for Delinquency Penalty
|
|
|
540,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Cancellation
of Common Stock
|
|
|
(1,580,532
|
)
|
|
(300,000
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(300,000
|
)
|
Net
Loss
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(3,159,016
|
)
|
|
(3,159,016
|
)
|
Balance
- December 31, 2005
|
|
|
114,363,384
|
|
$
|
9,522,961
|
|
|
—
|
|
$
|
—
|
|
$
|
(6,550,399
|
)
|
$
|
2,972,562
|
|
Stock
Issued for Cash
|
|
|
1,000,000
|
|
|
100,000
|
|
|
|
|
|
|
|
|
|
|
|
100,000
|
|
Stock
Issued upon Exercise of Options and Warrants
|
|
|
1,030,000
|
|
|
26,400
|
|
|
|
|
|
|
|
|
—
|
|
|
26,400
|
|
Warrants
Issued in Connection with Debt Agreement
|
|
|
—
|
|
|
554,000
|
|
|
|
|
|
|
|
|
—
|
|
|
554,000
|
|
Warrants
Issued for Settlement of Liability
|
|
|
—
|
|
|
72,326
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
72,326
|
|
Warrants
Issued for Services
|
|
|
—
|
|
|
504,091
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
504,091
|
|
Stock
Compensation Expense for Compensatory Options and Warrants
|
|
|
—
|
|
|
279,896
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
279,896
|
|
Net
Loss
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(2,595,759
|
)
|
|
(2,595,759
|
)
|
Balance
- December 31, 2006
|
|
|
116,393,384
|
|
$
|
11,059,674
|
|
|
—
|
|
$
|
—
|
|
$
|
(9,146,158
|
)
|
$
|
1,913,516
|
|
See
accompanying notes to financial statements.
HEALTH
DISCOVERY CORPORATION
Statements
of Cash Flows
For
the
Years Ended December 31, 2006 and 2005
|
|
2006
|
|
2005
|
|
Cash
Flows From Operating Activities:
|
|
|
|
|
|
Net
Loss
|
|
$
|
(2,595,759
|
)
|
$
|
(3,159,016
|
)
|
Adjustments
to Reconcile Net Loss to Net Cash
|
|
|
|
|
|
|
|
Used
by Operating Activities:
|
|
|
|
|
|
|
|
Non-cash
Compensation
|
|
|
279,896
|
|
|
426,185
|
|
Cancellation
of Common Stock Compensation
|
|
|
—
|
|
|
(300,000
|
)
|
Accretion
of Debt Discount
|
|
|
92,333
|
|
|
—
|
|
Increase
in Accounts Receivable
|
|
|
(20,000
|
)
|
|
—
|
|
Services
Exchanged for Common Stock or Warrants
|
|
|
504,091
|
|
|
381,876
|
|
Increase
in Deferred Revenue
|
|
|
101,111
|
|
|
—
|
|
Gain
on Restructuring Accounts Payable
|
|
|
(97,864
|
)
|
|
—
|
|
Depreciation
and Amortization
|
|
|
270,316
|
|
|
256,038
|
|
Increase
in Prepaid Expense
|
|
|
(37,480
|
)
|
|
(17,708
|
)
|
Increase
in Accounts Payable - Trade
|
|
|
140,145
|
|
|
33,287
|
|
Increase
in Accrued Liabilities
|
|
|
228,077
|
|
|
(41,732
|
)
|
Net
Cash Used by Operating Activities
|
|
|
(1,135,134
|
)
|
|
(2,421,070
|
)
|
|
|
|
|
|
|
|
|
Cash
Flows From Investing Activities:
|
|
|
|
|
|
|
|
Purchase
of Equipment
|
|
|
(9,287
|
)
|
|
(11,623
|
)
|
Amounts
Paid to Acquire Patents
|
|
|
—
|
|
|
(293,744
|
)
|
Net
Cash Used by Investing Activities
|
|
|
(9,287
|
)
|
|
(305,367
|
)
|
|
|
|
|
|
|
|
|
Cash
Flows From Financing Activities:
|
|
|
|
|
|
|
|
Repayments
of Notes Payable
|
|
|
(26,780
|
)
|
|
(560,248
|
)
|
Proceeds
from Sales of Common Stock, Net
|
|
|
126,400
|
|
|
3,842,375
|
|
Proceeds
from Borrowing
|
|
|
1,000,000
|
|
|
—
|
|
Net
Cash Provided by Financing Activities
|
|
|
1,099,620
|
|
|
3,282,127
|
|
|
|
|
|
|
|
|
|
Net
Increase (Decrease) in Cash
|
|
|
(44,801
|
)
|
|
555,690
|
|
|
|
|
|
|
|
|
|
Cash,
at Beginning of Period
|
|
|
719,167
|
|
|
163,477
|
|
Cash,
at End of Period
|
|
$
|
674,366
|
|
$
|
719,167
|
|
|
|
|
|
|
|
|
|
Non-Cash
Investing and Financing Transactions:
|
|
|
|
|
|
|
|
Debt
Discount in exchange for Warrants
|
|
$
|
554,000
|
|
$
|
0
|
|
Patents
Purchased Using Debt
|
|
$
|
—
|
|
$
|
185,273
|
|
Stock
Issued in Exchange for Convertible Notes
|
|
$
|
—
|
|
$
|
609,576
|
|
Issuance
of Shares Previously Paid For
|
|
$
|
—
|
|
$
|
695,761
|
|
Stock
Issued in Settlement of Liability
|
|
$
|
—
|
|
$
|
78,746
|
|
|
|
|
|
|
|
|
|
Supplemental
Disclosures of cash Flow Information:
|
|
|
|
|
|
|
|
Cash
Paid for Interest
|
|
$
|
3,242
|
|
$
|
20,024
|
|
See
accompanying notes to financial statements.
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements
Note
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE
OF OPERATIONS
Health
Discovery Corporation (the “Company”) is a biotechnology-oriented company that
has acquired 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.
USE
OF ESTIMATES
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management
to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date
of the
financial statements and the reported amounts of revenues and expenses
during
the period. Accordingly, actual results could differ from those estimates.
Significant estimates that are particularly suspectible to change in the
near-term include the valuation of non-cash consideration for services
and the
recoverability of the patents.
RECLASSIFICATIONS
Certain
amounts from 2005 have been reclassified to conform to the presentation
used in
2006.
REVENUE
RECOGNITION
Revenue
is generated through the sale or license of patented technology and processes
and from services provided through development agreements. These arrangements
are controlled by contracts that dictate responsibilities and payment terms.
The
Company recognizes revenues as they are earned over the duration of a license
agreement or upon the sale of any owned patent once all contractual obligations
have been fulfilled. Revenue is earned under development agreements in
the
period the services are performed. Deferred revenue represents the unearned
portion of payments received in advance for licensing agreements. The Company
had unearned revenue of $101,111 as of December 31, 2006 and expects to
recognize $40,000 of that in 2007 and $61,111 thereafter.
COST
OF SALES
Cost
of
sales includes the acquisition cost less accumulated amortization of patents
sold, plus internal development costs and fees directly associated with
sales
contracts.
Cost
of
sales for licensing and development revenue includes fees directly asssociated
with the contracts and salary expense allocated to cost of sales based
upon the
amount of estimated time worked on the licensing or development
contract.
PROPERTY
AND EQUIPMENT
Property
and equipment, which consists of office furniture and computer equipment
and
leasehold improvements, are stated at cost. Depreciation is calculated
using the
straight-line method over the estimated useful lives of the assets, which
range
from 3 to 10 years. Leasehold improvements are amortized using the
straight-line method over the estimated useful lives of the assets or the
term
of the lease, whichever is shorter.
PATENTS
Patents
are amortized over their remaining legal lives, that range from 15 to 20
years,
from the date they are acquired or approved. Legal costs directly associated
with the patent acquisitions and the application process for new patents
are
capitalized when incurred and are being amortized over the remaining legal
life
of the related patent. If the applied for patents are abandoned or are
not
issued, the Company will expense the capitalized costs to date in the period
of
abandonment.
The
carrying value of patents is reviewed for impairment whenever events or
changes
in circumstances indicate that the carrying amount may not be recoverable.
As of
December 31, 2006, the Company does not believe there has been any impairment
of
its intangible assets.
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
continued
INCOME
TAXES
The
Company accounts for income taxes using the asset and liability method. Deferred
tax assets and liabilities are recognized for future tax benefits and expenses
or consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income for the years in which
those temporary differences are expected to be recovered or
settled.
In
the
event the future tax consequences of differences between the financial reporting
bases and tax bases of the Company’s assets and liabilities result in deferred
tax assets, an evaluation of the probability of being able to realize the
future
benefits indicated by such assets is made. A valuation allowance is provided
for
the portion of the deferred tax asset when it is more likely than not that
some
portion or all of the deferred tax asset will not be realized. In assessing
the
realizabilty of the deferred tax assets, management considers the scheduled
reversals of deferred tax liabilities, projected future taxable income and
tax
planning strategies.
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. Under the Standard, 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 compensation for periods presented prior to the Company’s
adoption of Statement 123(R):
|
|
|
2005
|
|
|
Net
loss as reported
|
|
$
|
(3,159,016
|
)
|
|
|
|
|
|
|
|
Deduct:
Stock-based expense determined under fair value based method for
employee
stock options
|
|
|
(7,723
|
)
|
|
Proforma
Net Loss
|
|
$
|
(3,166,739
|
)
|
|
|
|
|
|
|
|
Loss
Per Share:
|
|
|
|
|
|
Basic
–
As
Reported
|
|
$
|
(.03
|
)
|
|
Basic –
Proforma
|
|
$
|
(.03
|
)
|
Stock-based
compensation expense included in the 2006 net loss consisted of $783,987
in
compensatory warrants, options, and stock for professional consulting services,
and compensation. Stock-based expense included in the net loss for 2005
consisted of $508,061 for the issuance of common stock, warrants, and
options.
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
continued
DETERMINING
FAIR VALUE UNDER SFAS 123R:
Valuation
and Amortization Method –
The Company estimates the fair value of stock options and warrants granted
using
the Black-Scholes option-pricing formula and a single option award approach.
This fair value is then amortized on a straight-line basis over the requisite
service periods of the awards, which is generally the vesting
period.
Expected
Term –
The expected term of the award represents the period that the Company’s
stock-based awards are expected to be outstanding and was determined based
on
historical experience, giving consideration to the contractual terms of the
stock-based awards, vesting schedules and expectations of future employee
behavior. Given the lack of historical data and start-up nature of the company’s
operations, the expected term is estimated as the contractual term.
Expected
Volatility –Volatility
is a measure of the amounts by which a financial variable such as stock price
has fluctuated (historical volatility) or is expected to fluctuate (expected
volatility) during a period. The Company uses the historical volatility to
estimate expected volatility.
Risk-Free
Interest Rate –
The Company bases the risk-free interest rate used in the Black-Scholes
valuation method on the implied yield currently available on U.S. Treasury
zero-coupon issues with a remaining term equivalent to the expected term
of a
stock award.
Estimated
Forfeitures –
When estimating forfeitures, the Company considers voluntary termination
behavior as well as analysis of actual option forfeitures.
Estimated
Dividend yield –
The
Company has not paid any dividends and has no current plans to do so therefore
dividend rate is assumed to be zero.
The
adoption of SFAS 123R also requires additional accounting related to income
taxes. Due to the full valuation allowance provided on its net deferred tax
assets, the Company has not recorded any tax benefit attributable to stock-based
compensation expense.
FAIR
VALUE OF FINANCIAL INSTRUMENTS
The
Company’s financial instruments consist of cash, accounts payable, accrued
expenses and long-term debt. Pursuant to SFAS No. 107, Disclosures
about Fair Value of Financial Instruments,
the
Company is required to estimate the fair value of all financial instruments
at
the balance sheet date. The Company considers the carrying values of its
financial instruments in the financial statements to approximate their fair
value due to the short term nature of such items.
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 cause an anti-dilutive result and therefore is not
presented. Potentially dilutive shares at December 31, 2006 and 2005 include
the
following:
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Stock
options
|
|
|
3,500,000
|
|
|
2,500,000
|
|
Warrants
|
|
|
68,796,250
|
|
|
50,931,250
|
|
Convertible
notes
|
|
|
3,915,547
|
|
|
3,915,547
|
|
|
|
|
76,211,797
|
|
|
57,346,797
|
|
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
continued
CONCENTRATIONS
OF CREDIT RISK
The
Company maintains its cash balances at financial institutions that are insured
by the Federal Deposit Insurance Corporation (“FDIC”) up to $100,000. From
time-to-time, the Company’s cash balances exceed the amount insured by the FDIC.
Management believes the risk of loss of cash balances in excess of the insured
limit to be low.
RECENT
ACCOUNTING PRONOUNCEMENTS
In
December 2004, the FASB issued SFAS No. 153, Exchanges
of Non-Monetary Assets,
an
amendment of APB Opinion 29, Accounting
for Non-Monetary Transactions.
The
amendments made by SFAS No. 153 are based on the principle that exchanges
of
non-monetary assets should be measured based on the fair value of the assets
exchanged. Further, the amendments eliminate the narrow exception for
non-monetary exchanges of similar productive assets and replaces it with
a
broader exception for exchanges of non-monetary assets that do not have
“commercial substance.” The Company adopted this statement on January 1, 2006.
The adoption of the statement did not have a material impact on the Company’s
financial statements.
In
May 2005, the FASB issued SFAS No. 154, Accounting
Changes and Error Corrections
(“SFAS 154”), which changes the requirements in the accounting for and reporting
of a change in accounting principle. We were required to adopt the provisions
of
SFAS 154 effective January 1, 2006. We will follow the provisions of this
statement in the event of any future accounting changes.
In
June
2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting
for Uncertainty in Income Taxes,
an
interpretation of FASB Statement No. 109. This interpretation is effective
for
fiscal years beginning after December 15, 2006. This Interpretation clarifies
the accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with FASB No. 109, Accounting
for Income Taxes.
This
Interpretation prescribes a recognition threshold and measurement attribute
for
the financial statement recognition and measurement of a tax position taken
or
expected to be taken in a tax return. This Interpretation also provides guidance
on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. FIN 48 is not expected to have a material
impact on the Company’s financial statements.
In
September 2006, FASB issued SFAS No. 157, Fair
Value Measurements.
This
statement is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. This Statement defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles (GAAP), and expands
disclosures about fair value measurements. This Statement applies under other
accounting pronouncements that require or permit fair value measurements.
Accordingly, this Statement does not require any new fair value measurements.
However, for some entities, the application of this Statement will change
current practice. This Statement is not expected to have a material impact
on
the Company’s financial statements.
Note
B - RELATED PARTY TRANSACTIONS
Payments
to the Company’s Chief Executive Officer of $91,875 were made in 2005 related to
the purchase of patents from Barnhill, LLC and Fractal Genomics,
LLC.
The
Company leases the location used as the principle executive office from a
company owned by the wife of the Company’s Chief Executive Officer. The term of
the principle executive office lease is month-to-month and the rent expense
associated with this lease is $1,036 per month. Rent expense under this lease
arrangement amounted to approximately $12,432 and $11,000 in 2006 and 2005,
respectively.
Note
C - 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 patent costs. The Company has recorded $3,305,540 and
$3,568,259 in patents and patent related costs, net of accumulated amortization,
at December 31, 2006 and 2005.
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
C - PATENTS, continued
Amortization
charged to operations for the years ended December 31, 2006 and 2005 was
$262,719 and $251,097, 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
D - ACQUISITIONS
On
August
26, 2003, the Company acquired the assets of Barnhill Group, LLC, which
consisted of patents and related rights, through the issuance of 29,825,564
common shares of the Company (then known as Direct Wireless Communications,
Inc.). The purchase of Barnhill Group, LLC’s assets was recorded at $596,511,
which was the market value of the shares issued at the date of
acquisition.
On
September 30, 2003, the Company acquired the patents, patent rights, and
all
pending intellectual property of Fractal Genomics, LLC through the issuance
of
3,825,000 common shares of the Company (then known as Direct Wireless
Communications, Inc.). The purchase of Fractal Genomics, LLC’s assets was
recorded at $767,750, which was the market value of the shares issued at
the
date of acquisition plus the amount of the note.
On
July
30, 2004, the Company acquired certain
rights to patents and patents pending applications for certain machine learning
tools used for diagnostic and drug discovery.
The
rights to these assets were purchased from unrelated third parties for a
combination of non-interest bearing notes payable and interest bearing notes
payable that were convertible to common stock. Under the non-interest bearing
note payable, an initial cash payment of $175,394 was paid to the sellers
on
December 30, 2004 and four additional payments of $175,394 were made four
months
from the date of the initial payment and every fourth month thereafter until
$876,970 had been paid. The Company has imputed interest on the non-interest
bearing note payments using a rate of 3.16 %. The sellers received interest
bearing notes convertible to common stock amounting to $1,127,818 that bear
interest at 3.16% and were convertible into 6,634,221 shares of common stock
(at
$0.17 per share) until maturity on July 28, 2009. The agreements place certain
limitations on the selling of the common stock shares during certain periods
after conversion. The purchase of these patents and patents pending applications
was recorded at $1,975,477, which was the estimated present value of the
notes
issued at the date of acquisition. During 2005, convertible notes totaling
$462,175 were converted by holders in exchange for 2,718,676 shares of common
stock.
On
May 6,
2005 the Company acquired the remaining interest in a portfolio of patents
from
a group of unrelated third parties. The cost of this remaining interest
consisted of a cash payment of $270,863, the issuance of promissory notes
totaling $37,872, and convertible notes totaling $147,401. The convertible
notes
were converted by the holders immediately upon issuance in exchange for 867,065
shares of common stock.
The
entire purchase price of each of these acquisitions was assigned to the acquired
patents since no other net assets were acquired and the patents were the
sole
interest of the Company.
No
acquisitions occurred in 2006.
During
2005, fees totaling $22,881 were capitalized as part of the cost of the patents
acquired. No fees were capitalized in 2006.
Note
E - LICENSE FEES EXPENSE-LICENSE AGREEMENT
Effective
September 26, 2004, the Company was assigned a patent license agreement with
Lucent Technologies GRL Corporation (“Lucent”). The patent license agreement was
associated with the patents acquired July 30, 2004. The Company agreed to
pay
royalty fees to Lucent in the amount of the greater of an annual fee of $10,000
or at the rate of five percent (5%) on each licensed product which is sold,
leased, or put into use by the Company, until cumulative royalties equal
$40,000
and at the rate of one percent (1%) subsequently. The license granted will
continue for the entire unexpired term of Lucent’s patents. During 2006 and 2005
each, the Company paid approximately $10,000 in royalty fees to Lucent.
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
F - INCOME TAXES
The
Company’s effective tax rate differs from the federal and state statutory rates
due to the valuation allowance recorded for the deferred tax asset due. An
allowance has been provided for by the Company which reduced the tax benefits
accrued by the Company for its net operating losses and other deferred tax
attributes to zero, as management cannot determine when, or if, the tax benefits
derived from these operating losses and other deferred tax attributes will
materialize. At December 31, 2006, the Company had net operating loss carry
forwards totaling approximately $7,167,742 that will expire in various years
beginning in 2021. The net operating loss carryforwards are the Company’s
primary deferred tax attribute.
Note
G - NOTES PAYABLE AND CONVERTIBLE NOTES PAYABLE
Notes
payable consist of the following:
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Term
promissory notes payable to individuals and institutions. Principal
and
interest at 18% is payable in common stock on September 1,
2008.
|
|
$
|
321,911
|
|
$
|
348,691
|
|
|
|
|
|
|
|
|
|
Note
payable to shareholder/director net of $461,667 unamortized discount
due
September 1, 2008 with interest payable at 5% due at
maturity.
|
|
$
|
538,333
|
|
|
—
|
|
|
|
$
|
860,244
|
|
$
|
348,691
|
|
Less
current maturities
|
|
|
—
|
|
|
(26,780
|
)
|
|
|
$
|
860,244
|
|
$
|
321,911
|
|
Convertible
notes outstanding at December 31, 2006 and 2005 totaled $665,643 both years.
The
notes mature on July 28, 2009, and may be converted at the election of the
noteholders until that time into shares of the Company’s common stock at $0.17
per share. A total of 3,915,547 shares may be issued upon the conversion
of the
notes. In addition, the noteholders are further limited to not sell more
than
10% of such holder’s shares in any calendar quarter after the minimum holding
period has expired. The convertible notes accrue interest at a rate of
3.16%.
In
2005,
convertible notes totaling $609,576 were converted by the debt holders in
exchange for 3,585,741 shares of common stock.
On
December 28, 2005, certain holders of term promissory notes totaling $321,911
agreed to defer the balance due in 2006 until October 31, 2007. The deferred
portion of the term notes accrues interest at a rate of 18%, payable with
issuance of the Company’s common stock. On September 1, 2006, the Company and
these holders of promissory notes entered into second amendments to extend
deferment of all remaining payments due under the notes until September 1,
2008,
all other terms remained in place. As of December 31, 2006, the notes had
aggregate remaining principal of $321,911, with accrued interest of
approximately $59,393. The deferred amounts will continue to accrue interest
at
a stated rate of 18%, which will be paid in shares of the Company’s common stock
valued at $0.24 per share at maturity.
On
September 1, 2006, the Company obtained a $1,000,000 loan from a director.
The
loan bears interest at 5%, all interest and principal is due at maturity
on
September 1, 2008. The Company also issued 10,000,000 warrants to this director
with an exercise price of $0.16 in connection with the promissory note dated
September 1, 2006. The warrants vest over ten months if the note remains
unpaid
during that period. The warrants were assigned a value of $554,000 and recorded
as additional paid-in capital. A discount of the loan was recorded in the
amount
of $554,000 and is being accreted through interest expense over the 2-year
loan
period. The vesting period of these warrants may cease if certain conditions
related to new financing are met.
All
of
the Company’s debt is collateralized by specific patents in the Company’s patent
portfolio.
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
H - COMMITMENTS
The
Company entered into an employment agreement with its Chief Executive Officer
on
September 15, 2003. The employment agreement will automatically renew for
successive one-year terms unless either party gives notice to the other party
of
its intent not to renew within a thirty-day period prior to the end of the
current term. The employment agreement provides for a base salary and other
perquisites commensurate with his employment. On December 30, 2005, the Company
and the Company’s Chief Executive Officer agreed to amend the employment
agreement to defer a portion of his salary until January 1, 2008. The
Company’s
Chief Executive Officer agreed to waive the receipt of this deferred
compensation pursuant to an amendment dated September 1, 2006.
The
Company entered into an employment agreement with its Executive Vice President.
The employment agreement is for a term of three years beginning November
14,
2005. The employment agreement provides for a base salary, issuance of stock
options and other perquisites commensurate with his employment.
The
Company has also entered into agreements with members of its Scientific Advisory
Board wherein they are entitled to receive 100,000 shares each annually of
the
Company’s common stock upon satisfactory completion of one year of service. The
Company is accruing an expense for the anticipated issuance over the service
period. At December 31, 2006, the Company has recorded $52,500 of consultant
expense for anticipated issuances of the shares.
Note
I - STOCK OPTIONS
The
Company approved 8,000,000 shares of common stock to be reserved solely for
issuance and delivery upon the exercise of option grants. At December 31,
2006
and 2005, options to purchase shares of common stock outstanding were as
follows:
2006
|
|
Grant
Date
|
|
Number
of
Shares
|
|
Exercise
Price
|
|
Vesting
|
|
|
January
2006
|
|
1,500,000
|
|
$0.11
|
|
Immediate
|
|
|
January
2006
|
|
500,000
|
|
$0.11
|
|
125,000
shares every six months
|
|
|
December
2005
|
|
1,500,000
|
|
$0.10
|
|
250,000
shares every six months
|
|
|
|
|
|
|
|
|
|
2005
|
|
Grant
Date
|
|
Number
of
Shares
|
|
Exercise
Price
|
|
Vesting
|
|
|
October
2003
|
|
600,000
|
|
$0.01
|
|
October
2003
|
|
|
October
2003
|
|
400,000
|
|
$0.10
|
|
November
2004
|
|
|
December
2005
|
|
1,500,000
|
|
$0.10
|
|
250,000
shares every six months
|
The
2006
options were awarded to an employee and expire January 2016. The 2005 options
were awarded to an employee and expire in December 2015.
The
following schedule summarizes stock option activity for 2006 and
2005:
|
|
2006
|
|
2005
|
|
|
|
Option
Shares
|
|
Weighted
Avg.
Exercise
Price
|
|
Option
Shares
|
|
Weighted
Avg.
Exercise
Price
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
Beginning of Year
|
|
|
2,500,000
|
|
$
|
0.08
|
|
|
3,000,000
|
|
$
|
0.08
|
|
Granted,
During the Year
|
|
|
2,000,000
|
|
|
0.11
|
|
|
1,500,000
|
|
|
0.10
|
|
Exercised
During the Year
|
|
|
(600,000
|
)
|
|
0.01
|
|
|
—
|
|
|
—
|
|
Forfeited,
During the Year
|
|
|
(400,000
|
)
|
|
0.10
|
|
|
(2,000,000
|
)
|
|
0.10
|
|
Outstanding,
End of the Year
|
|
|
3,500,000
|
|
$
|
0.11
|
|
|
2,500,000
|
|
$
|
0.08
|
|
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
I - STOCK OPTIONS, continued
There
were 2,125,000 and 1,000,000 options exercisable at December 31, 2006 and
2005,
respectively. The weighted average exercise prices of those options are $0.11
and $0.05 at December 31, 2006 and 2005, respectively. The weighted remaining
life of all exercisable and non-vested options at December 31, 2006 is 9
years.
As
of December 31, 2006, there was approximately $822,441 of unrecognized cost
related to stock option and warrant grants. The cost is to be recognized
over
the remaining vesting periods that average approximately 3.25 years. The
aggregate intrinsic value of options exercised during 2006 was $60,000. The
aggregate intrinsic value of options outstanding and exercisable as of December
31, 2006 was $148,235 and $90,000 respectively.
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%. No other options were granted in
2006.
The
Company granted 1,500,000 options during 2005. The fair value of each option
granted in 2005 was $0.19 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 4.57%, an expected life of 10 years, and
volatility of 128%.
Note
J - WARRANTS
Information
about warrants outstanding at December 31, 2006 and 2005 is summarized
below:
Exercise
Prices
|
|
Number
Outstanding
|
|
Weighted-
Average
Remaining
Contractual
Life
(years)
|
|
Number
Exercisable
|
|
Weighted-Average
Remaining
Contractual
Life
(years)
of
Exercisable
Warrants
|
$0.01
|
|
1,000,000
|
|
1
|
|
1,000,000
|
|
1
|
$0.10
|
|
1,365,000
|
|
2
|
|
1,215,000
|
|
2
|
$0.11
|
|
1,000,000
|
|
1
|
|
800,000
|
|
1
|
$0.12
|
|
150,000
|
|
2
|
|
150,000
|
|
2
|
$0.13
|
|
5,500,000
|
|
3
|
|
3,500,000
|
|
3
|
$0.15
|
|
1,000,000
|
|
2
|
|
1,000,000
|
|
2
|
$0.16
|
|
10,000,000
|
|
2
|
|
4,000,000
|
|
2
|
$0.20
|
|
500,000
|
|
1
|
|
500,000
|
|
1
|
$0.22
|
|
500,000
|
|
2
|
|
500,000
|
|
2
|
$0.24
|
|
32,546,250
|
|
2
|
|
32,546,250
|
|
2
|
$0.35
|
|
15,235,000
|
|
.2
|
|
15,235,000
|
|
.2
|
TOTAL
|
|
68,796,250
|
|
|
|
60,446,250
|
|
|
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
J - WARRANTS, 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
|
|
2
|
|
800,000
|
|
1
|
$0.08
|
|
600,000
|
|
1
|
|
600,000
|
|
1
|
$0.12
|
|
150,000
|
|
3
|
|
150,000
|
|
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
|
TOTAL
|
|
50,931,250
|
|
|
|
50,331,250
|
|
|
During
2005, the Company issued 1,300,000 warrants to consultants and others for
services with an exercise price of $0.01 per share. A total of $254,584 was
recorded as consulting expense related to these warrants. The warrants vest
after satisfactory completion of one year of service. The expense is being
recorded over the service period.
In
addition, during 2005 the Company issued 1,000,000 warrants to consultants
for
services rendered on behalf of the Company at an exercise price of $0.20
per
share for 500,000 warrants and $0.22 per share for the remaining 500,000.
A
total of $164,560 was recorded as consulting expense related to these warrants.
The warrants vested immediately upon issuance.
In
December 2005, the Company issued 150,000 warrants to a director with an
exercise price of $0.12 per share. The Company recorded $12,291 as consulting
expense related to these warrants.
During
January 2006, the Company issued 3,400,000 warrants to consultants and other
service providers with a weighted-average exercise price of $0.12 per share.
A
total of $290,000 was charged to expense for Compensatory Warrants. The warrants
became exercisable upon issuance.
The
Company also issued 3,000,000 warrants to two directors in January 2006 with
an
exercise price of $0.13 per share. The grant date fair value of these warrants
was $355,500. 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.
In
January 2006, the Company issued 1,000,000 warrants to a director with an
exercise price of $0.15 per share in connection with a common stock sale.
The
Company has ascribed no value to the warrants associated with the common
stock
sale described in Note K.
During
the second quarter of 2006, the Company issued 500,000 warrants to two members
of its Scientific Advisory Board. The grant date fair value of these warrants
was $35,000. These warrants vest over a one-year period and have an exercise
price of $0.11. The Company also issued 200,000 warrants to a service provider
in exchange for professional services. The grant date fair value of these
warrants was $14,000. These warrants vest over a two-year period and have
an
exercise price of $0.10. The estimated value of all of these warrants is
being
charged as expense over the respective vesting periods.
On
September 1, 2006, the Company issued 10,000,000 warrants with an exercise
price
of $0.16 to a director in connection with a $1,000,000 promissory note. The
warrants expire September 1, 2008. The fair value of these warrants was recorded
as additional paid-in capital and a debt discount that is being amortized
as
interest expense over the term of the debt.
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
J - WARRANTS, continued
During
the third quarter of 2006, the Company issued 300,000 warrants to service
providers. The grant date fair value of these warrants was $16,872. These
warrants vested immediately and have an exercise price of $0.10. The Company
also issued 500,000 warrants to a member of the Scientific Advisory Board
for
providing advisory services to the Company beyond which was expected in his
capacity as a Scientific Advisory Board member. The grant date fair value
of
these warrants was $15,115. These warrants vested immediately and have an
exercise price of $0.10. In the fourth quarter of 2006 no warrants were issued
and 570,000 warrants expired unexercised.
Note
K - STOCKHOLDERS’ EQUITY
Private
Placement - Round 1
From
February through July 2004, the Company offered for sale shares of restricted
stock to accredited investors through a private offering. The price of the
restricted stock was $.10 per share. A total of 15,235,000 restricted common
shares were issued to accredited investors for $1,499,900, net of issuance
cost
of $23,600. The issuance cost consisted of $22,400 in cash and 3,429 in common
shares valued at $1,200, paid to consultants for assistance in selling the
Company’s common stock. The value of Company’s stock was based on a contractual
agreement of $.35 per share. In addition, each purchaser of shares of common
stock was granted a warrant to acquire an equal number of restricted common
shares at a fixed price of $0.35 per share until February 2007. No portion
of
the proceeds was assigned to the value of the warrants because the exercise
price of the warrant exceeded the market value of the underlying common stock
on
the date of purchase.
Private
Placement - Round 2
From
November 2004 through March 2005, the Company offered for sale shares of
restricted stock to accredited investors through a private offering. The
price
of the restricted stock was $.16 per share. In addition, each purchaser of
shares of common stock was granted a warrant to acquire an equal number of
restricted common shares at a fixed price of $0.24 per share until December
2008. No portion of the proceeds was assigned to the value of the warrants
because the exercise price of the warrant exceeded the market value of the
underlying common stock on the date of purchase. As of December 31, 2004,
a
total of 5,434,375 restricted common shares were sold to accredited investors
for $695,761, net of issuance costs of $173,739. The issuance cost consisted
of
$128,950 in cash, 218,746 warrants, each entitling the holder to buy one
share
of the Company’s common stock for $0.24 valued at $32,812 and 34,277 shares of
common stock valued at $11,977 which was paid or accrued to consultants for
assistance in selling the Company’s common stock. As of December 31, 2004, the
common shares and related warrants had not been issued to the purchasers
and
were recorded as common shares purchased and not issued on the Company’s balance
sheet. As of December 31, 2005, all shares previously paid for and not issued
had been issued. The
value
of Company stock was derived based on a contractual arrangement of $.35 per
share. The values of the warrants were calculated using the Black-Scholes
option-pricing model.
On
March
10, 2005, the Company finalized a sale of shares of restricted common stock
to
accredited investors through a private offering. The price of the restricted
stock was $.16 per share. In addition, each purchaser of the shares of common
stock received a warrant to acquire an equal number of common shares at a
fixed
price of $0.24 per share until December 2008. No portion of the proceeds
was
assigned to the value of the warrants because the exercise price of the warrant
exceeded the market value of the underlying common stock on the date of
purchase. A total of 13,018,750 restricted common shares were sold to accredited
investors for $1,799,493, net of issuance costs of $283,507. The issuance
cost
consisted of $157,000 in cash, 806,250 warrants, each entitling the holder
to
buy one share of the Company’s common stock for $0.24 valued at $120,938, and
15,855 shares of common stock valued at $5,569 which was paid or accrued
to
consultants for assistance in selling the Company’s common stock. The value of
Company stock was derived based on a contractual arrangement of $.35 per
share.
The values of the warrants were calculated using the Black-Scholes
option-pricing model.
During
2005, the Company extended its fundraising efforts through the sale of common
stock to accredited investors through a private placement. The price of the
restricted stock was $.16 per share. In addition, each purchaser of stock
shares
was granted a warrant to acquire an equal number of restricted common shares
at
a fixed price of $0.24 per share until December 2008. No portion of the proceeds
was assigned to the value of the warrants because the exercise price of the
warrant exceeded the market value of the underlying common stock on the date
of
purchase. A total
of 12,250,000 restricted common shares were sold to accredited investors
for
$1,847,981, net of issuance costs of $112,019. The issuance cost consisted
of
$70,300 in cash, 278,125 warrants, each entitling the holder to buy one share
of
common stock for $0.24 valued at $41,719.
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
K - STOCKHOLDERS’ EQUITY, continued
Under
the
Round 2 Private Placements, 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 within 120 days of March 10, 2005. As a result of provisions in
certain of the Round 2 Private Placement documents, on August 7 and September
6,
2005, 68,125 shares of the Company’s common stock and 68,125 warrants to
purchase the Company’s common stock were issued to certain shareholders who
acquired in the aggregate 6,812,500 shares in Round 2 Private Placement for
each
date as a result of the registration statement not becoming effective by
such
date. The additional number of shares and warrants was based upon one percent
of
the number of shares and warrants purchased by such participants for each
30-day
period beginning on the 121st
day
until the registration statement was declared effective. Beginning September
7,
2005, the number of shares and warrants to be issued increased from one percent
to two percent for each 30-day period until the registration statement was
declared effective. On October 6, 2005, November 9, 2005, and December 9,
2005,
an additional 136,250, 136,250, and 131,250 in penalty shares and warrants
were
issued. The
registration statement was declared effective on December 20, 2005.
In
addition, certain shareholders who purchased 6,812,500 shares of the Company’s
common stock have anti-dilution rights until the registration statement has
been
effective for 365 days. If
the Company sells shares of the Company’s common stock at a price less than
$0.16 per share or issues warrants to purchase the Company’s common stock at an
exercise price less than $0.24 per share, certain shareholders will receive
an
amount of shares or warrants at no cost so that those shareholders have no
diluted effect from the sales of common stock or warrant issuances.
Shares
Issued in 2006
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.
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 $0.10 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 1,000,000 shares
of
the Company’s common stock at a fixed price of $0.15 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.
During
the second quarter of 2006, 200,000 warrants were exercised at $0.01 each.
The
Company issued 200,000 shares of stock and recorded the proceeds of $2,000
in
common stock.
During
the third quarter of 2006, the Company issued 230,000 shares of stock for
warrants exercised at $0.08 each. Proceeds of $18,400 were recorded in capital
stock.
Shares
Issued in Exchange for Services
During
2005, the Company issued 2,039,453 common stock shares to consultants for
services and 308,133 shares to settle accrued liabilities for services totaling
$78,746. The shares were granted at the fair market value of the services
provided as determined by the consultants. Total net consultant expense of
$381,876 was recorded for the issuances in 2005. No shares of stock were
issued
to consultants in exchange for services in 2006.
Stock
Cancellation
In
2005,
consultants who had previously been issued shares of stock in return for
services provided rescinded 1,580,532 of these shares. The Company recorded
a
$300,000 credit to consulting expense as a result of this action.
HEALTH
DISCOVERY CORPORATION
Notes
to Financial Statements, continued
Note
K- STOCKHOLDERS’ EQUITY, continued
As
discussed in Note 1 to Financial Statements and in accordance with guidance
provided in Statement of Financial Accounting Standards No. 123R,
Share-Based Payment, in fiscal 2006 Health Discovery Corporation changed
its
method of accounting for stock-based compensation.
Note
L - GOING CONCERN
The
accompanying financial statements have been prepared in conformity with
principles of accounting applicable to a going concern, which contemplates
the
realization of assets and the liquidation of liabilities in the normal course
of
business. Limited revenue has been derived since inception, and the Company
has
not yet generated sufficient working capital to support its operations. The
Company’s ability to continue as a going concern is dependent, among other
things, on its ability to reduce certain costs and obtain new contracts to
eventually attain a profitable level of operations.
The
Company initiated licensing the technology underlying several of its patents
and
providing supporting services related to the application of such technology
that
is resulting in ongoing revenue. In addition, management has successfully
negotiated agreements with its debt holders, which resulted in the deferral
of
cash payments on debt until September 2008. In late 2005, management instituted
a cost reduction program whereby the salaries of company employees, including
certain members of senior management, have been reduced or deferred. Based
on
these developments, management believes revenue generation will continue,
additional licensing agreements will be obtained in the near-term, and
non-revenue generating costs will be controlled.
Note
M - SUBSEQUENT EVENT
On
February 1, 2007, Health Discovery Corporation (the “Company”) issued in the
aggregate 15,235,000 warrants to purchase common stock of the Company (the
“Warrants”) to certain institutional investors and individual accredited
investors. The Warrants vest immediately and have an exercise price of $.35
per
share. The Warrants expire on November 1, 2007. On February 1, 2007, an equal
number of warrants issued to the same institutional and individual investors
and
with substantially similar terms expired. The aggregate value of these warrants
is approximately $33,755 and they will be recorded as expense on the issue
date.