HEALTH DISCOVERY CORP - Quarter Report: 2015 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2015

or

For the transaction period from _____________ to _____________

Commission file number 333-62216

HEALTH DISCOVERY CORPORATION

(Exact name of registrant as specified in its charter)

4243 Dunwoody Club Drive

Suite 202

Atlanta, Georgia 30350 

(Address of principal executive offices)

(678) 336-5300 

(Registrant's telephone number, including area code)

(Former name, former address and former fiscal year,

if changed since the last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for at least the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

HEALTH DISCOVERY CORPORATION

Balance Sheets

(unaudited)

See accompanying notes to financial statements.

HEALTH DISCOVERY CORPORATION

Statements of Operations

(unaudited)

For the Three and Nine Months Ended September 30, 2015 and 2014

See accompanying notes to financial statements.

HEALTH DISCOVERY CORPORATION

Statements of Cash Flows

(unaudited)

For the Nine Months Ended September 30, 2015 and 2014

See accompanying notes to financial statements.

HEALTH DISCOVERY CORPORATION

Notes to Financial Statements (unaudited)

Note A - BASIS OF PRESENTATION

Health Discovery Corporation (the “Company”) is a biotechnology-oriented company that has acquired patents and has patent pending applications for certain machine learning tools, primarily pattern recognition techniques using advanced mathematical algorithms to analyze large amounts of data thereby uncovering patterns that might otherwise be undetectable.  Such machine learning tools are currently in use for diagnostics and drug discovery, but are also marketed for other applications.  The Company licenses the use of its patent protected technology and may provide services to develop specific learning tools under development agreements or to sell to third parties.

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

The interim financial statements included in this report are unaudited but reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of the results of a full year’s operations and should be read in conjunction with the financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2014.

Note B – 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 generally governed 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.  If a license agreement has an undetermined or unlimited life, the revenue is recognized over the remaining expected life of the patents. Revenue is recognized under development agreements in the period the services are performed.

The Company treats the incremental direct cost of revenue arrangements, which consists principally of employee bonuses, as deferred charges and these incremental direct costs are amortized to expense using the straight-line method over the same term as the related deferred revenue recognition.

Deferred revenue represents the unearned portion of payments received in advance for licensing and development agreements. The Company had total unearned revenue of $159,087 as of September 30, 2015. Unearned revenue of $43,388 is recorded as current and $115,699 is classified as long-term.

Note C - NET (LOSS) INCOME PER SHARE

Basic Earnings Per Share (“EPS”) includes no dilution and is computed by dividing income or loss attributable 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 for the three and nine month periods ended September 30, 2015, the calculation of diluted per share amounts would create an anti-dilutive result and therefore are not presented in the following table.

HEALTH DISCOVERY CORPORATION

Notes to Financial Statements (unaudited), continued

Note C - NET (LOSS) INCOME PER SHARE, continued

The following is an analysis of the basic and diluted earnings per common share computations for the three and nine months ended September 30, 2014:

During the three and nine month periods ended September 30, 2014, 18,890,000 outstanding stock options and warrants were not included in the computation of diluted earnings per common share because to do so would have an antidilutive effect due to the fact that the strike prices were higher than the market price for the Company’s common stock. In addition, for the three and nine month periods ended September 30, 2014, 14,967,500 in convertible preferred stock was not included in the diluted earnings per common share calculation because to do so would have had an antidilutive effect due to the fact that the strike prices were higher than the market price for the Company’s common stock.

Note D - STOCK-BASED COMPENSATION and other EQUITY BASED PAYMENTS

Stock-based expense included in our net loss for the three months and nine months ended September 30, 2015 consisted of $17,071 and $51,212, respectively, for stock options granted to officers and directors. Stock-based expense included in our net income for the three months and nine months ended September 30, 2014 consisted of $18,714 and $56,145, respectively, for stock options granted to officers and directors.

As of September 30, 2015, there was $68,962 of unrecognized cost related to stock option grants.  The cost is to be recognized over the remaining vesting periods that average approximately 1.0 year.  

There were no grants, exercises, forfeitures or expirations of stock options for the three and nine month periods ended September 30, 2015. There were grants of warrants relating to the issuance of Series C Preferred Stock and Common Stock during the three month period ended September 30, 2015. As of September 30, 2015, there were 46,750,000 option and warrant shares outstanding with a weighted average exercise price of $0.032.

HEALTH DISCOVERY CORPORATION

Notes to Financial Statements (unaudited), continued

Note D – STOCK-BASED COMPENSATION AND OTHER EQUITY BASED PAYMENTS, continued

The following schedule summarizes combined stock option and warrant information for the nine months ended September 30, 2015.

The following schedule summarizes combined stock option and warrant information as of September 30, 2015:

The weighted average remaining life of all outstanding warrants and options at September 30, 2015 is 7.75 years. The aggregate intrinsic value of all options and warrants outstanding and exercisable as of September 30, 2015 was zero, based on the market closing price of $0.026 on September 30, 2015, less exercise prices.

Note E - PATENTS

The Company has acquired and developed a group of patents related to biotechnology and certain machine learning tools used for diagnostic and drug discovery. Legal costs associated with patent acquisitions and the application processes for new patents are capitalized as patent assets. The Company has recorded as other assets $1,006,746 in patents and patent related costs, net of $2,979,048 in accumulated amortization, at September 30, 2015.

Amortization charged to operations for the three months and nine months ended September 30, 2015 was $65,680 and $197,039, respectively. For the three months and nine months ended September 30, 2014, amortization charged to operations was $65,679 and $197,039, respectively. Estimated amortization expense for the next four years is $262,720 per year.

HEALTH DISCOVERY CORPORATION

Notes to Financial Statements (unaudited), continued

Note F – STOCKHOLDERS’ EQUITY

Series B Preferred Stock

The Company sold to individual investors a total of 19,402,675 shares of Series B Preferred Stock for $1,490,015, net of associated expenses, in 2009.  

The Series B Preferred Stock was converted into Common Stock of the Company in the fourth quarter of 2014, which was the fifth anniversary of the date of issuance as outlined in the original purchase agreement.

Dividends have been accrued for the Series B Preferred Stock in the amount of $373,346 as of December 31, 2014. The Company gave the Series B holders the choice of either (1) Common Stock for the amount of the dividend accrued based upon the price of $0.05 per share or (2) to defer payment of the dividend in cash until the Company is able to pay, at the sole discretion of the Company. During the first quarter of 2015, $166,709 in dividends were paid with the issuance of 3,334,179 shares of Common Stock. The remaining accrued dividend is recorded as a current liability in the amount of $206,637 as of September 30, 2015.

Series C Preferred Stock

In the fourth quarter of 2013, the Board of Directors authorized the issuance of Series C Preferred Shares in private placement transactions. As of December 31, 2014 and September 30, 2015, the Company had issued a total of 6,640,000 and 30,000,000 preferred shares, respectively. The Series C Preferred Shares were fully subscribed in the third quarter 2015. The Company received total net proceeds of $900,000, of which $568,000 was received in the period ended September 30, 2015. The Series C Preferred Shares are accompanied by $0.03 warrants and $0.03 contingency warrants. The contingency warrants will be issued only if the Company has not attained profitability by the end of the first quarter 2016. The holders must exercise fifty percent of the warrants if the market price for the Company’s common stock is $0.20 for a period of thirty consecutive calendar days.  The holders must also exercise fifty percent of the warrants if the market price for the Company’s common stock is $0.30 for a period of thirty consecutive calendar days.  The warrants were valued at $0.025 each using the Black Scholes Method.

The Series C Preferred Stock has not been registered under either federal or state securities laws and must be held until a registration statement covering such securities is declared effective by the Securities and Exchange Commission or an applicable exemption applies.

The Series C Preferred Stock may be converted into Common Stock of the Company at the option of the holder, without the payment of additional consideration by the holder, so long as the Company has a sufficient number of authorized shares to allow for the exercise of all of its outstanding warrants and options. The Shares of Series C Preferred Stock must be converted into Common Stock of the Company either by the demand by the shareholder or at the fifth anniversary of the date of issuance. If the Company were to be dissolved, the Series C Preferred Stock receives preferential treatment over Common Stock.

Note G – INVESTMENT IN AVAILABLE FOR SALE SECURITIES

The Company has elected the fair value option in accordance with ASC 825, Financial Instruments, as it relates to its shares held in NeoGenomics’ common stock that were acquired resulting from the NeoGenomics Master License Agreement executed on January 6, 2012. Management made the election for the fair value option related to this investment because it believes the fair value option for the NeoGenomics common stock provides a better measurement from which to compare financial statements from reporting period to reporting period. No other financial assets or liabilities are measured at fair value using the fair value option.

HEALTH DISCOVERY CORPORATION

Notes to Financial Statements (unaudited), continued

Note G – INVESTMENT IN AVAILABLE FOR SALE SECURITIES, continued

The Company’s investment in NeoGenomics’ common stock is recorded on the accompanying balance sheets under the caption Investment in Available for Sale Securities. The carrying value of this investment on the date of acquisition approximated $1,945,000. The change in fair value from December 31, 2014 to September 30, 2015 was a net gain of $72,231 for the remaining 18,000 shares held and is classified as other income (expense) under the captions Realized and Unrealized (Loss) Gain on Available for Sale Securities in the accompanying statements of operations. The change in fair value from December 31, 2013 to September 30, 2014 was a net gain of $237,730 and is classified as other income (expense) under the captions Realized and Unrealized (Loss) Gain on Available for Sale Securities for the nine months ended September 30, 2014 in the accompanying statements of operations. The Company classifies its investment as an available for sale security and the fair value is considered a Level 1 investment in the fair value hierarchy. The September 30, 2015 fair value of the investment of $104,434 is for the remaining shares held and is calculated using the closing stock price of the NeoGenomics common stock at the end of the reporting period. As of September 30, 2015, the Company held 18,000 shares of NeoGenomics stock as compared to 86,900 shares as of December 31, 2014.

Note H – COMMITMENTS AND CONTINGENCIES

On July 17, 2013, the Company received a Civil Investigative Demand (the "Demand") from the Federal Trade Commission of the United States of America (the "FTC") relating to the Company's MelApp software application. In the Demand, the FTC has requested information relating to potentially unfair or deceptive acts or practices related to (i) false advertising and (ii) consumer privacy and data security, in violation of Trade Commission Act, 15 U.S.C. Sections 45 and 42.

On February 23, 2015, the FTC notified the Company of its approval, by a vote of 4-1, to accept an Agreement Containing Consent Order (“Agreement”). This Agreement is for settlement purposes only. The Company neither admits nor denies any of the allegations, except as specifically stated in the Agreement. The Company believes the effort to contest this matter with the FTC would require funds greater than the Company has at its disposal.

The Agreement does, among other things, bar the Company from claiming that any device detects or diagnoses melanoma or its risk factors, or increases users’ chances of early detection, unless the representation is not misleading and supported by competent and reliable scientific evidence in the form of human clinical testing of the device. The Agreement also prohibits the Company from making any other misleading or unsubstantiated claims about a device’s health benefits or efficacy, unless the representation is not misleading and supported by competent and reliable scientific evidence in the form of human clinical testing of the device. Finally, the Company was required to pay $17,693 to the FTC, which was accrued during the three month period ended March 31, 2015. This amount is included as Settlement Expense in the accompanying statements of operations.

The Company’s balance sheet for the year ended December 31, 2014 reflected an accrued liability of approximately $239,910 for professional services.  In an effort to conserve cash, the Company worked with several of the vendors regarding a portion of this amount by negotiating with the service providers regarding potential reduction of the amount billed. During the quarter ended September 30, 2015, the Company and the service providers negotiated the amounts owed and as a result, the Company recorded a decrease in accounts payables of $121,503.

The Company is subject to various claims primarily arising in the normal course of business.  Although the outcome of these matters cannot be determined, the Company does not believe it is probable that any such claims will result in material costs and expenses.

HEALTH DISCOVERY CORPORATION

Notes to Financial Statements (unaudited), continued

Note I – FINANCIAL CONDITION

We have prepared our financial statements on a “going concern” basis, which presumes that we will be able to realize our assets and discharge our liabilities in the normal course of business for the foreseeable future.

Our ability to continue as a going concern is dependent upon our licensing arrangements with third parties, achieving profitable operations, obtaining additional financing and successfully bringing our technologies to the market.  The successful outcome of these matters cannot be predicted at this time.  Our financial statements have been prepared on a going concern basis and do not include any adjustments to the amounts and classifications of the assets and liabilities that might be necessary should we be unable to continue in business.

At September 30, 2015, we had $506,551 cash on hand along with stock available for sale worth $104,434. The Company’s plan to have sufficient cash to support operations is comprised of generating revenue through its relationship with NeoGenomics, providing services related to those patents, selling its NeoGenomics stock, and obtaining additional equity or debt financing.

As a result, the Company focused its efforts to secure funds via licensing activity or other forms of fund raising either in the debt or equity markets.  In addition, prior to the beginning of this year, the Company began raising capital through the Series C Preferred Stock offering. The Series C Preferred Stock offering was fully subscribed and completed in August 2015. As a result, the Company received $568,000 in 2015 in addition to the $332,000 received in prior years for a total of $900,000.

The Company believes the funds received from the Series C Preferred Stock offering, along with disciplined expense management, will allow the Company to maintain operations through 2016. While the Company believes these efforts will create a profitable future, there is no guarantee the Company will be successful in these efforts.

Item 2.  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. The Company operates primarily in the 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 healthcare technology markets.

Our historical foundation lies in the molecular diagnostics field where we have made a number of discoveries that play a role in developing more personalized approaches to the diagnosis and treatment of certain diseases. However, our Support Vector Machine (“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 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 over 60 patents that have been issued or are currently pending around the world.

HEALTH DISCOVERY CORPORATION

Management’s Discussion and Analysis, continued

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 diagnostic and prognostic predictive tests; licensing of the SVM and FGM technologies directly to diagnostic companies; and, the potential formation of new ventures with domain experts in other fields where our pattern recognition technology holds commercial promise.

Operational Activities

The Company markets its technology and related developmental expertise to prospects in the healthcare, biotech, and life sciences industries.  Given the scope of some of these prospects, the sales cycle can be quite long, but management believes that these marketing efforts may produce favorable results in the future.  

NeoGenomics License

On January 6, 2012, we entered into a Master License Agreement (the “NeoGenomics License”) with NeoGenomics Laboratories, Inc. (“NeoGenomics Laboratories”), a wholly owned subsidiary of NeoGenomics, Inc. (“NeoGenomics”). Pursuant to the terms of the NeoGenomics License, we granted to NeoGenomics Laboratories and its affiliates an exclusive worldwide license to certain of our patents and know-how to use, develop and sell products in the fields of laboratory testing, molecular diagnostics, clinical pathology, anatomic pathology and digital image analysis (excluding non-pathology-related radiologic and photographic image analysis) relating to the development, marketing production or sale of any “Laboratory Developed Tests” or LDTs or other products used for diagnosing, ruling out, predicting a response to treatment, and/or monitoring treatment of any or all hematopoietic and solid tumor cancers excluding cancers affecting the retina and breast cancer. We retain all rights to in-vitro diagnostic (IVD) test kit development.

Upon execution of the NeoGenomics License, NeoGenomics paid us $1,000,000 in cash and issued to us 1,360,000 shares of NeoGenomic’s common stock, par value $0.001 per share, which had a market value of $1,945,000 using the closing price of $1.43 per share for NeoGenomic’s common stock on the OTC Bulletin Board on January 6, 2012. In addition, the NeoGenomics License provides for milestone payments in cash or stock, based on sublicensing revenue and revenue generated from products and services developed as a result of the NeoGenomics License. Milestone payments will be in increments of $500,000 for every $2,000,000 in GAAP revenue recognized by NeoGenomics up to a total of $5,000,000 in potential milestone payments. After $20,000,000 in cumulative GAAP revenue has been recognized by NeoGenomics, we will receive a royalty of (i) 6.5% (subject to adjustment under certain circumstances) on net revenue generated from all Licensed Uses except for the Cytogenetic Interpretation System and the Flow Cytometry Interpretation System and (ii) a royalty of 50% of net revenue (after the recoupment of certain development and commercialization costs) that NeoGenomics derives from any sublicensing arrangements it may put in place for the Cytogenetic Interpretation System and the Flow Cytometry Interpretation System.

NeoGenomics agreed to use its best efforts to commercialize certain products within one year of the date of the license, subject to two one-year extensions per product if needed, including a “Plasma Prostate Cancer Test”, a “Pancreatic Cancer Test”, a “Colon Cancer Test”, a “Cytogenetic Interpretation System”, and a “Flow Cytometry Interpretation System.” NeoGenomics has completed both of its one-year extension terms of the license. While those one-year extension terms are complete, the Company and NeoGenomics continue to collaborate on efforts to commercialize the licensed technologies.

If NeoGenomics has not generated $5.0 million of  revenue for Health Discovery Corporation from products, services and sublicensing arrangements by January 2017, we may, at our option, revoke the exclusivity with respect to any one or more of the initial licensed products, subject to certain conditions.

The Company believes our relationship with NeoGenomics is instrumental in our medical and diagnostic testing development. We further believe the majority, if not all, of our applications in the medical field will be done in conjunction with NeoGenomics.

HEALTH DISCOVERY CORPORATION

Management’s Discussion and Analysis, continued

Plasma Test for Prostate Cancer

NeoGenomics is developing a Blood Test for Prostate Cancer under the direction of Dr. Maher Albitar using the genes patented by HDC. The test is performed on blood plasma and urine rather than only prostate tissue biopsies. NeoGenomics completed Phase I of their research and published the results in 2014. Additionally, NeoGenomics completed Phase II of their prostate test validation in 2014. The results were largely the same as those published regarding Phase I. NeoGenomics is currently conducting a clinical trial for this test. NeoGenomics has announced their expectation is to launch this test in 2016.

Cytogenetic Analysis

Cytogenetic analysis is the science of studying chromosomes. Microscopic evaluation of individual chromosomes remains the first step in the evaluation of the human genome. Cytogenetic analysis is performed on almost all patients with hematopoietic diseases (blood cancers such as leukemia and lymphoma) and on a significant number of patients with solid tumors. The collected data is useful for diagnosis, prognosis and monitoring of diseases. Currently, specially trained technicians perform most of the analysis manually. The work is labor-intensive and subjective. Computer automation of this work could significantly reduce cost and improve the quality of the test.

NeoGenomics is currently working on development, validation and commercialization of this new image analysis tool for cytogenetic analysis under the direction of Dr. Maher Albitar. The Company and NeoGenomics have spent a considerable amount of time using SVM Technology to create significant improvement in cytogenetic analysis. NeoGenomics is currently beta testing this co-developed technology within their facilities. One of the goals with this technology is for NeoGenomics to sub-license this technology after successful internal testing and validation. Per the license agreement, HDC will receive a portion of the sub-license revenue generated by NeoGenomics.

Flow Cytometry

Management believes that our efforts to develop an SVM-based diagnostic test to help interpret flow cell cytometry data for myelodysplastic syndrome (pre-leukemia) has resulted in a successful proof of concept. The Company, along with NeoGenomics, is now capable of completing development, final validation and commercialization of the new diagnostic test for the interpretation of flow cytometry data. This test has been licensed to NeoGenomics for final development and work has begun on the further development of this technology.

SVM Capital, LLC

In January 2007, SVM Capital, LLC (“SVM Capital”) was formed as a joint venture between HDC and Atlantic Alpha Strategies, LLC (“Atlantic Alpha”) to explore and exploit the potential applicability of our SVM technology to quantitative investment management techniques.  Atlantic Alpha’s management has over thirty years of experience in commodity and futures trading.    

In November 2012, Atlantic Alpha began auditable formal live trading by applying SVM technology to quarterly fundamental corporate data such as sales, earnings and projected earnings. The SVM algorithm is utilized to select U.S. stocks which are expected to outperform or underperform in the next quarter based on current data while at the same time rendering superior portfolio risk metrics. This application of SVM technology allows the creation of a variety of equity portfolios. SVM Capital has been pleased with the results of the application of the SVM technology.

On June 16, 2015, SVM Capital joined Manifold Partners, LLC (“Manifold Partners”) as a partner. Manifold Partners is a San Francisco-based multi-strategy portfolio management firm specializing in quantitative investment methodologies. This new collaboration will be known as Manifold Vector. SVM Capital specializes in the application of an artificial intelligence technique to investment strategies. SVM Capital has developed mathematical algorithms to rank-order S&P 500 stocks to determine investment desirability, including long and short equity positions. Importantly, only fundamental corporate data is analyzed, which Manifold Partners believes to be unique in the quantitative investment field. This technology is an outgrowth of the machine learning techniques created the Company. A thorough exposition of SVM Capital may be found on the appropriate link in HDC's web page.

HEALTH DISCOVERY CORPORATION

Management’s Discussion and Analysis, continued

Intellectual Property Developments

The Company now holds the exclusive rights to 53 issued U.S. and foreign patents covering uses of SVM and FGM technology for discovery of knowledge from large data sets. The Company also has 10 pending U.S. and foreign patent applications covering uses of the SVM technology as well as diagnostic methods that have been discovered using the SVM technology. The reduction in the total number of issued and pending patents during 2014 resulted from the Company’s decision to allow certain foreign patents issued and/or filed in countries that were deemed to have lower strategic value to lapse. In addition, a few U.S. patents that were either near the ends of their terms and/or had parallel applications with broader claims in force were allowed to expire. In addition, significant changes in the U.S. Patent Laws relating to the eligibility of certain subject matter for patent protection influenced the Company’s decision to abandon a few of its pending U.S. applications. This in turn reduced the Company’s total expenses for patent maintenance.

Intel Update

The Company’s patent application that was submitted to provoke an interference with Intel’s Patent No. 7,685,077 remains pending. The application file was transferred to the U.S. Patent Office’s Interference Division in December 2014 and is awaiting further action.

Three Months Ended September 30, 2015 Compared with Three Months Ended September 30, 2014

Revenue

For the three months ended September 30, 2015, revenue was $12,050 compared with $256,247 for the three months ended September 30, 2014. The revenue earned during the third quarter of 2015 is related to the revenue recognition of the Vermillion settlement and the revenue earned during the third quarter of 2014 is primarily related to the licensing revenue recognition for the NeoGenomics License.

Operating and Other Expenses

Amortization expense was $65,680 for the three months ended September 30, 2015 and $65,679 for the three months ended September 30, 2014. Amortization expense relates primarily to the costs associated with filing patent applications and acquiring rights to the patents.

Professional and consulting fees totaled $30,965 for the three months ended September 30, 2015, compared with $26,985 for the same 2014 period. These fees consist primarily of patent filing and maintenance costs, professional fees, and accounting fees. The increase was due to higher patent filing fees.

Legal fees decreased over the three-month period with fees totaling $9,000 during the three months ended September 30, 2015 and $14,792 during the same period in 2014. The decrease was related to elimination of legal costs incurred in the second quarter 2014 related to the Company’s resolution of the FTC matter.

Research and development expense was $9,000 for the three months ended September 30, 2015, and $23,438 for the same period in 2014. This expense for research and development relates primarily to work completed under the NeoGenomics License.

Compensation expense of $48,328 for the three months ended September 30, 2015 was lower than the $62,955 reported for the comparable 2014 period. The decrease is attributed to the sacrifices made by current management through reduction, or elimination of, compensation in order to preserve cash.

Other general and administrative expense decreased to $33,633 for the three months ended September 30, 2015, compared to $35,562, for the same period in 2014. This expense remains lower than earlier periods principally due to a reduction in all non-essential costs by the new leadership beginning in August 2013. 

Loss / Income from Operations

The loss from operations for the three months ended September 30, 2015 was $184,556, compared to income from operations of $26,836 for the three months ended September 30, 2014. The loss was due to the reduction in revenue recognized, specifically the revenue from the NeoGenomics license.

HEALTH DISCOVERY CORPORATION

Management’s Discussion and Analysis, continued

Other Income and Expense

The Company received a portion of the NeoGenomics license fee in NeoGenomics stock. The Company has chosen to measure the gain or loss on the value of this asset using the fair value option method. During the three month period ended September 30, 2015, the change in the NeoGenomics stock fair value increased by $9,275, which is recorded as other income (expense) in the statements of operations. During the same three month period in 2014, the change in the NeoGenomics stock fair value increased by $280,214.

As previously discussed in Note H to the financial statements, the Company negotiated a reduction of amounts owed with certain service providers. As a result, the Company realized an increase in other income and expense (forgiveness on payables) of $121,503.

Net Loss / Income

The net loss for the three months ended September 30, 2015 was $53,778, compared to net income of $307,050 for the three months ended September 30, 2014. The change was due primarily to the expiration of the revenue recognition related to the NeoGenomics license and the gain on available for sale securities.

The loss attributable to common shareholders was $53,778 for the three months ended September 30, 2015 compared to income of $289,250 in the three months ended September 30, 2014. This significant change is related to the expiration of the NeoGenomics license revenue recognition, which occurred in the three-month period ended September 30, 2014, and the gain on available for sale securities.

Basic and diluted loss per share was $0.0001 for the three-month period ended September 30, 2015 compared to earnings per share of $0.0011 for the quarterly period ended September 30, 2014.

Nine Months Ended September 30, 2015 Compared with Nine Months Ended September 30, 2014

Revenue

For the nine months ended September 30, 2015, revenue was $33,754 compared with $773,901 for the nine months ended September 30, 2014. Revenue is recognized for licensing and development fees over the period earned. The revenue earned is almost entirely related to the licensing revenue recognition for the NeoGenomics License, which expired in 2014.

Operating and Other Expenses

Amortization expense was $197,039 for both the nine months ended September 30, 2015 and 2014. Amortization expense relates primarily to the costs associated with filing patent application and acquiring rights to the patents.

Professional and consulting fees were $129,377 for the nine months ended September 30, 2015 compared with $144,700 for the same 2014 period. The decrease was due to the elimination or reduction of professional services provided to the Company.

Legal fees totaled $37,357 during the nine months ended September 30, 2015 compared to $49,171 during the same period in 2014. The reduction was related to legal costs in 2014 pertaining to the Company’s matter with the FTC.

Research and Development fees were $31,813 for the nine months ended September 30, 2015 and $70,763 for the same period in 2014. This expense for research and development relates primarily to work completed under the NeoGenomics License.

Compensation expense of $142,665 for the nine months ended September 30, 2015 was less than the $202,311 reported for the comparable 2014 period. The decrease is attributed to the sacrifices made by current management through reduction, or elimination of, compensation in order to preserve cash.

Other general and administrative expenses decreased to $116,843 for the nine months ended September 30, 2015 compared to $129,803 in 2014. This decrease was due to the reduction in all non-essential costs by the new leadership beginning in August 2013.

HEALTH DISCOVERY CORPORATION

Management’s Discussion and Analysis, continued

Loss from Operations

The loss from operations for the nine months ended September 30, 2015 was $621,340 compared to $19,886 for the comparable period ended September 30, 2014. The increased loss was due to the reduction in revenue recognized, specifically the revenue from the NeoGenomics license.

Other Income and Expense

The Company received a portion of the NeoGenomics license fee in NeoGenomics stock. The Company has chosen to measure the gain or loss on the value of this asset using the fair value option method. During the nine month period ended September 30, 2015, the NeoGenomics stock fair value increased by $72,231, which is recorded as other income in the statements of operations. During the same period in 2014, the NeoGenomics stock increased by $237,730.

As previously discussed in Note H to the financial statements, the Company negotiated a reduction of amounts owed with certain service providers. As a result, the Company realized an increase in other income and expense (forgiveness of payables) of $121,503.

As a result of the settlement with the FTC over actions by previous management, the Company recognized a settlement expense of $17,693 during the first quarter 2015.

Net Loss / Income

The net loss for the nine months ended September 30, 2015 was $445,299 compared to net income of $217,844 for the nine months ended September 30, 2014. This reversal from a net income to a net loss was due to the reduction in revenue recognized, specifically the revenue from the NeoGenomics license.

The net income attributable to common shareholders was $445,299 for the nine months ended September 30, 2015 compared to a net income of $165,024 in the nine months ended September 30, 2014.

Basic and diluted loss per share was $0.0017 for the nine-month period ended September 30, 2015 compared to earnings per share of $0.0007 for the nine month period ended September 30, 2014.

Liquidity and Capital Resources

We have prepared our financial statements on a “going concern” basis, which presumes that we will be able to realize our assets and discharge our liabilities in the normal course of business for the foreseeable future.

Our ability to continue as a going concern is dependent upon our licensing arrangements with third parties, achieving profitable operations, obtaining additional financing and successfully bringing our technologies to the market.  The successful outcome of these matters cannot be predicted at this time.  Our financial statements have been prepared on a going concern basis and do not include any adjustments to the amounts and classifications of the assets and liabilities that might be necessary should we be unable to continue in business.

At September 30, 2015, we had $506,551 of cash on hand along with stock available for sale worth $104,434. The Company’s plan to have sufficient cash to support operations is comprised of generating revenue through its relationship with NeoGenomics, providing services related to those patents, selling its NeoGenomics Stock, and obtaining additional equity or debt financing.

As a result, the Company is focusing its efforts to secure funds via licensing activity or other forms of fund raising either in the debt or equity markets.  In addition, prior to the beginning of this year, the Company began raising capital through the Series C Preferred Stock offering. The Series C Preferred offering was subsequently completed in August 2015. In addition, the Company believes the NeoGenomics relationship will provide revenue to the Company in 2016, though no assurances to this effect can be made at this time. Therefore, the Company believes the Series C Preferred Stock offering, along with disciplined expense management, will allow the Company to maintain operations through 2016.

HEALTH DISCOVERY CORPORATION

Management’s Discussion and Analysis, continued

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements that provide financing, liquidity, market or credit risk support or involve leasing, hedging or research and development services for our business or other similar arrangements that may expose us to liability that is not expressly reflected in the financial statements.

Forward-Looking Statements

This Report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 12E of the Securities Exchange Act of 1934, including or related to our future results, certain projections and business trends. Assumptions relating to forward-looking statements involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. When used in this Report, the words “estimate,” “project,” “intend,” “believe,” “expect” and similar expressions are intended to identify forward-looking statements. Although we believe that assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate, and we may not realize the results contemplated by the forward-looking statement. Management decisions are subjective in many respects and susceptible to interpretations and periodic revisions based on actual experience and business developments, the impact of which may cause us to alter our business strategy or capital expenditure plans that may, in turn, affect our results of operations. In light of the significant uncertainties inherent in the forward-looking information included in this Report, you should not regard the inclusion of such information as our representation that we will achieve any strategy, objective or other plans. The forward-looking statements contained in this Report speak only as of the date of this Report as stated on the front cover, and we have no obligation to update publicly or revise any of these forward-looking statements. These and other statements which are not historical facts are based largely on management’s current expectations and assumptions and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those contemplated by such forward-looking statements. These risks and uncertainties include, among others, the failure to successfully develop a profitable business, delays in identifying customers, and the inability to retain a significant number of customers, as well as the risks and uncertainties described in the “Risk Factors” section to our Annual Report for the fiscal year ended December 31, 2014.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Not Applicable.

Item 4. Controls and Procedures

As of the end of the period covered by this report (the “Evaluation Date”), we carried out an evaluation regarding the fiscal quarter ended September 30, 2015, under the supervision and with the participation of our management, including our Interim Chief Executive Officer, who is also serving as 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 management concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports that are filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms and that our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management including our Chief Executive Officer, as appropriate, to allow timely decisions regarding required disclosure.

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. 

HEALTH DISCOVERY CORPORATION

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.

Our Annual Report on Form 10-K contains information regarding a material weakness in our internal control over financial reporting as of December 31, 2014 due to an inadequate segregation of duties resulting from our small number of employees.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the risk factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

In the fourth quarter of 2013, the Board of Directors authorized the issuance of Series C Preferred Shares in private placement transactions. As of December 31, 2014 and September 30, 2015, the Company had issued a total of 6,640,000 and 30,000,000 preferred shares, respectively. The Series C Preferred Shares were fully subscribed in the third quarter 2015. The Company received total net proceeds of $900,000, of which $568,000 was received in the period ended September 30, 2015. The Series C Preferred Shares are accompanied by $0.03 warrants and $0.03 contingency warrants. The contingency warrants will be issued only if the Company has not attained profitability by the end of the first quarter 2016. The holders must exercise fifty percent of the warrants if the market price for the Company’s common stock is $0.20 for a period of thirty consecutive calendar days.  The holders must also exercise fifty percent of the warrants if the market price for the Company’s common stock is $0.30 for a period of thirty consecutive calendar days.  The warrants were valued at $0.025 each using the Black Scholes Method.

The Series C Preferred Stock has not been registered under either federal or state securities laws and must be held until a registration statement covering such securities is declared effective by the Securities and Exchange Commission or an applicable exemption applies.

The Series C Preferred Stock may be converted into Common Stock of the Company at the option of the holder, without the payment of additional consideration by the holder, so long as the Company has a sufficient number of authorized shares to allow for the exercise of all of its outstanding warrants and options. The Shares of Series C Preferred Stock must be converted into Common Stock of the Company either by the demand by the shareholder or at the fifth anniversary of the date of issuance. If the Company were to be dissolved, the Series C Preferred Stock receives preferential treatment over Common Stock.

Item 3. Defaults upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

The following exhibits are attached hereto or incorporated by reference herein (numbered to correspond to Item 601(a) of Regulation S-K, as promulgated by the Securities and Exchange Commission) and are filed as part of this Form 10-Q:

SIGNATURES

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