HEALTH DISCOVERY CORP - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

2002 Summit Blvd NE, Suite 300, Atlanta, Georgia 30319

(404) 566-4865

www.healthdiscoverycorp.com

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 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 ¨  No x

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ¨  No x

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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

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

HEALTH DISCOVERY CORPORATION

FORM 10-Q

For the Quarter Ended September 30, 2020

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION

HEALTH DISCOVERY CORPORATION

Balance Sheets

(In thousands, except share amounts)

See accompanying notes to financial statements.

HEALTH DISCOVERY CORPORATION

Statements of Operations

(In thousands, except per share and share amounts) (Unaudited)

See accompanying notes to financial statements.

HEALTH DISCOVERY CORPORATION

Statements of Stockholders’ equity (deficit)

(In thousands, except share amounts) (Unaudited)

See accompanying notes to financial statements.

HEALTH DISCOVERY CORPORATION

Statements of Stockholders’ equity (deficit), continued

(In thousands, except share amounts) (Unaudited)

See accompanying notes to financial statements.

HEALTH DISCOVERY CORPORATION

Statements of Cash Flows

(In thousands) (Unaudited)

See accompanying notes to financial statements.

HEALTH DISCOVERY CORPORATION 

Notes to Financial Statements (unaudited)

Note 1 - BASIS OF PRESENTATION

Health Discovery Corporation (“HDC” or the “Company”) is a machine learning 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 may play a role in developing more personalized approaches to the diagnosis and treatment of certain diseases. However, our Support Vector Machines (“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, as well as biomarkers that we discovered by applying our SVM 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 31 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 diagnostic and prognostic predictive tests; licensing of the SVM 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. 

The accompanying 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 for the Company. All such adjustments are of a normal recurring nature. The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America (“GAAP”). Interim results 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, 2019.

Estimates and assumptions

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 due to risks and uncertainties, including uncertainty in the current economic environment due to the recent outbreak of a novel strain of the coronavirus (“COVID-19”).

Segments

Our chief executive officer and president, in making decisions regarding resource allocation and assessing performance, views our operations and manages our business as one operating segment.

Note 2 – SIGNIFICANT ACCOUNTING POLICIES

Valuation of Common Stock Warrants Liability

The Company has, from time to time beginning in 2014, issued convertible preferred stock, preferred stock warrants, common stock, common stock warrants, and fully vested options to purchase shares of common stock in excess of its available shares of underlying stock to be issued.

In the event the number of shares or warrants of common stock granted exceeds the number of shares available if the holders exercised all of the previously issued outstanding options and warrants, the Company accounts for this excess as a common stock warrants liability, which is adjusted to fair value at the end of each reporting period. If and when the Company authorizes sufficient shares of common stock and preferred stock, the common stock warrants liability is reclassified to equity at the fair value of the liability at the date of reclassification. The Company accounts for the reclassification from equity to liability (or vice versa) similar to a modification of a share-based payment award.

See further discussion in Note 6 – Statement of Stockholders’ Equity (Deficit) and Note 7– Common Stock Warrants Liability.

Stock-based Compensation

Stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the requisite service period using the straight-line method.

Valuation and Amortization Method – The fair value of stock awards that do not contain a market condition target are estimated on the grant date using the Black-Scholes option-pricing model. The fair value of options that contain a market condition, such as a specified hurdle price, is estimated on the grant date using a probability weighted fair value model similar to a lattice valuation model.  Both the Black-Scholes and the probability weighted valuation models require assumptions and estimates of expected volatility, expected life, expected dividend yield and expected risk-free interest rates.

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 forfeitures due to departure prior to the end of the vesting schedule.

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, employing a prior period equivalent to the expected term 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.

Note 3 – NET INCOME (LOSS) PER SHARE

Basic earnings per share (“EPS”) is computed by dividing income or loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options, convertible promissory notes payable, convertible preferred stock, and warrants.

The computation of basic and diluted earnings per share was as follows:

The dilutive effect of 18,144,680 and 17,494,354, and zero and 2,370,141, options and warrants were excluded from diluted weighted average shares during the three and nine months ended September 30, 2020, respectively, and the three and nine months ended September 30, 2019, respectively, because the strike or conversion price was below the average share price during the related period.

Note 4 – STOCK-BASED COMPENSATION and other EQUITY BASED PAYMENTS

In connection with their election to the Company’s Board of Directors at the Annual Shareholder Meeting and in recognition of their continuing contributions to the Company, on June 1, 2020, the Company granted to certain of the directors each a one-time cash payment of $20,000 as well as an option to purchase 3,000,000 shares of the Company’s common stock. Additionally, the Chairman of the Board and the President and Chief Operating Officer were each granted an option to purchase 5,000,000 shares and 4,500,000 shares, respectively, of the Company’s common stock. The option grants are consistent with what has been granted to other board members and management of the Company. The options immediately vest, have an exercise price of $0.0138 and expire on June 1, 2030. The exercise price is based upon the closing price of the Company’s common stock on the date of the option grant. The fair value of each option granted was $0.0125 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 1.84%, an expected life of 5 years, and volatility of 147%. The aggregate value of $268,000 related to the options granted was charged to stock-based compensation expense during the second quarter of 2020.

As of September 30, 2020, there was no unrecognized cost related to stock option grants. As the market closing price was $0.0326 on September 30, 2020, there was $2.0 million aggregate intrinsic value of all options and warrants outstanding and exercisable as of September 30, 2020.

Stock-based compensation expense recorded in the financial statements was the following (in thousands):

The following schedule summarizes stock option information as of December 31, 2019 and September 30, 2020.

The Company has outstanding the following common stock warrants:

Note 5 – PATENTS

The Company’s principal asset is its intellectual property, which includes advanced mathematical algorithms called Support Vector Machines (“SVM”), as well as biomarkers that we discovered by applying its SVM techniques to complex genetic and proteomic data. Biomarkers are biological indicators or genetic expression signatures of certain disease states. The Company’s intellectual property is protected by 31 patents that have been issued or are currently pending around the world.

Initial costs paid to purchase patents are capitalized and amortized using the straight-line method over the remaining life of the patent. Amortization charged to operations for the three and nine months ended September 30, 2019 totaled $22,000 and $153,000, respectively. There was no amortization charged to operations for the three and nine months ended September 30, 2020. Patent costs have been fully amortized as of September 30, 2020 and December 31, 2019.

Note 6 – STOCKHOLDERS’ EQUITY(DEFICIT)

Authorized capital

On May 27, 2020, the Company held its Annual Shareholder Meeting. One of the proposals presented by the Company in its proxy statement was an approval to amend the Company’s Articles of Incorporation to increase the number of authorized shares of common stock from 450,000,000 to 900,000,000 and to increase the number of authorized shares of preferred stock from 45,000,000 to 90,000,000. This proposal received a majority of votes and was therefore approved by the shareholders.

Series D Preferred Stock

The Company’s Series D preferred stock has the following rights and preferences:

Dividend rights: The holders of Series D preferred stock shares pari passu with the holders of common stock in dividends payable to stockholders.

Voting rights: Each share of Series D preferred stock is entitled to vote on all matters submitted to stockholder vote and each share has a number of votes equal to ten votes for the same number of shares of common stock into which it is then convertible.

Conversion rights: Each share of Series D preferred stock is convertible into shares of the Company’s common stock at a 1:1 ratio at the option of the holder or on the ten-year anniversary of issuance, whichever occurs first.

Liquidation rights: In the event of voluntary or involuntary liquidation, dissolution or winding up of the Company, the Series D holders receive distribution before any payments to common stockholders.

In February 2020, the Company effected the conversion of its $200,000 outstanding promissory note, plus accrued interest of $16,688, into shares of its Series D Preferred Stock. The note holders retain their outstanding warrants to purchase an aggregate of 41,983,781 shares of the Company’s common stock at a weighted average price of $0.0103. Each warrant expires on July 31, 2029.

Common Stock

On June 1, 2020, the Chairman of the Board and the Company entered into an agreed upon settlement whereby accrued wages of $212,500 were immediately converted into 15,398,551 shares of the Company’s common stock at a conversion price of $0.0138.

All of these issuances of equity securities were made in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended.

Note 7 – COMMON STOCK WARRANTS LIABILITY

The common stock warrants liability is recorded based upon the vested number of warrants or other equity-linked instruments outstanding which exceed the number of authorized shares available to meet the assumed exercise or conversion of such instruments at each reporting period.

In the nine months ended September 30, 2020, the Company recorded other income of approximately $992,000 related to the reduction of the common stock warrants liability. At September 30, 2020, the common stock warrants liability is zero as the Company has adequate authorized shares available to meet the assumed exercise or conversion of its issued options, warrants, convertible debt and convertible preferred stock.

The following table presents a reconciliation of the Company’s common stock warrants liability for the nine months ended September 30, 2020 (in thousands):

As of September 30, 2020, the Company had 179,858,781 options and warrants outstanding with exercise prices varying from $0.003 to $0.075.

Note 8 – CONVERTIBLE DEBT

On June 1, 2020, an additional $212,000 in accrued wages was converted into a convertible promissory note. The promissory note and accrued interest are convertible into common stock of the Company at a conversion price of $0.0138. The conversion price is based upon the closing price of the Company’s common stock on June 1, 2020. The promissory note bears interest at an annual rate of 8%.

Note 9 – FAIR VALUE MEASUREMENT

The carrying values of our prepaid expenses, accounts payable, accrued wages, and accrued liabilities approximate their recorded values due to the short-term nature of these instruments.

Note 10 – COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company does not own any real property.  The Company leases approximately 600 square feet of office space in Atlanta, Georgia, pursuant to a short-term lease as of August 2019. The Company currently pays base rent in the amount of $2,539 per month. The Company also leases approximately 400 square feet of office space in Berwyn, Pennsylvania, pursuant to a short-term lease as of November 2019. The Company currently pays base rent in the amount of $1,078 per month.

Legal Proceedings

Intel Matter

In September 2016, the Company initiated an Interference proceeding between the Company and Intel Corporation (“Intel”) with United States Patent and Trademark Office (“USPTO”) for Interference between the Company’s pending patent application covering SVM-Recursive Feature Elimination (“SVM-RFE”) and Intel’s Patent No. 7,685,077, entitled “Recursive Feature Eliminating Method based on a Support Vector Machine”.

On February 27, 2019, the USPTO ruled in favor of the Company on the SVM-RFE Patents. The Patent Trial and Appeal Board of the USPTO issued its decision, finding that the Company is entitled to claim exclusive rights to the SVM-RFE technology. The decision, issued by Administrative Patent Judge James Moore, ordered Intel’s patent to be cancelled. The decision also dismissed Intel’s motions challenging the validity of the Company’s pending claims and issued patents covering SVM-RFE.

On July 23, 2020, the Company filed an infringement lawsuit against Intel. This infringement suit pertains to the Company’s SVM-RFE. The lawsuit was filed in the United States District Court for the Western District of Texas, Waco Division.

Quirk and Bear Matter

On February 7, 2020, two shareholders of the Company, William F. Quirk, Jr. (“Quirk”) and Cindy Bear (“Bear”), filed a motion for a temporary restraining order and preliminary injunction in DeKalb County Superior Court. Among the items in the motion, Quirk and Bear requested to have a special meeting of the shareholders and Quirk and Bear alleged misconduct by the Company and its directors.

On March 2, 2020, Quirk and Bear filed a notice of dismissal in DeKalb County. Quirk and Bear subsequently filed a new lawsuit in Fulton County Superior Court based on substantially similar allegations and seeking similar relief. On March 4, 2020, the Fulton County court ordered a hearing on the emergency motion for a temporary restraining order against the Company for the following day.

At the hearing on March 5, 2020, Quirk and Bear presented their version of the facts through affidavits submitted by both Quirk and Bear, arguing that the affidavits supported the emergency relief they sought. The judge denied the motion and did not enter a temporary restraining order. The court set an evidentiary hearing on Quirk and Bear’s motion for a preliminary injunction for March 27, 2020. Due to the COVID-19 pandemic and multiple requests by Quirk and Bear, the scheduling of the hearing was cancelled and has never taken place.

On September 2, 2020, the Company moved to dismiss the complaint on the grounds that Quirk and Bear lacked standing and failed to state claims for relief. Facing the Company’s motion to dismiss, on September 23, 2020, Quirk voluntarily dismissed the Fulton County case. This was Quirk’s second dismissal of these claims.

On September 25, 2020, the Company filed, among other documents, a Motion for Attorney’s Fees and Expenses. HDC’s motion is made pursuant to O.C.G.A. § 9-11-41(a)(3), which states “the filing of a second notice of dismissal operates as an adjudication upon the merits.” Additionally, the Company noted in its motion that Mr. Quirk’s claims lacked substantial justification, were commenced and maintained without reasonable cause or for an improper purpose, and the Company’s attorneys’ fees and expenses of litigation in the amount of $193,000 are reasonable.

Bear remains a plaintiff in the case. The Company firmly denies Bear’s claims and will continue to vigorously defend itself against these unsubstantiated and unjustified claims. Additionally, Bear has been notified of the Company’s intent to pursue abusive litigation claims against Bear as a result of these claims. 

The Company denies all allegations of improper conduct in the complaint and will continue to defend itself against all allegations.  As a result, the Company has incurred expenses totaling $9,000 and $193,000 for the three and nine months ended September 30, 2020, respectively, related to legal fees associated with this litigation. Although the Company believes that it will ultimately be successful in its defense, there can be no assurance that the Company will be successful in its defense. Should Quirk and Bear be successful, the outcome could have a material adverse effect on the Company.

Venning Matter

On September 24, 2020, the Company accepted service of a lawsuit filed by Laurie Venning (“Venning”) and one of his companies, Vennwest Global Technologies, Inc. (“Vennwest”) from Alberta, Canada. According to recent publications, Venning is involved in additional lawsuits, one of which is against his formal legal counsel, Dentons, who has countersued Venning.

The Vennwest lawsuit contains virtually identical claims against HDC that Quirk and Bear have alleged. In addition, Vennwest is represented by the same law firm that previously withdrew its representation of Bear and Quirk in their lawsuits. As Quirk’s dismissal reflects, the Company believes these claims are without merit and serve only to deplete the Company’s resources to the detriment of its shareholders. Similar to the Quirk and Bear matter, the Company will vigorously defend itself against these baseless claims and evaluate all options against the plaintiffs including, but not limited to, pursuing counterclaims.

The Company denies all allegations of improper conduct in the complaint and will continue to defend itself against all allegations.  As a result, the Company has incurred expenses totaling $2,000 for both the three and nine months ended September 30, 2020, related to legal fees associated with this litigation. Although the Company believes that it will ultimately be successful in its defense, there can be no assurance that the Company will be successful in its defense. Should Venning and Vennwest be successful, the outcome could have a material adverse effect on the Company.

Note 11 – RECENT ACCOUNTING PRONOUNCEMENTS

Fair Value Measurement

On August 28, 2018, Financial Accounting Standards Board (“FASB”) the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” The new standard modifies the disclosure requirements on fair value measurements in Topic 820, “Fair Value Measurement.” Certain requirements were removed such as the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, certain requirements were modified and certain disclosures were added such as the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period. This standard will be effective for the Company on January 1, 2021. The Company is currently evaluating the effects this standard will have, if any, on its financial position, results of operations and cash flows.

Financial Instruments – Credit Losses

In November 2019, the FASB issued ASU No. 2019-10 which provides a framework to stagger effective dates for future major accounting standards and amends the effective dates for certain new accounting standards, including ASU No. 2016-13, “Credit Losses,” to give implementation relief. The new standard, as amended, will replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The Company will be required to use a forward-looking expected credit loss model for accounts receivable, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be adopted upon the effective date for the Company beginning January 1, 2023. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align the Company’s credit loss methodology with the new standard. The Company is currently evaluating the effects this standard will have, if any, on its financial position, results of operations, and cash flows.

Income Taxes

On December 18, 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” This new guidance simplifies the accounting for income taxes by removing certain exceptions such as the exception to the incremental approach for intra period tax allocation when there is a loss from continuing operations and income/gain from other items; and the exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. The new guidance also simplifies the accounting for income taxes under certain circumstances such as requiring that an entity recognize a franchise tax that is partially based on income as an income-based tax and account for any incremental amount incurred as a non-income-based tax; requiring that an entity evaluate when a step up in the tax basis of goodwill should be considered part of a business combination in which the book goodwill was originally recognized and when it should be considered a separate transaction; and requiring that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. This standard will be effective for the Company on January 1, 2021. The Company is currently evaluating the effects this standard will have, if any, on its financial position, results of operations and cash flows.

Note 12 – FINANCIAL CONDITION AND GOING CONCERN

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

The Company’s 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 the Company’s technologies to the market.  The outcome of these matters cannot be predicted at this time.  The Company’s 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 the Company be unable to continue in business.

If the going concern assumption was not appropriate for the Company’s financial statements then adjustments would be necessary in the carrying value of assets and liabilities, the reported expenses and the balance sheet classifications used.  Such adjustments may be material. 

At September 30, 2020, the Company had $1.3 million cash on hand. As a result, the Company estimates cash will be depleted by the first quarter of 2022 if the Company does not generate sufficient cash to support operations.

The Company’s plan to have sufficient cash to support operations is comprised of generating revenue through providing services related to the Company’s patents, pursuing infringement opportunities and obtaining additional equity or debt financing.

The Company believes the funds received from the NeoGenomics arbitration award will allow the Company to maintain operations until first quarter 2022. While the Company believes these efforts will allow the Company to continue operations, there is no guarantee the Company will be successful in these efforts.  

As previously disclosed in the Company’s Annual Report filed on Form 10-K dated May 12, 2020, the Company estimated that cash resources available to meet its ongoing obligations would extend to the second quarter 2023. However, as a result of the additional costs associated with the Company’s defense of the shareholder litigation brought by Quirk, Bear and Venning, we now anticipate that our current cash resources will allow operations to continue until the first quarter of 2022. This represents an estimated reduction of 1.5 years available to the Company to pursue its business plans. The Company continues to believe that these suits are baseless and continues to vigorously defend itself. These suits and the legal expenses associated therewith represent an unnecessary distraction of management time and effort as well as a drain on the Company’s limited cash resources. The Company believes the claims in the Bear and Quirk matter and the Venning matter are without merit and serve only to deplete the Company’s resources to the detriment of its shareholders.

Note 13 – SUBSEQUENT EVENTS

The Company has evaluated subsequent events through the filing of this Quarterly Report on Form 10-Q, and determined that there have been no events that have occurred, other than those previously disclosed, that would require adjustments to our disclosures 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 “Risk Factors” section to our Annual Report for the fiscal year ended December 31, 2019.

Overview

The objective of our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are to provide users of our financial statements with the following:

Our MD&A is provided as a supplement to, and should be read together with, our unaudited financial statements for the three and nine months ended September 30, 2020 and 2019, included in Part I, Item 1 of this Form 10-Q and our audited financial statements included in Part II, Item 8 of our Form 10-K for the year ended December 31, 2019.

Business Overview

Health Discovery Corporation (the “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. We operate primarily in the field of molecular diagnostics where such tools are critical to scientific discovery. The terms artificial intelligence (“AI”) and machine learning are sometimes used to describe pattern recognition tools.

Our principal asset is our intellectual property, which includes advanced mathematical algorithms called Support Vector Machines (“SVM”), as well as biomarkers that we discovered by applying our SVM 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 31 patents that have been issued or are currently pending around the world. While 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, our SVM assets in particular have broad applicability in many other fields. Intelligently applied, our pattern recognition technology can be a portal between enormous amounts of otherwise undecipherable data and truly meaningful discovery. 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. Today, our commercialization efforts include utilization of our discoveries and knowledge to help develop diagnostic and prognostic predictive tests; licensing of the SVM 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.

Intellectual Property Developments and Patent Defense Matters

As previously disclosed in our Form 10-K, the Company submitted Patent Application Number 14/754,434 (the “Patent”) to the United States Patent and Trademark Office (“USPTO”).

The Company subsequently announced that the USPTO has issued a Notice of Allowance of this Patent covering the four-gene prostate cancer test developed using its proprietary SVM-RFE technology.  The allowed claims cover a method for screening for and treating prostate cancer by measuring expression levels of the four genes within a patient sample compared to one or more reference genes and generating a prediction score based on the averaged relative expression levels.  This Notice of Allowance is important after encountering the significant barriers to patenting of biomarkers that had been raised by the U.S. Supreme Court’s controversial decisions in Mayo Collaborative Services v. Prometheus Laboratories and Association for Molecular Pathology v. Myriad Genetics. This Patent complements the Company’s already issued European Patent that covers similar claims.

The Company believes that this Patent demonstrates the ability of the Company’s proprietary technology in the discovery and validation of biomarkers for diseases. The Company believes this same method can be applied to numerous different diseases and will explore opportunities with partners to deploy these same methods using its proprietary technology in biomarker discovery.

The Company now holds the exclusive rights to 31 issued U.S. patents covering uses of SVM and FGM technology for discovery of knowledge from large data sets. The Company also has 1 pending U.S. patent application covering uses of the SVM technology as well as diagnostic methods that have been discovered using the SVM technology.

Intel Matter

As previously disclosed in September 2016, the USPTO had declared an Interference between the Company’s SVM-RFE Patent application and Intel Corporation’s Patent No. 7,685,077, entitled “Recursive Feature Eliminating Method based on a Support Vector Machine”.   The Interference was an administrative proceeding within the USPTO used to determine which party was the first to invent an invention that was claimed in two (or more) independently owned patent applications.  Subsequently, on February 27, 2019, the USPTO ruled in favor of the Company on the SVM-RFE Patent application. The Patent Trial and Appeal Board (“PTAB”) of the USPTO issued its decision, finding that the Company is entitled to claim exclusive ownership rights to the SVM-RFE technology as set forth in the SVM-RFE Patent application that was filed to provoke the Interference.  The decision ordered Intel Corporation’s Patent No. 7,685,077 to be cancelled.  The decision also dismissed Intel Corporation’s motions challenging the validity of Health Discovery Corporation’s pending claims and issued patents covering SVM-RFE.

In September 2019, the USPTO issued U.S. Patent No. 10,402,685 (“SVM-RFE Patent”) for Health Discovery Corporation’s patent application covering SVM-RFE.  Health Discovery Corporation now owns four patents in the United States and five international patents related to SVM-RFE and is the sole owner of all patents related to SVM-RFE. Furthermore, the USPTO, granted a Patent Term Adjustment (“PTA”) to the SVM-RFE Patent. The PTA is 1,785 days (almost 5 years), which is added to the normal 20-year-from-filing patent term. The USPTO granted this adjustment to offset delays that occurred within the USPTO during the examination process and interference proceedings.  This means the SVM-RFE Patent term has been extended from August 7, 2020 to June 7, 2025.

As a result of the issuance of the SVM-RFE Patent, Health Discovery Corporation now has the right to exclude others from developing, commercializing or licensing this patented technology without the uncertainty of the Interference or concerns over the ownership of the SVM-RFE patents. On July 23, 2020, the Company filed a patent infringement lawsuit against Intel. This infringement suit pertains to Health Discovery’s SVM-RFE. The lawsuit was filed in the United States District Court for the Western District of Texas, Waco Division.

COVID-19

In March 2020, the World Health Organization declared the outbreak of COVID-19 to be a pandemic. The COVID-19 pandemic is having widespread, rapidly evolving and unpredictable impacts on global society, economies, financial markets and business practices. Federal and state governments have implemented measures in an effort to contain the virus, including social distancing, travel restrictions, border closures, limitations on public gatherings, work from home, and closure of non-essential businesses. The COVID-19 pandemic has impacted and may continue to impact our business operations, including our employees, customers, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time.

The intense focus on COVID-19 has also led to the suspension of clinical trials and research projects relating to other conditions, which may impact our ability to form new contractual arrangements to exploit our technology. While the potential economic impact brought by and the duration of the pandemic may be difficult to assess or predict, it has already caused, and is likely to result in further, significant disruption of global financial markets, which may reduce our ability to access capital either at all or on favorable terms. In addition, a recession, depression or other sustained adverse market event resulting from the spread of the coronavirus could materially and adversely affect our business and the value of our common stock.

The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors which we cannot reasonably predict, including the duration and scope of the pandemic; governmental, business and individuals’ actions in response to the pandemic; and the impact on economic activity including the possibility of recession or financial market instability. These factors may materially and adversely affect our business and financial condition.

RESULTS OF OPERATIONS

Three and Nine Months Ended September 30, 2020 Compared with Three and Nine Months Ended September 30, 2019

Revenue for the three months ended September 30, 2020 was zero compared with $370 for the three months ended September 30, 2019. The revenue earned during the nine months ended September 30, 2019 was primarily related to licensing revenue from the NeoGenomics arbitration award in April 2019.

In April 2019, we were awarded $1.5 million from NeoGenomics, related to the decision by the arbitration panel for its conclusion that NeoGenomic’s SmartFlow infringes a Valid Patent Claim and internal use by NeoGenomics is subject to Milestone and Royalty payments (as defined under the Master License Agreement, or MLA).

We were awarded an additional $5.1 million based on the Panel’s conclusion that NeoGenomics failed to use its best efforts with respect to the development and commercialization of SVM-CYTO, and the Panel further held that the MLA was terminated with the exception of certain obligations including NeoGenomics’ obligations to make payment of any sum due to HDC pursuant to Article 3 of the MLA, license fees and royalty payments. The $5.1 million payment was received in the second quarter of 2019 and recorded to other income as further discussed below.

Operating and Other Expenses

Amortization expense was zero for both the three and nine months ended September 30, 2020 compared to $22,000 and $153,000, respectively, for the three and nine months ended September 30, 2019. Our patent assets were fully amortized as of December 31, 2019 and September 30, 2020, and as a result, no further amortization is expected.

Professional and consulting fees were $38,000 for the three months ended September 30, 2020, compared with $14,000 for the three months ended September 30, 2019, and $230,000 for the nine months ended September 30, 2020 compared with $57,000 for the nine months ended September 30, 2019. The increase was due to higher accounting fees related to bringing the Company’s filings with the Securities and Exchange Commission current.

Legal fees were $101,000 for the three months ended September 30, 2020 compared to $6,000 during the same period in 2019, and $286,000 for the nine months ended September 30, 2020 compared to $78,000 for the nine months ended September 30, 2019. Legal fees in the prior year and current year-to-date period related primarily to the lawsuit brought by Quirk and Bear. In the three months ended September 30, 2020, we incurred $56,000 related to the Intel matter.

Compensation expense decreased to $103,000 for the three months ended September 30, 2020 compared to $145,000 for three months ended September 30, 2019 due primarily to $25,000 of bonuses in the 2019 period. Compensation expense was $339,000 for the nine months ended September 30, 2020, compared to $311,000 for the nine months ended September 30, 2019. The higher compensation expense for the nine months ended September 30, 2020 was due to additional personnel and increased salaries.

Other general and administrative expense increased slightly to $48,000 for the three months ended September 30, 2020, compared to $41,000 for the same period in 2019, due primarily to increased costs related to filing with the SEC. Other general and administrative expenses decreased to $533,000 for the nine months ended September 30, 2020 compared to $700,000 for the comparable period in 2019, due to lower directors’ stock-based compensation, partially offset by expenses related to our annual shareholder meeting and higher rent.

Loss from Operations for the three months ended September 30, 2020 was $290,000, compared to $228,000 for the three months ended September 30, 2019, related to the increases in expenses discussed above. Loss from operations for the nine months ended September 30, 2020 was $1.4 million compared to income from operations of $220,000 in the nine months ended September 30, 2019. The significant decrease in the year-to-date period was primarily due to a reduction in revenue from arbitration.

Other Income and Expense. As previously disclosed, the Company was awarded $5.1 million in an arbitration award related to the NeoGenomics litigation in the second quarter of 2019, and recorded net of $3.6 million in related expenses. This resulted in net proceeds from arbitration of $1.5 million during the nine months ended September 30, 2019.

The Company recorded a decrease in the common stock warrants liability of $992,000 during the nine months ended September 30, 2020, and reclassified the common stock warrants liability to equity as of September 30, 2020, as our shareholders approved the necessary increase in authorized share capital at our annual shareholder meeting held in May 2020.

Net loss for the three months ended September 30, 2020 was $295,000 compared to $237,000 for the three months ended September 30, 2019. The increase was primarily due to increased expenses as discussed above. Net loss for the nine months ended September 30, 2020 was $400,000 compared to net income of $1.7 million for the nine months ended September 30, 2019. The decrease was due primarily to the decrease in proceeds from arbitration, partially offset by the decrease in the common stock warrants liability.

Diluted loss per share was $0.001 for both the three-month periods ended September 30, 2020 and 2019. Diluted loss per share was $0.001 in the nine months ended September 30, 2020 compared to diluted earnings per share of $0.004 per share in the nine-month period in 2019.

Liquidity and Capital Resources

Introduction

We have relied primarily on equity and debt financing for liquidity, and most recently, proceeds from intellectual property litigation or arbitration. The Company produced sales, licensing, and developmental revenue starting in late 2005 and must increase revenues in order to generate sufficient cash to continue operations. Our plan to have sufficient cash to support operations is comprised of:

We are pursuing licensing activity and collaborations to increase revenue. Additionally, we are evaluating options to secure funding for infringement activities to protect our proprietary technology or other forms of fund-raising either in the debt or equity markets. None of these options are definitive and there is no guarantee we will be successful in these fund-raising efforts. In addition, while the potential economic impact brought by and the duration of the COVID-19 pandemic may be difficult to assess or predict, it has already caused, and is likely to result in further, significant disruption of global financial markets, which may reduce our ability to access capital either at all or on favorable terms. At September 30, 2020, we had $1.3 million in cash and total current liabilities of $562,000. We estimate cash will be depleted by the first quarter of 2022 unless we are able to increase revenues or raise additional capital.

As previously disclosed in the Company’s Annual Report filed on Form 10-K dated May 12, 2020, the Company estimated that cash resources available to meet its ongoing obligations would extend to the second quarter 2023. However, as a result of the additional costs associated with the Company’s defense of the shareholder litigation brought by Quirk, Bear and Venning, we now anticipate that our current cash resources will allow operations to continue until the first quarter of 2022. This represents an estimated reduction of 1.5 years available to the Company to pursue its business plans. The Company continues to believe that these suits are baseless and continues to vigorously defend itself. These suits and the legal expenses associated therewith represent an unnecessary distraction of management time and effort as well as a drain on the Company’s limited cash resources. The Company believes the claims in the Bear and Quirk matter and the Venning matter are without merit and serve only to deplete the Company’s resources to the detriment of its shareholders.

Short-term borrowings

Our principal commitments consist of our obligations under our operating leases which are short-term in nature. In addition, in June 2020, we settled accrued wages in the amount of $212,000 through the issuance of a convertible promissory note in the same amount with our chief executive officer. The note bears interest at an 8% annual interest rate and is convertible at the option of the holder into shares of our common stock at a conversion price of 0.0138 shares of common stock. See further discussion in Note 8 – Convertible Debt.

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.

Critical Accounting Policies and Estimates

Refer to Note 2 – Significant Accounting Policies.

Recent Accounting Pronouncements

Refer to Note 11 – Recent Accounting Pronouncements.

Not Applicable.

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, who is also serving as our Principal Executive Officer and our President 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 Chief Executive Officer and President concluded that, as of the Evaluation Date, because of the Company’s internal control weakness, our disclosure controls and procedures were not 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 and President, 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.

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, 2019 because we do not have an adequate segregation of duties due to a limited number of employees among whom duties can be allocated. The lack of segregation of duties is due to the limited nature and resources of the Company.

In light of the conclusion that our internal disclosure controls were ineffective as of September 30, 2020, we have applied procedures and processes as necessary to ensure the reliability of our financial reporting in regard to this quarterly report. Accordingly, the Company believes, based on its knowledge, that: (i) this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading with respect to the period covered by this report; and (ii) the financial statements, and other financial information included in this quarterly report, fairly present in all material respects our financial condition, results of operations and cash flows as of and for the periods presented in this quarterly report.

PART II — OTHER INFORMATION

See discussion of legal proceedings under Note 10 – Commitments and Contingencies to the Notes to financial statements.

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, 2019, 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.

None. 

Not applicable.

Not applicable.

None.

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.