Health Discovery (HDVY) 10QSB 2006 Q2 Quarterly report (small business)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2006

[   ] Transition report under Section 13 or 15(d) of the Exchange Act

For the transaction period from ______ to _______

Commission file number 333-62216

HEALTH DISCOVERY CORPORATION 

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

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

5501 ½ Abercorn Street Savannah, Georgia	31405
(Address of principal executive offices)	(Zip Code)

912-352-7488

(Issuer's telephone number, including area code)

(Former name, former address and former fiscal year,

if changed since the last report)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

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

Yes [  ] No [X]  

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS

Check whether the registrant filed all documents and reports required to be filed by Section l2, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes [  ] No [  ]

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 116,163,384 shares of common stock, no par value, were issued and outstanding as of August 10, 2006.

Transitional Small Business Disclosure Format (Check one): Yes [  ] No [X]

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION	Page
Item 1.	Financial Statements
	Balance Sheet	1
	Statements of Operations	2
	Statements of Cash Flows	3
	Notes to Unaudited Financial Statements	4-7
Item 2.	Management’s Discussion and Analysis or Plan of Operation	7-11
Item 3.	Controls and Procedures	11
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	11-12
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	12
Item 6.	Exhibits	12-13
	Signatures	14

HEALTH DISCOVERY CORPORATION

Balance Sheet

(unaudited)

Assets
	June 30,
	2006
Current Assets
Cash	$	244,078
Prepaid Expenses and Other Assets		37,020
Total Current Assets		281,098
Equipment, Less Accumulated Depreciation of $10,168		10,046
Other Assets
Patents, Less Accumulated Amortization of $548,895		3,436,900
Total Assets	$	3,728,044
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts Payable - Trade	$	355,559
Accrued Liabilities		227,036
Total Current Liabilities		582,595
Convertible Notes Payable		665,643
Long-Term Debt		321,911
Total Liabilities		1,570,149
Commitments
Stockholders’ Equity
Common Stock, No Par Value, 200,000,000 Shares Authorized
116,163,384 Shares Issued and Outstanding		10,272,316
Accumulated Deficit		(8,114,421	)
Total Stockholders' Equity		2,157,895
Total Liabilities and Stockholders' Equity	$	3,728.044

See accompanying notes to unaudited financial statements.

1

HEALTH DISCOVERY CORPORATION

Statements of Operations

(unaudited)

For the Six Months Ended June 30, 2006 and 2005

	Three			Three			Six			Six
	Months			Months			Months			Months
	Ended			Ended			Ended			Ended
	June 30,			June 30,			June 30,			June 30,
	2006			2005			2006			2005
Revenues:
Licensing	$	70,000			-			175,000			-
Total Revenues		70,000			-			175,000			-
Cost of Sales:
Internal Development		9,654			-			9,654			-
Total Cost of Sales		9,654			-			9,654			-
Gross Profit		60,346			-			165,346			-
Operating Expenses:
Amortization		65,679			62,778			131,359			119,597
Professional and Consulting Fees		174,036			384,057			747,265			832,099
Compensation		200,724			169,612			560,022			369,155
Other General and Administrative Expenses		95,204			198,166			335,415			404,531
Total Operating Expenses		535,643			814,613			1,774,061			1,725,382
Loss From Operations		(475,297	)		(814,613	)		(1,608,715	)		(1,725,382	)
Other Income (Expense)
Interest Income		3,169			-			7,999			-
Gains on Restructuring of Accounts Payable		-			-			77,546			-
Interest Expense		(21,107	)		(14,391	)		(40,852	)		(31,542	)
Total Other Income (Expense)		(17,938	)		(14,391	)		44,693			(31,542	)
Net Loss	$	(493,235	)		(829,004	)		(1,564,022	)		(1,756,924	)
Weighted Average Outstanding Shares		116,113,384			99,826,460			115,534,813			92,531,807
Loss Per Share	$	(.00	)		(.01	)		(.01	)		(.02	)

See accompanying notes to unaudited financial statements.

2

HEALTH DISCOVERY CORPORATION

Statements of Cash Flows

(unaudited)

For the Six Months Ended June 30, 2006 and 2005

	Six Months			Six Months
	Ended			Ended
	June 30, 2006			June 30, 2005
Cash Flows From Operating Activities:
Net Loss	$	(1,564,022	)		(1,756,924	)
Adjustments to Reconcile Net Loss to Net Cash
Used by Operating Activities:
Stock-based compensation expense		220,158			-
Stock issued for professional and consulting services		365,743			-
Services Exchanged for Common Stock		-			178,876
Gains on Restructuring of Accounts Payable		(77,546	)		-
Depreciation and Amortization		134,868			121,720
Increase in Employee Advances		-			(11,216	)
Increase in Prepaid Expenses and Other Assets		(19,312	)		(18,462	)
Increase in Accounts Payable - Trade		220,587			43,042
Increase in Accrued Liabilities		163,717			28,510
Net Cash Used by Operating Activities		(555,807	)		(1,414,454	)
Cash Flows From Investing Activities:
Purchase of Equipment		(502	)		(5,881	)
Amounts Paid to Acquire Patents		-			(293,738	)
Net Cash Used by Investing Activities		(502	)		(299,619	)
Cash Flows From Financing Activities:
Repayments of Notes Payable		(26,780	)		(293,279	)
Proceeds from Sales of Common Stock, Net Proceeds from Exercise of Stock Options and Warrants		100,000 8,000			2,358,500 -
Net Cash Provided by Financing Activities		81,220			2,065,221
Net Increase (Decrease) in Cash		(475,089	)		351,148
Cash, at Beginning of Period		719,167			163,477
Cash, at End of Period	$	244,078			514,625
Non-Cash Investing and Financing Transactions:
Patents Purchased Using Debt	$	-			185,272
Stock Issued for Professional and Consulting Services	$	365,743			238,276
Stock-based compensation expense	$	220,158			-
Non-cash Stock Issuance Costs	$	-			166,451
Warrants Issued in Restructuring of Accounts Payable	$	55,454			-
Stock Issued for Convertible Notes Payable	$	-			409,616
Supplemental disclosures of cash flow information:
Cash Paid for Interest	$	1,056			2,774

See accompanying notes to unaudited financial statements.

3

HEALTH DISCOVERY CORPORATION

Notes to Unaudited Financial Statements

Note A - BASIS OF PRESENTATION

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

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

The interim financial statements included in this report are unaudited but reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the period ended June 30, 2006 are not necessarily indicative of the results of a full year’s operations. For further information, refer to the financial statements and footnotes included in the Company’s annual report on Form 10-KSB for the year ended December 31, 2005.

RECLASSIFICATIONS

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

Note B - NET LOSS PER SHARE

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

Note C - STOCK-BASED COMPENSATION

Effective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment (“SFAS No. 123(R)”) using the modified prospective transition method provided for under the standard. SFAS 123(R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee’s requisite service period. We had previously applied Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations and provided the required pro forma disclosures of SFAS No. 123.

The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation for periods presented prior to the Company’s adoption of Statement 123(R):

4

HEALTH DISCOVERY CORPORATION

Notes to Unaudited Financial Statements, continued

Note C - STOCK-BASED COMPENSATION, continued

	Three months ended			Six months ended
	June 30, 2005			June 30, 2005
Net loss as reported	$	(829,004	)	$	(1,756,924	)
Deduct: Stock-based Expense Determined Under Fair Value Based Method for Employee Stock Options		-			-
Proforma Net Loss	$	(829,004	)	$	(1,756,924	)
Stock-based Expense Included in Net Loss	$	163,276		$	238,276
Loss Per Share:
Basic - As Reported	$	(.01	)	$	(.02	)
Basic - Proforma	$	(.01	)	$	(.02	)

Stock-based expense included in our net loss for the three and six months ended June 30, 2006 consisted of $90,314 and $585,901, respectively, in compensatory warrants and options for professional and consulting services and compensation. Stock-based expense included in our net loss for the three and six months ended June 30, 2005 consisted of $163,276 and $238,276, respectively, for the issuance of common stock to consultants for services.

As of June 30, 2006, there was approximately $621,012 of unrecognized cost related to stock option and warrant grants. The cost is to be recognized over the remaining vesting periods that averages approximately 2 years.

The Company granted 2,000,000 options during the first quarter of 2006. The fair value of each option granted in 2006 was $0.11 and was estimated on the date of grant using the Black-Scholes pricing model with the following assumptions: dividend yield at 0%, risk-free interest rate of 5.00%, an expected life of 10 years, and volatility of 133%. Expected option lives and volatilities used in the fair valuation calculations are based on historical data of the Company and the related expense is recognized on a straight-line basis over the vesting period. No options were granted in the second quarter of 2006 or during the six month period ending June 30, 2005.

The following schedule summarizes stock option activity for the six months ended June 30, 2006:

	Option			Weighted Average
	Shares			Exercise Price
Outstanding, December 31, 2005		2,500,000		$	0.08
Granted		2,000,000			0.11
Exercised		(600,000	)		0.01
Forfeited		(400,000	)		0.10
Outstanding, June 30, 2006		3,500,000		$	0.11

The weighted average remaining life of the outstanding options at June 30, 2006 is 10 years.

There were 1,750,000 options exercisable at June 30, 2006. The exercisable options have a weighted average exercise price of $0.11 and a weighted average remaining life of 10 years.

5

HEALTH DISCOVERY CORPORATION

Notes to Unaudited Financial Statements, continued

Note C - STOCK-BASED COMPENSATION, continued

Information about warrants outstanding at June 30, 2006 is summarized below:

Exercise Prices	Number Outstanding		Weighted- Average Remaining Contractual Life (years)		Number Exercisable		Weighted Average Remaining Contractual Life (years) of Exercisable Warrants
$0.01		1,200,000		1		600,000		1
$0.08		600,000		1		600,000		1
$0.10		565,000		3		365,000		3
$0.11		1,000,000		3		500,000		3
$0.12		150,000		3		150,000		3
$0.13		5,500,000		5		2,500,000		3
$0.15		1,000,000		3		1,000,000		3
$0.20		500,000		2		500,000		2
$0.22		500,000		3		500,000		3
$0.24		32,546,250		3		32,546,250		3
$0.35		15,235,000		1		15,235,000		1
		58,796,250				54,496,250

During 2006, the Company issued 2,600,000 warrants to consultants and other service providers with a weighted-average exercise price of $0.13 per share. A total of $258,724 was recorded as Paid in Capital for Compensatory Warrants. The warrants became exercisable upon issuance.

The Company issued 3,000,000 warrants to two directors with an exercise price of $0.13 per share. A total of $29,625 was recorded as Paid in Capital for Compensatory Warrants. The warrants vest at a rate of 500,000 warrants (250,000 warrants for each director) after satisfactory completion of each 6 months of service until 3 years of service has been completed. The expense is being recorded over the service period.

The Company issued 1,000,000 warrants to a director with an exercise price of $0.15 per share in conjunction with a common stock sale. The Company has ascribed no value to the warrants associated with the common stock sale described in Note E.

The Company issued 765,000 warrants to three of its service providers with a weighted-average exercise price of $0.11 in settlement of certain accounts payable due to the service providers. The Company recorded a total of $55,454 as Paid in Capital for Compensatory Warrants and recognized total gains of $77,546 as a result of the restructuring the accounts payable amounts.

In addition, the Company recorded a total of $16,916 during 2006 as Paid in Capital for Compensatory Warrants associated with previous warrant grants that have not fully vested. The expense is being recorded over the service period.

During the second quarter of 2006, the Company issued 500,000 warrants to two employee members of its Scientific Advisory Board. These warrants vest over a one-year period and have an exercise price of $0.11. The Company also issued 200,000 warrants to a service provider in exchange for professional services. These warrants vest over a two-year period and have an exercise price of $0.10. The estimated value of these warrants is being recorded to expense over the respective service periods.

Note D - PATENTS

The Company has acquired a group of patents related to biotechnology and certain machine learning tools used for diagnostic and drug discovery. Additionally, legal costs associated with patent acquisitions and the application process are also capitalized as a part of patents. The Company has recorded as other assets $3,436,900 in patents and patent related costs, net of $548,895 in accumulated amortization, at June 30, 2006.

6

HEALTH DISCOVERY CORPORATION

Notes to Unaudited Financial Statements, continued

Note D - PATENTS, continued

Amortization charged to operations for the six months ended June 30, 2006 and 2005 was $131,359 and $119,597, respectively. Amortization charged to operations for the three months ended June 30, 2006 and 2005 was $65,679 and $62,778, respectively. The weighted average amortization period for patents is 14 years. Estimated amortization expense for the next five years is $262,575 per year.

Note E - STOCKHOLDERS’ EQUITY

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

In addition, the Company sold 1,000,000 shares of its common stock to one of its directors for $100,000. The shares were sold for $0.10 per share which was the closing price of the stock on the date of the sale. As part of the purchase, the director also received warrants to purchase an additional 100,000 shares of the Company’s common stock at a fixed price of $0.15 per share until December 2008. No portion of the proceeds was assigned to the value of the warrants because the exercise price of the warrants exceeded the market value of the underlying common stock on the date of purchase.

During the second quarter of 2006, 200,000 warrants were exercised at $0.01 each. The Company issued 200,000 shares of its common stock and recorded the proceeds of $2,000.

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

Corporate Overview

Our Company is uniquely positioned in the field of pattern recognition technology. Through the application of our patent protected technology, the Company is a biology-oriented biomarker and pathway discovery company providing all aspects of First-Phase Biomarker Discovery. Our primary business consists of licensing that intellectual property and working with prospective customers on the development of varied products that utilize pattern recognition tools. We also endeavor to develop our own product line of newly discovered biomarkers and pathways that include human genes and genetic variations, as well as gene, protein, and metabolite expression differences. In drug discovery, biomarkers can help elicit disease targets and pathways and validate mechanisms of drug action. They may also be pharmacodynamic indicators of drug activity, response and toxicity for use in clinical development.

We intend to provide pharmaceutical and diagnostic companies with all aspects of first phase diagnostic and drug discovery, from expert assessment of the clinical dilemma through proper selection and procurement of high quality specimens. We will then apply our proprietary analytical evaluation methods and state-of-the-art computational analysis to derive relevant and accurate clinical data, producing accurate biomarker and pathway discoveries, resulting in patent protection of our biomarker discoveries for future development.

First Phase Biomarker Discovery is based on the belief that in order to discover the most clinically relevant biomarkers, the computational component must begin at the inception of the clinical dilemma to be solved. This process includes several critical levels of decision-making - all of which are part of our business strategy.

We intend to produce more relevant and predictable biomarkers for drug discovery so that new and better medicines and diagnostic markers can be developed for patients worldwide.

7

Three Months Ended June 30, 2006 Compared with Three Months Ended June 30, 2005

Revenue

For the three months ended June 30, 2006, revenue was $70,000 compared with no revenue for the three months ended June 30, 2005, which was reported as a developmental stage company. Revenue was recognized for licensing and development fees.

During most of the second quarter and first half of 2006, the Company was engaged in intensive negotiations with a U.S. medical diagnostic company for exclusive, worldwide licensing and product development agreements in the tissue- and serum-based cancer diagnostics field. The potential revenue was so significant and dependent in large part on the exclusive nature of the relationship that the Company suspended and did not initiate new discussions with other parties in order to preserve the exclusivity feature for this company. Just prior to closing, this prospective licensee abruptly suspended final negotiations pending the resolution of certain of its internal issues unrelated to the transaction. As a result, because the Company generated no revenue from this company with respect to the contemplated transaction or from any new sources during such period, and also expended significant cash resources, our cash position declined. The Company cannot say if this company's internal issues will be resolved or, if they are, whether this transaction will be completed on terms favorable to the Company or at all. In any event, the Company’s management has now resumed its business development strategy and reduced certain expense categories in an attempt to safeguard its financial viability.

Cost of Sales and Gross Margin

Internal development costs of $9,654 were recorded as cost of sales for the second quarter of 2006. Cost of sales includes all direct costs associated with the acquisition and development of patents and processes sold. All direct costs, primarily professional fees associated with licensing negotiations, are also included in cost of sales. No such direct costs were incurred during the second quarter of 2005.

Operating Expenses

Amortization expense was $65,679 for the second quarter of 2006 compared with $62,778 for the second quarter of 2005. This increase was due to amortization being charged in 2006 for intangibles acquired throughout 2005.

Professional and consulting fees totaled $174,036 for the second quarter of 2006 compared with $384,057 for the second quarter of 2005. These fees, related to legal, accounting and scientific activities, were lower in 2006 because of efforts to control costs related to regulatory filing activity, patent protection efforts, and general corporate legal and accounting work.

Compensation of $200,724 for the second quarter of 2006 was higher than the $169,612 reported for the second quarter of 2005. This increase was due to the implementation of SFAS 123(R) favorably offset by a reduction in salaries due to reduced headcount.

Other general and administrative expenses decreased from $198,166 for the second quarter of 2005 to $95,204 for the second quarter of 2006. This decrease was largely due to increased cost containment efforts undertaken throughout the period.

Loss from Operations

The loss from operations for the second quarter of 2006 was $475,297 compared to $814,613 for the second quarter of 2005. This reduction in loss was largely due to increased cost reduction efforts as enumerated above.

Other Income and Expense

Interest income was $3,169 for the second quarter of 2006. No interest income was earned in 2005.

Interest expense was $21,107 in the second quarter of 2006 compared with $14,391 in the second quarter of 2005. This increase was due to interest being charged in 2006 for the debt assumed in 2005, as well as the higher interest rate associated with the renegotiated promissory notes.

8

Net Loss

The net loss for the second quarter of 2006 was $493,235 compared to $829,004 for the second quarter of 2005. The reduced loss was due to the diminished loss from operations, offset by the increased interest expense.

Net loss per share was $0.00 for the second quarter of 2006 compared to the net loss per share of $0.01 for 2005. The smaller net loss per share in 2006 was due to the smaller net loss and the increased average number of shares outstanding in 2006.

Six Months Ended June 30, 2006 Compared with Six Months Ended June 30, 2005

Revenue

For the six months ended June 30, 2006, revenue was $175,000 compared with no revenue for the six months ended June 30, 2005, which was reported as a developmental stage company. Revenue was recognized for licensing and development fees.

Cost of Sales and Gross Margin

Cost of sales for the 2006 period was $9,654. Cost of sales includes all direct costs associated with the acquisition and development of patents and processes sold. All direct costs, primarily professional fees associated with licensing negotiations, are also included in cost of sales. No such direct costs were incurred during the six month period ending June 30, 2005.

Operating Expenses

Amortization expense was $131,359 for the six months ended June 30, 2006 compared with $119,597 for the comparable period in 2005. This increase was due to amortization being charged in 2006 for intangibles acquired during 2005.

Professional and consulting fees totaled $747,265 for six months ended June 30, 2006 compared with $832,099 for the six months ended June 30, 2005. These fees, related to legal, accounting and scientific activities, were lower in 2006 because of continued efforts to control costs related to regulatory filing activity, patent protection efforts, and general corporate legal and accounting work. The amount for 2006 includes $421,198 in compensatory warrants issued to consultants for services. No compensatory warrants were issued to consultants for services during the six months ended June 30, 2005.

Compensation of $560,022 for the six months ended June 30, 2006 was higher than the $369,155 reported for the comparable period of 2005. This increase was due to the implementation of SFAS 123(R) favorably offset by a reduction in salaries due to reduced headcount.

Other general and administrative expenses decreased from $404,531 in 2005 to $335,415 in 2006. This decrease was largely due to expense reduction efforts throughout the entire 2006 period.

Loss from Operations

The loss from operations for the six months ended June 30, 2006 was $1,608,715 compared to $1,725,382 for the prior year. The decreased loss was due to the factors enumerated above.

Other Income and Expense

Interest income was $7,999 for the six months ended June 30, 2006. No interest income was earned in 2005.

A gain on the restructuring of accounts payable of $77,546 was recorded in the first quarter of 2006 to reflect common stock warrants issued in payment of liabilities. No such amount was recorded in the comparable 2005 period.

Interest expense was $40,852 in 2006 compared with $31,542 in 2005. This increase was due to interest being charged in 2006 for the debt assumed in 2005, as well as the higher interest rate associated with the renegotiated promissory notes.

9

Net Loss

The net loss for the six months ended June 30, 2006 was $1,564,022 compared to $1,756,924 for the six months ended June 30, 2005. The reduced loss was due to the smaller loss from operations and increased net other income.

Net loss per share was $0.01 and $0.02 for the six months ended June 30, 2006 and 2005, respectively. The smaller net loss in 2006 compared to that in 2005 was due to the smaller net loss and the increased average number of shares outstanding in 2006.

Liquidity and Capital Resources

At June 30, 2006, the Company had $244,078 in available cash. Cash used by operating activities was $555,807. This was due primarily to the net loss of $1,564,022; however net non-cash expenses and changes in balance sheet accounts of approximately $1,008,000, favorably impacted the computation of the net cash used. Cash used by investment activities was $502 due to the acquisition of assets. Net cash provided by financing activities was $81,220 due to the proceeds from the sale of common stock and the exercise of stock options and warrants, less repayment of debt totaling $26,780.

A portion of our cash will be used to satisfy the Company’s outstanding debt obligations related to the acquisition of the SVM assets and fees due to professionals for services performed.

The following table summarizes the due dates of our contractual obligations. The Company has no long term lease agreements in effect as of June 30, 2006.

	Total		Less than 1 Year		1-3 Years
Convertible Notes Payable	$	665,643	$	-	$	665,643
Term Debt		321,911		-		321,911
Total	$	987,554	$	-	$	987,554

The Company has relied primarily on equity funding plus debt financing for liquidity during its developmental phase that ended in 2005. The Company produced sales, licensing, and developmental revenue in 2005 and 2006 and must continue to do so in order to generate sufficient cash to continue operations. Our plan to have sufficient cash to support operations is comprised of generating revenue through licensing our significant patent portfolio, providing services related to those patents, and obtaining additional equity or debt financing. We have been and continue to be in meaningful discussions with a variety of parties, which if successful, will result in significant revenue. We have implemented a cash conservation plan that includes salary deferrals, reduction in consulting payments, negotiated settlements with creditors whereby we substituted equity instruments for amounts owed, and a heightened scrutiny of all potential expenditures.

Should it prove necessary, the Company may also consider such alternatives as raising additional equity through private placements and/or debt offerings. Although this raises doubt with respect to our ability to operate as a going concern, the Company believes that it has sufficient capability to operate through the next twelve months.

Off-Balance Sheet Arrangements

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

Subsequent Events and Developments

After final negotiations for exclusive licensing and development agreements with a U.S. medical diagnostics company were suspended late in the second quarter of 2006, the Company immediately redirected its attention to other revenue-generating opportunities in licensing, product development and consulting. Below is a summary of the status of several of these undertakings.

On June 26, 2006, the Company filed lawsuits in the United States District Court for the Eastern District of Texas against Ciphergen Biosystems, Inc. and Equbits LLC for infringing certain of the Company’s patents related to SVM technology.  The Company granted a request by Equbits for an extension to respond, and is now in preliminary discussions with Equbits to resolve this matter.  Ciphergen has also requested an extension to respond, which the Company has granted.

10

On August 1, 2006, the Company and Bruker Daltronics Inc. signed a non-exclusive licensing agreement for the use of the Company’s  patented SVM technology for Bruker’s ClinProTool diagnostic equipment.

On August 3, 2006, the Company signed an agreement with IPotential, LLC, a San Mateo, California-based firm, to market for the first time the Company’s patented SVMs and other intellectual property within the information technology and communications field.

On August 14, 2006, the Company delivered to a German biotechnology company a draft license agreement comporting with a previously agreed upon term sheet for a non-exclusive license for the use of the Company’s patented SVM technology in the field of methylation and genomic analysis.

In the third quarter of 2006, the Company advanced to a substantive licensing and product development negotiations with five pharmaceutical and medical diagnostic companies domiciled variously in Canada, Holland and the U.S. with respect to the Company’s  SVMs, prostate cancer biomarkets and BPH biomarkers.  While there is no assurance of any favorable outcome, management believes that reaching satisfactory agreements with one or more of these companies would positively affect the Company.

Forward-Looking Statement

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

Item 3. Controls and Procedures.

As of June 30, 2006 (the “Evaluation Date”), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and President and our Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon this evaluation, our Chief Executive Officer and our Principal Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective under Rule 13a-15.

Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company to disclose material information otherwise required to be set forth in the Company’s periodic reports.

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

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

On May 25, 2004, we filed suit in the District Court of McLennan County, Texas, against Bill G. Williams, Shirley K. Williams, W. Steven Walker, Jerry W. Petermann and a company controlled by Mr. Williams. In this action we allege that an aggregate of 700,000 shares of our common stock (4,900,000 after a 7-1 stock split) issued to Mr. Williams, Mr. Walker, Mr. Braswell and Mr. Petermann were not issued in compliance with Texas law and we sought to restrain the defendants and persons acting on their behalf or in concert with them from selling any shares of our stock. We also requested that the Court declare we were permitted to cancel the shares issued to the defendants and sought monetary damages, attorney’s fees and costs of the action.

In June 2004, Jerry W. Petermann agreed to return to the Company 1,000,000 shares of the Company stock, which were canceled upon return to the Company as full and final settlement of the claims brought in the aforementioned lawsuit. In addition, in June 2004, Robert S. Braswell IV agreed to return to the Company 2,100,000 shares of the company stock, all of which were canceled upon return to the Company.

In July 2004, W. Steven Walker Esq., former general counsel, an officer and director of the Company, agreed to settle with the Company and return 366,036 shares of our common stock, which was all of the shares then owned by him, and he will no longer be a party to the suit. Accordingly, only the shares originally issued to Mr. Williams are subject to the suit, and the Company believes he controls approximately 2.1 million shares of our common stock.

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After several rulings at the District Court, on August 25, 2004 the Court of Appeals for the Tenth District of the State of Texas granted our appeal and entered an order, remanding the case to the original trial judge with instructions to issue a temporary injunction to preserve the status quo. The injunction will remain until a judgment in the case becomes final or the court otherwise instructs. The injunction requires the remaining defendants, their agents, employees, affiliates, any person or entity they control, and any person acting in concert with them to (i) stop and refrain from selling or otherwise disposing of any share of our common stock, and (ii) deposit into the registry of the District Court all shares of our common stock they now own or hold. Costs of the appeal were assessed against the Respondents. The defendants have asserted several counter claims against the Company, including a derivative action, and have brought third-party claims against several current officers of the Company.

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

During the second quarter of 2006, the Company issued 500,000 warrants to two employee members of its Scientific Advisory Board. These warrants vest over a one-year period and have an exercise price of $0.11. The Company also issued 200,000 warrants to a service provider in exchange for professional services. These warrants vest over a two-year period and have an exercise price of $0.10. All of these issuances were made in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended.

Item 6. Exhibits.

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

3.1	Articles of Incorporation. Registrant incorporates by reference Exhibit 3.1 to Registration Statement on Form SB-2,  filed June 4, 2001.
3.1 (a)	Articles of Amendment to Articles of Incorporation.  Registrant incorporates by reference Exhibit 2.2 to Form 10-QSB, filed November 14, 2001.
3.1 (b)	Articles of Amendment to Articles of Incorporation changing Registrant name from Direct Wireless Communications, Inc., to Health Discovery Corporation. Registrant incorporates by reference Exhibit 3.1 (b) to form 10-KSB, filed March 3, 2004.
3.2	By-Laws. Registrant incorporates by reference Exhibit 3.2 to Registration Statement on Form SB-2, filed June 4, 2001.
4.1	Copy of Specimen Certificate for shares of common stock. Registrant incorporates by reference Exhibit 4.1 to Registration Statement on Form SB-2, filed June 4, 2001.
4.1 (b)	Copy of Specimen Certificate for shares of common stock. Registrant incorporates by reference Exhibit 4.1 (b) to Form 10-KSB, filed March 30, 2004.
4.2	Excerpt from By-Laws. Registrant incorporates by reference Exhibit 4.2 to Registration Statement on Form SB-2,  filed June 4, 2001.
4.2(A)	Corrected Article 3.02 of By-Laws. Registrant incorporates by reference Exhibit 4.2(A) to Amendment No. 2 to Registration Statement on Form SB-2, filed August 15, 2001.
4.3(a)	Non Qualified stock option agreements dated October 30, 2003 between registrant and David Cooper. Registrant incorporates by reference Exhibit 4.3(a) to Form 10-KSB, filed March 30, 2004.
10.1	Asset Purchase Agreement between Registrant dated September 15, 2003 and Barnhill Group LLC. Registrant incorporates by reference Exhibit 10.2 to Form 10-KSB, filed March 30, 2004.
10.2	Asset Purchase Agreement between Registrant dated December 30, 2003 and Fractal Genomics LLC. Registrant incorporates by reference Exhibit 10.3 to Form 10-KSB, File No. 333-62216, filed March 30, 2004.
10.3	Employment Agreement with Stephen Barnhill. Registrant incorporates by reference Exhibit 10.3 to Form 10-KSB, filed April 19, 2005. *
10.4	Employment Agreement with David Cooper. Registrant incorporates by reference Exhibit 10.4 to Form 10-KSB, filed April 19, 2005. *

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10.5	Form of Asset Purchase Agreement between the Registrant and the Sellers of the SVM Portfolio and related assets. Registrant incorporates by reference Exhibit 10.5 to Form 10-KSB, filed March 30, 2004.
10.6	Form of Securities Purchase Agreement. Registrant incorporates by reference Exhibit 10.6 to Form 10-KSB, filed April 19, 2005.
10.7	Form of Warrant. Registrant incorporates by reference Exhibit 10.7 to Form 10-KSB, filed April 19, 2005.
10.8	Form of Securities Purchase Agreement. Registrant incorporates by reference Exhibit 10.8 to Form 10-KSB, filed April 19, 2005.

10.9	Form of Warrant. Registrant incorporates by reference Exhibit 10.9 to Form 10-KSB, filed April 19, 2005.
10.10	Form of Amendment to Securities Purchase Agreement. Registrant incorporates by reference Exhibit 10.10 to Form SB-2/A, filed December 14, 2005.
10.11	Employment Agreement with David R. Furth, dated as of December 5, 2005. Registrant incorporates by reference Exhibit 10.11 to Form SB-2/A, filed December 14, 2005.
10.12	Employment Agreement with Robert S. Braswell IV, dated as of January 1, 2006. Registrant incorporates by reference Exhibit 99.1 to Form 8-K, filed February 2, 2006.

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

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SIGNATURES

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

        Health Discovery Corporation

        Registrant

Date: August 14, 2006                   /s/ Stephen D. Barnhill M.D.                                                                     

       Printed Name: Stephen D. Barnhill M.D.

       Title: Chief Executive Officer

Date: August 14, 2006                   /s/ Daniel R. Furth                                                                                     

       Printed Name: Daniel R. Furth

      Title: Chief Financial Officer / Secretary

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