Dear Fellow Shareholders: Since I wrote you this past November 2009, the global economy continues to be deeply shaken, the financial markets are in turmoil, significant unemployment continues and the Gulf has absorbed a massive oil spill. Major health care legislation became U.S. law and will formally incorporate tens of millions of new patients into the health care insurance market. This past year has been historic for these and many other reasons. For Health Discovery Corporation (the “Company”) (OTCBB:HDVY), this has been a time of significant achievement and real progress. We believe the Company overall has never been in a better position for achieving success now and in the future. We continue to be a company on the move and I would like to provide you with a summary of our recent activities. People We have added a number of new people to assist in the growth our business. To our management team we have added Tom Gallagher, a Wall Street securities lawyer and former Vice President of Goldman, Sachs & Co. (NYSE: GS), as Executive Vice President; John Norris, a former Deputy Commissioner of the FDA has joined the Company as COO; and Maher Albitar, M.D., a world-class scientist, inventor and author of more than 250 peer-reviewed medical publications has joined our team as Chief Medical Officer. Dr. Albitar is a globally respected cancer researcher with a combination of both academic and commercial experience having held high-level appointments at Quest Diagnostics, Incorporated (NYSE: DGX), the largest commercial clinical laboratory in the world and MD Anderson Cancer Center, one of the leading cancer centers in the U.S. This past spring we added Paul Graham of Graham Capital Partners to our Board of Directors and have benefited from his 25 years in national and international investment banking, mergers and acquisitions, and finance. Our Science Advisory Board expanded by the addition of Nitesh Chawla, Ph.D., a professor in the Department of Computer Science and Engineering and co-director of the Interdisciplinary Center for Network Science and Applications at the University of Notre Dame, South Bend, Indiana. Dr. Chawla is an expert in machine learning. We are delighted that these professionals have joined the talented team already assembled at Health Discovery Corporation.
Whenever an opportunity presents itself to retain world-class talent, we will do whatever we can to bring such people on to our team.Molecular Diagnostic Product Update We continue to be very pleased with the progress of the clinical trial results related to our 4-gene urine test for "clinically significant" prostate cancer in development with our commercialization partners, Quest Diagnostics, Incorporated (NYSE: DGX) and Abbott Laboratories (NYSE: ABT). We are under confidentiality agreements which prevent me from sharing specific details about the validation studies. Once this test is commercialized, HDC will be paid a royalty on each test performed by both Quest and Abbott. We believe that our 4-gene urine test for prostate cancer will enter the prostate cancer screening market in which there are currently 25 million PSA tests performed annually in the U.S. and an additional 25 million PSA tests performed outside of the U.S. The need for a new prostate cancer test to replace PSA is well documented. In March 2009, the New England Journal of Medicine published the findings of two major studies on prostate cancer screening with PSA and Digital Rectal Exam, one study in the U.S. involving approximately 75,000 men followed for 7 years and the other in Europe involving approximately 180,000 men followed for 9 years. The U.S. study reported “no mortality benefit from combined screening with PSA testing and digital rectal examination during a median follow-up of 11 years.” (See N. Engl. J. Med. 2009; 360:1310-1319, March 26, 2009). The European study concluded that "the rate of over-diagnosis of prostate cancer (defined as the diagnosis in men who would not have clinical symptoms during their lifetime) has been estimated to be as high as 50% in the PSA screening group” (See N. Engl. J. Med. 2009; 360:1320-1328, March 26, 2009) As a result of this study, the American Cancer Society is now warning men and their doctors about the risks of using the PSA test for routine prostate cancer screening.
In a New York Times article by Tara Parker-Pope (March 23, 2009), she writes:"Last week, two major studies from the United States and Europe found that PSA testing — the annual blood test used to screen men for prostate cancer — saves few if any lives, while exposing patients to aggressive and unnecessary treatments that can leave them impotent and incontinent." Ms. Pope continues: “…PSA testing increases a man’s risk of being treated for a cancer that would never have harmed him in the first place. The European study found that for every man who was helped by PSA screening, at least 48 received unnecessary treatment that increased risk for impotency and incontinence. Dr. Otis Brawley, chief medical officer of the American Cancer Society, summed up the European data this way: ‘The test is about 50 times more likely to ruin your life than it is to save your life.’” In a Wall Street Journal article titled, “The Man, The Gland, The Dilemmas,” by Melinda Beck (March 31, 2009) she writes: "You've been getting annual blood tests to check for prostate cancer. But two big studies in the New England Journal of Medicine just found that screening for PSA -- prostate specific antigen -- doesn't save many lives." ‘We've got potentially game-changing biomarkers that could get us out of the dilemma we are in with PSA,” says oncologist Jonathan Simons, President of the Prostate Cancer Foundation. Health Discovery Corporation’s new, 4-gene biomarker test for prostate cancer which has been shown to have a 90% Sensitivity (for finding clinically significant, grade 3 or higher prostate cancer cells) and a 97% Specificity (for finding non-cancerous cells) was published in the peer-reviewed publication UroToday International, August 2009. Health Discovery Corporation also licensed the 4-gene urine test for prostate cancer to Abbott on a world-wide co-exclusive basis with Quest. As part of our License Agreement with Abbott, the Company will receive from Abbott, upon completion of both Phases 1 and 2 described in the FDA Submission Plan, a one-time Phase 1 and 2 Completion Milestone Fee of Two-Hundred-Fifty-Thousand U.S. Dollars ($250,000.00). This milestone payment is non-refundable and non-creditable towards royalties. The Company expects to be eligible for the milestone payment by year-end. Once the test kits are FDA-approved and commercialized by Abbott, Health Discovery Corporation will receive royalties from Abbott on a per test basis.
For each Licensed Product (as defined in the License Agreement) that is sold by Abbott, Abbott shall pay HDC a running royalty equal to: (a) For Licensed Products with medical utility claims solely for use on prostate tissue samples, ten percent (10%) of Abbott’s Net Sales of such Licensed Product; and (b) For Licensed Products with medical utility claims solely for use on urine samples, five percent (5%) of Abbott’s Net Sales of such Licensed Product. Abbott will pay sales milestone payments as well.In March 2010, we joined Smart Personalized Medicine, LLC and entered into a breast cancer therapeutic test development agreement with Quest Diagnostics. This agreement represents the second major contract with Quest Diagnostics. We were paid $500,000 upfront in licensing fees in addition to receiving $375,000 in equal installments over nine consecutive months for development costs. Once this test is commercialized, HDC will be paid a royalty on each test performed by Quest. We are delighted that Quest had the confidence in us to once again partner with our Company to license, develop and commercialize another new molecular diagnostic test - this time for breast cancer. Our partnership with The Pancreas and Biliary Center based primarily in New York and with satellite centers in New Jersey and Florida will allow us to develop a new molecular diagnostic test for cancer of the pancreas. Since treatment outcomes for pancreatic cancer are so poor, the identification of “at risk” patients or early malignancies by molecular or genetic markers represents hope for improving the lifespan of patients with this devastating disease. We are currently in discussions with national clinical laboratories to become our development and commercialization partner in this effort. We expect to choose our partner for the development and commercialization of this new molecular diagnostic test for pancreatic cancer in the very near future. The Company owns the exclusive intellectual property and commercialization rights to the valuable specimen bank being used to develop this new molecular diagnostic test for pancreatic cancer
Our collaborators in this are Avram Cooperman, M.D., an experienced pancreatic surgeon and well-recognized clinical investigator; Michael Wayne, D.O., who continues the surgical effort; and Robert Ollar, Ph.D., a distinguished scientist and genetic investigator.In addition to our pancreatic cancer partnership, we also entered an agreement with The Pancreas and Biliary Center which believe, will allow us to complete the final validation of our molecular diagnostic test for cancer of the colon which has shown a sensitivity of 93% and a specificity of 93% in our prior validation study. We are currently in discussions with both national clinical laboratories and in-vitro diagnostic companies to become our development and commercialization partner in this effort. We expect to choose our partner/partners for the development and commercialization of this new molecular diagnostic test for colon cancer in the very near future. We are very pleased with the development progress of our iPhone app for melanoma risk assessment. A beta version of the melanoma app has been completed and is currently being field tested in advance of commercial full release. A more advanced version of the app with features and a user interface optimized for consumer use is currently in development. The melanoma app will recommend certain physicians to "at risk" customers based on their geographic location as identified by the cell phone GPS system. The Company is currently in partnership discussions with international and U.S. clinical and dermatopathology laboratories who wish to have their current physician clients who perform skin biopsies become the referral centers for patients identified as "at risk" by the melanoma app, thereby potentially significantly increasing their revenue from the number of skin biopsies sent to these laboratories. In addition to the revenues generated directly from the iPhone app, the Company intends to share in the revenues being generated by the increased number of skin biopsies performed by our clinical laboratory partners.
We have continued to advance the development of the PAP Smear interpretation product. The test performance has now advanced to the point where we are ready to partner with a national clinical laboratory to complete development and proceed to commercialization. We believe that the image analysis techniques developed for the PAP Smear interpretation will allow the Company to move quickly into developing products for the interpretation of other anatomic pathology and cytology specimens such as biopsies and surgical tissues.We have completed the initial development of the flow cytometry interpretation product. We believe that the demonstrated success of this new technique is now ready to be partnered with a national clinical laboratory for final development and commercialization. The U.S. Food and Drug Administration (FDA) The FDA held important meetings in the Washington, DC, area on July 19-20, 2010, for the purpose of discussing the current and possible regulatory framework around lab developed tests (LDTs). Health Discovery Corporation was represented by several people at the meetings. Both John Norris and I attended. It is clear that recent DNA-related, direct-to-consumer LDTs are raising concerns for the regulators. For the vast majority of LDTs, the current regulations are currently unchanged. Nonetheless, Health Discovery Corporation has stayed close to our key partners, Abbott and Quest Diagnostics, on these issues. We are keeping a close eye on any potential changes related to LDTs. The federal regulators also emphasized that whatever shape new regulations might take, there could be a “grandfather” clause included in order not to disrupt the current pipeline in the marketplace. Whatever route the FDA takes, we will be prepared to adjust as needed to the new regulatory environment. At this moment, it is too early to tell exactly how new regulations, if any, will impact our business. Given the potential for regulatory changes in the future, we are working with alacrity to get our molecular diagnostic tests to completion and into the market. We continue to stay abreast of ongoing developments with our key partners on this topic.
Significant Opportunities Beyond Molecular DiagnosticsSVM Capital, LLC We are excited about the risk-adjusted performance of SVM Capital, which uses our technology in creating an equity markets trading algorithm. We have a 45% ownership stake in SVM Capital. Back tested pro forma results for 1951-2009:
|Buy&Hold||SVM K-1||SVM K-2|
A recent story in The Economist stated: “Everywhere you look, the quantity of information in the world is soaring. According to one estimate, mankind created 150 exabytes (billion gigabytes) of data in 2005. This year, it will create 1,200 exabytes.” (See The Economist, “The Data Deluge,” February 25, 2010)We are actively pursuing one or more key relationships in the fields of data management and data-mining. Health Discovery Corporation’s technology can play a pivotal role in electronic health records management, health care insurance, fraud detection (especially in the Medicaid/Medicare system), banking, customer data management, marketing, risk management and homeland security. Our goal is to have this new vertical up and running soon and certainly before year-end 2010. Independent Validation of HDC’s Intellectual Property On May 11, 2010, Health Discovery Corporation was awarded the prestigious MICO Award for our intellectual property portfolio. The word “mico” is Latin for “to shine.” Unbeknownst to the Company, San Francisco, Calif.-based MDB Capital Group, LLC, spent millions of dollars and hours creating PatentVest, a proprietary intellectual property analytical tool. MDB Capital rigorously analyzed the intellectual property portfolios of 1,600 publicly-traded, small cap companies to determine which ones had the most valuable and disruptive technology. Health Discovery Corporation was honored to be chosen by MDB Capital as the recipient of their MICO award. In a press release announcing the winner, Christopher Marlett, Chairman and CEO of MDB Capital, had this to say about Health Discovery Corporation: "Among public companies in the healthcare industry, our IP metrics found that Health Discovery Corporation is a leading innovator of game-changing IP,” said Christopher Marlett, Co-Founder, Chairman & CEO, MDB Capital Group. "Intellectual property is no longer an intangible asset class," said Marlett. "MDB Capital built PatentVest to help investors easily assign a tangible value to patents, and we've proven that market leading IP is predictive of superior business performance. Companies like Health Discovery Corporation typify the market leading IP presented at our Bright Lights Conference.” I would like to share with you a few of the details from the PatentVest Report (April 27, 2010). Highlights from the PatentVest Report include the following:
Intellectual Property Portfolio UpdateSince late last year, our patent portfolio has gotten deeper and stronger. In November 2009, the U.S. Patent and Trademark Office issued a patent based on the Company’s application covering an alternative method of feature selection that reduces the number of support vectors to create a sparse-SVM that can be used to generate a codebook for identifying patterns in data, including applications to signal compression. In March 2010, the U.S. Patent and Trademark Office issued a patent based on the Company's method for analyzing spectral data obtained from a mass spectrometer for identification of the most important features in the data that can be used for classification of patient samples. This method is particularly suited for discovery of biomarkers using protein samples. Also in March 2010, the U.S. Patent and Trademark Office issued a notice of allowance of the Company's application covering methods for analyzing data in a text document to identify matches between strings of characters. This technique for text recognition can be incorporated in a search engine. In May 2010, the U.S. Patent and Trademark Office issued a notice of allowance of the Company’s application covering a system for providing data analysis services using a support vector machine for processing data received from a remote source. The U.S. Patent and Trademark Office issued another notice of allowance in May 2010 for the Company's application covering a method of feature selection and feature ranking using a support vector machine. This method differs from the Company's patented RFE-SVM, thus expanding its coverage of a variety of feature selection methods, which have become essential for identifying the most important data in large datasets. In June 2010, the Canadian Intellectual Property Office issued a notice of allowance of the Company’s application covering Pre-Processing and Post-Processing for Enhancing Knowledge Discovery Using Support Vector Machines. In addition to covering pre-processing and post-processing of data in conjunction with SVM analysis, the claims of this patent cover methods of providing data analysis services using a support vector machine for processing data received from a remote source.
In July 2010, the European Patent Office issued a notice of intent to grant a European patent covering the Company's RFE-SVM method. With the issuance of this patent, the Company will have 6 issued patents covering its RFE-SVM technique in the U.S., Australia, Europe and Japan. Additional patents covering the RFE-SVM method are pending.With the issuance of these patents, the Company will hold the exclusive rights to 47 issued U.S. and foreign patents covering uses of SVM and FGM technology for discovery of knowledge from large and/or complex data sets. The Company currently has 43 issued patents and 34 pending patents. Patent Enforcement In the first quarter of this year, Vermillion, Inc. (NasdaqGM: VRML) paid us the last installment of $150,000 of the $600,000 settlement for using Health Discovery Corporation’s Support Vector Machines patented technology in the development of OVA1 ovarian cancer triage test, which has been recently brought to market by Vermillion and Quest Diagnostics. We remain vigilant and are waiting for the appropriate time to pursue possible infringement claims when products are commercialized and we can identify damages. Support Vector Machines Technology Takes First Place in Global Challenge Throughout the year, I am asked repeatedly about whether Support Vector Machines technology can work in fields beyond molecular diagnostics. The answer is an unequivocal “yes.” I am pleased to provide a recent example of SVMs succeeding in a global challenge. In May 2010, we announced that Support Vector Machines technology was used to take first place in solving a complex marketing problem in the recent Active Learning Challenge. The results of the Active Learning Challenge were presented at the 13th International Conference on Artificial Intelligence and Statistics, in Sardinia, Italy. The sponsors of the Active Learning Challenge included the European Network of Excellence, Pascal2, Orange, the French telecom company (Euronext: FTE, NYSE: FTE), Microsoft Corporation (NasdaqGS: MSFT), ETH Zurich, and the IEEE, the world’s largest professional association dedicated to advancing technological innovation and excellence for the benefit of humanity.
Teams from both industry and academia from all over the world participated in the challenge.Each team could choose any hardware, software and algorithms to solve the challenge problems. Some of the classifiers used in the Active Learning Challenge included linear classifiers, non-linear kernels, Naïve Bayes, Nearest Neighbors, Neural Networks, Bayesian Network, and Bayesian Neural Networks, Random Forests and Support Vector Machines. The winners of the marketing challenge included two students from the National Taiwan University, Ming-Hen Tsai and Chia-Hua Ho from the group lead by Professor Chih-Jen Lin, who successfully applied Support Vector Machines to the complex business marketing problem. Financial Condition and Capital Structure Health Discovery Corporation is a company on the move. This necessarily makes a year-over-year comparison a challenge, as we are a better-positioned company today than a year ago. One gauge of how we are doing is our cash position. We have almost $4 million in cash and cash-equivalents and no long-term debt. Our significant cash position is a first in the Company’s history. As a result, we are not seeking outside capital at this time, unlike many emerging companies. During the first quarter 2010, the Company, Smart Personalized Medicine, LLC and Quest Diagnostics Incorporated entered into a Development Agreement. The Company, SPM and Quest also entered into a related Licensing Agreement (the “Quest License”). In consideration for the license, Quest will separately make payments to the Company and SPM. Payments to the Company included a $500,000 up front fee and $375,000 in equal installments for development costs. The $500,000 upfront Development License Fee was received by the Company in April 2010. With respect to the $375,000 Development Agreement, the Company has received five of the nine installment payments of $41,666 each. Quest will also pay, upon the publication of a study performed for the Validation Work, an Initial Product License Fee of $125,000 for each of the first two Products, and Royalty Payments equal to 2.45% of the net sales of each Licensed Product.
An important accounting issue for an emerging company like ours is revenue recognition. In general, when we execute a new licensing and development agreement, we receive upfront fees and ongoing performance fees. Under existing accounting regulations, we recognize revenue as it is earned during the course of the agreement.Deferred revenue represents the unearned portion of payments received in advance for licensing and development agreements. The Company had total unearned revenue of $1,002,915 as of June 30, 2010. For the three months ended June 30, 2010, revenue was $153,506, compared with $16,215 for the three months ended June 30, 2009, and $54,178 for the three months ended March 31, 2010. As a result, revenue continues to trend positively on a quarterly and yearly basis. In late July 2010, we settled the issues we had with the lead investor in our 2007 Private Placement. This settlement is further detailed in our recent 10-Q filings. The Company has recognized a charge of $1,877,647 related to the settlement, including $597,647 in non-cash charges related to the issuance of the new warrants. Each of the 6,875,000 warrants has an exercise price of $0.17 and expires on July 26, 2012. If the warrants are fully exercised, that will generate $1,168,750 in cash for the Company. The negotiated settlement also caused a significant increase in legal fees and expenses as the Company vigorously denied the claims made by the lead purchaser. Legal fees totaled $249,315 during the three months ended June 30, 2010, compared to $79,832 during the same period in 2009. We are pleased to have this settlement behind us once and for all. As a result, the Company is making significant changes to better manage outside counsel legal fees. In 2009, we raised additional capital in the amount of $1,490,015 through the issuance of Series B Preferred Stock and received proceeds from the exercise of previously issued warrants to purchase our common stock of $2,450,430.
In March 2010, we received an additional $3,039,522 from the exercise of previously issued warrants to acquire our common stock.On September 7, 2010, the remaining outstanding $0.19 and $0.14 warrants issued in the 2007 private placement transaction will expire. If the warrants are fully exercised, the Company will receive additional capital upon their exercise of approximately $10 million. If the warrants are not exercised, the warrants will expire and the Company will significantly reduce shareholder dilution. We will have a definitive answer on September 7 th, 2010, and we will report the results of the warrant exercise shortly thereafter. We also expect to hold a shareholders meeting in the near future. In summary, I am very pleased with the successes to date which, I believe, are unusual for a biotech company that has only been in business for seven years. These successes include, but are not limited to, the following: 1) a strong cash position, 2) no long-term debt, 3) an award-winning intellectual property portfolio with 43 issued & 34 pending patents, 4) two royalty-bearing license agreements with Quest Diagnostics, 5) one royalty-bearing license agreement with Abbott Molecular, 6) a pipeline of products advancing towards national laboratory partnerships for development and commercialization, 7) a strong management team, 8) a world-renowned science team, 9) two equity investments with Smart Personalized Medicine, LLC and SVM Capital, LLC, and, 10) two successful patent infringement lawsuits. Since I joined and transitioned the Company from a wireless telecommunications company into a biotech molecular diagnostics company, our market cap has increased over 3,500%. As the summer winds its way towards Labor Day 2010, I am very proud of the significant achievements of the entire Health Discovery Corporation team and I am grateful to our long-time investors for their steadfast loyalty. We look forward to continuing to execute our business strategy in molecular diagnostic test development. In addition, we expect new growth through strategic opportunities outside of molecular diagnostics, such as data management and data-mining.
In a macro environment of significant and constant change of things we cannot control, Health Discovery Corporation remains alert and facile in responding to such change, and in fact, capitalizing on such change. As a result, we remain a company on the move.Stephen D. Barnhill, M.D.Chairman & Chief Executive Officer Savannah, Georgia Forward-Looking Statements This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, the accuracy of which is necessarily subject to risks and uncertainties, including, without limitation, statements regarding future performance, opportunities and investments, and anticipated results in general. From time to time the Company may make other forward-looking statements relation to other matters, including without limitation, commercialization plans and strategic partnerships. Actual results may differ materially due to a variety of factors, including, among other things, the acceptance of our approach to applying mathematics computer science and physics into the disciplines of biology, organic chemistry and medicine and our products and technologies associated with those approaches, the ability to develop and commercialize new drugs, therapies or other products based on our approaches, and other factors set forth from time to time in the Company’s Securities and Exchange Commission (SEC) filings. Shareholders are encouraged to refer to the Company’s filings with the SEC available at www.sec.gov for additional information regarding the Company. All forward-looking statements and cautionary statements included in this document are made as of the date hereof based on information available to the Company as of the date hereof, and the Company assumes no obligation to update any forward-looking statement or cautionary statement.