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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-QSB (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 2004
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACTFor the transition period from  to
 Commission file number 0-12627 MEDICAL DISCOVERIES, INC. 
  Utah
    
    87-0407858(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 738 Aspenwood Lane, Twin Falls, Idaho 83301 
  (208) 736-1799 
  N/A 
  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: As of July 29, 2004, there
were 93,581,577 shares of the issuers Common Stock outstanding. Transitional Small Business Disclosure Format (check one): Yes o No þ Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): Yes o No þ




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TABLE OF CONTENTS  PART I FINANCIAL INFORMATIONITEM 1. FINANCIAL STATEMENTSITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.ITEM 3. CONTROLS AND PROCEDURESPART II OTHER INFORMATIONITEM 2. CHANGES IN SECURITIESITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSITEM 6. EXHIBITS AND REPORTS ON FORM 8-KSIGNATURESINDEX TO EXHIBITSEXHIBIT 31EXHIBIT 32    Table of Contents  
 PART I
FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS The following financial statements are filed with this report: Condensed Consolidated Balance Sheet as of June 30, 2004, (unaudited) and
December 31, 2003 Condensed Consolidated Statements of Operations for the three- and six-month
periods ended June 30, 2004 (unaudited) and June 30, 2003 (unaudited) and
cumulative amounts since inception through June 30, 2004 (unaudited) Condensed Consolidated Statements of Cash Flows for the three- and six-month
periods ended June 30, 2004 (unaudited) and June 30, 2003 (unaudited) and
cumulative amounts since inception through June 30, 2004 (unaudited) Notes to Unaudited Financial Statements 2




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MEDICAL DISCOVERIES, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED BALANCE SHEET
As of June 30, 2004 (Unaudited) and December 31, 2003 June 30, 2004
    
    December 31, 2003Current assetsCash
    
    $
    346,929
    
    
    $
    424,216Prepaid expenses
    
    
    
    
    
    
    11,331Current portion of deferred charges
    
    
    
    
    
    
    12,077Total current assets
    
    
    346,929
    
    
    
    447,624Current liabilitiesAccounts payable
    
    $
    2,358,365
    
    
    $
    2,066,727Accrued interest
    
    
    526,810
    
    
    
    524,294Current portion of notes payable
    
    
    469,217
    
    
    
    789,217Convertible notes payable
    
    
    448,202
    
    
    
    498,202Total current liabilities
    
    
    3,802,594
    
    
    
    3,878,440Stockholders deficitEscrow receivable
    
    
    
    
    
    
    (227,300
    )Additional paid in capital
    
    
    4,276,863
    
    
    
    579,363Common stock, no par value, authorized
100,000,000 shares; 93,581,471 and 76,456,095
shares issued and outstanding at June 30, 2004 and December 31, 2003
    
    
    13,517,927
    
    
    
    12,546,957Accumulated deficit
    
    
    (21,023,155
    )
    
    
    (16,329,836
    )Treasury stock, 2,356,200 shares at cost
    
    
    (227,300
    )
    
    
    Total stockholders deficit
    
    
    (3,455,665
    )
    
    
    (3,430,816
    )$
    346,929
    
    
    $
    447,624
 See notes to consolidated financial statements 3




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MEDICAL DISCOVERIES, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three and Six Months Ended June 30, 2004 and Cumulative Amounts (Unaudited) For the Three Months
    
    For the Six MonthsEnded June 30,
    
    Ended June 30,
    
    Cumulative
AmountsSince November 20, 19912004
    
    2003
    
    2004
    
    2003
    
    (Date of Inception)Revenues
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    137,212Cost of goods sold
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,526Gross profit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    126,686Research and development expenses
    
    
    132,335
    
    
    
    
    
    
    
    170,978
    
    
    
    
    
    
    
    2,793,142Inventory writedown
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    96,859Impairment loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,709License
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,001,500General and administrative expenses
    
    
    2,391,770
    
    
    
    211,132
    
    
    
    4,439,463
    
    
    
    358,333
    
    
    
    16,226,236Operating loss
    
    
    (2,524,105
    )
    
    
    (211,132
    )
    
    
    (4,610,441
    )
    
    
    (358,333
    )
    
    
    (20,000,760
    )Other income (expense)Interest income
    
    
    1,426
    
    
    
    
    
    
    
    3,126
    
    
    
    
    
    
    
    26,532Other income
    
    
    720
    
    
    
    
    
    
    
    720
    
    
    
    
    
    
    
    881,204Interest expense
    
    
    (33,048
    )
    
    
    (68,933
    )
    
    
    (86,724
    )
    
    
    (126,966
    )
    
    
    (977,594
    )(30,902
    )
    
    
    (68,933
    )
    
    
    (82,878
    )
    
    
    (126,966
    )
    
    
    (69,858
    )Loss before income taxes and
extraordinary item
    
    
    (2,555,007
    )
    
    
    (280,065
    )
    
    
    (4,693,319
    )
    
    
    (485,299
    )
    
    
    (20,070,618
    )Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forgiveness of debt net of $0
income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,235,536Net loss available to shareholders
    
    $
    (2,555,007
    )
    
    $
    (280,065
    )
    
    $
    (4,693,319
    )
    
    $
    (485,299
    )
    
    $
    (18,835,082
    )Net loss per shareContinuing operations
    
    $
    (0.03
    )
    
    $
    (0.01
    )
    
    $
    (0.05
    )
    
    $
    (0.01
    )
    
    $
    (0.70
    )Extraordinary item
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.04Net loss per share
    
    $
    (0.03
    )
    
    $
    (0.01
    )
    
    $
    (0.05
    )
    
    $
    (0.01
    )
    
    $
    (0.66
    )Weighted average shares outstanding
    
    
    92,393,559
    
    
    
    55,698,856
    
    
    
    88,478,847
    
    
    
    55,649,132
    
    
    
    28,676,049
 See notes to consolidated financial statements 4




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MEDICAL DISCOVERIES, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Periods Ended June 30, 2004 (Unaudited), June 30, 2003 (Unaudited), and Cumulative Amounts For the Six MonthsEnded June 30,
    
    Cumulative AmountsSince November 20,
19912004
    
    2003
    
    (Date of Inception)Cash flows from operating activitiesNet loss
    
    $
    (4,693,319
    )
    
    $
    (485,299
    )
    
    $
    (19,623,578
    )Adjustments to reconcile net loss to net
cash used by operating activitiesCommon stock options issued for services
    
    
    
    
    
    
    
    
    
    
    3,136,253Common stock issued for services, expenses,
and litigation
    
    
    75,954
    
    
    
    7,000
    
    
    
    4,277,170Stock compensation expense
    
    
    3,697,500
    
    
    
    
    
    
    
    3,697,500Reduction of escrow receivable from
research and development
    
    
    
    
    
    
    
    
    
    
    272,700Reduction of legal costs
    
    
    
    
    
    
    
    
    
    
    (130,000
    )Notes payable issued for litigation
    
    
    
    
    
    
    
    
    
    
    385,000Depreciation
    
    
    
    
    
    
    
    
    
    
    100,271Write-off of subscription receivables
    
    
    
    
    
    
    
    
    
    
    112,500Impairment loss on assets
    
    
    
    
    
    
    
    
    
    
    9,709Loss on disposal of equipment
    
    
    
    
    
    
    
    
    
    
    30,364Gain on debt restructuring
    
    
    
    
    
    
    
    
    
    
    (1,235,536
    )Write-off of receivables
    
    
    
    
    
    
    
    
    
    
    193,965Changes in
assets and liabilitiesPrepaid expenses
    
    
    11,331
    
    
    
    32
    
    
    
    (1
    )Deferred charges
    
    
    12,077
    
    
    
    20,051
    
    
    
    1Accounts receivable
    
    
    
    
    
    
    
    
    
    
    (7,529
    )Accounts payable
    
    
    293,150
    
    
    
    163,872
    
    
    
    2,203,968Accrued expenses
    
    
    2,516
    
    
    
    88,427
    
    
    
    548,291Net cash used by operating activities
    
    
    (600,791
    )
    
    
    (205,917
    )
    
    
    (6,028,952
    )Cash flows from investing activitiesPurchase of equipment
    
    
    
    
    
    
    
    
    
    
    (132,184
    )Payments received on note receivable
    
    
    
    
    
    
    
    
    
    
    130,000Net cash used by investing activities
    
    
    
    
    
    
    
    
    
    
    (2,184
    )Cash flows from financing activitiesContributed equity
    
    
    
    
    
    
    
    
    
    
    131,374Issuance of common stock
    
    
    718,504
    
    
    
    10,800
    
    
    
    4,863,163Payments on notes payable
    
    
    (195,000
    )
    
    
    (25,000
    )
    
    
    (426,287
    )Proceeds from notes payable
    
    
    
    
    
    
    225,000
    
    
    
    1,336,613Payments on convertible notes payable
    
    
    
    
    
    
    
    
    
    
    (98,500
    )Proceeds from convertible notes payable
    
    
    
    
    
    
    
    
    
    
    571,702Net cash provided by financing activities
    
    
    523,504
    
    
    
    210,800
    
    
    
    6,378,065Net increase (decrease) in cash
    
    
    (77,287
    )
    
    
    4,883
    
    
    
    346,929Cash, beginning of period
    
    
    424,216
    
    
    
    14,555
    
    
    
    Cash, end of period
    
    $
    346,929
    
    
    $
    19,438
    
    
    $
    346,929Supplemental disclosure of non-cash activitiesRetirement of notes payable of common stock
    
    $
    175,000
    
    
    $
    
 See notes to consolidated financial statements 5




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MEDICAL DISCOVERIES, INC. AND SUBSIDIARIES
(A Development Stage Company)
NOTES TO UNAUDITED FINANCIAL STATEMENTS
June 30, 2004 Note 1. Basis of Presentation. Unaudited Interim Financial Statements The accompanying unaudited financial statements have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, all adjustments and disclosures
necessary to a fair presentation of these financial statements have been
included. These financial statements should be read in conjunction with the
financial statements and notes thereto included in the Companys 2003 Annual
Report on Form 10-KSB for the year ended December 31, 2003, as filed with the
Securities and Exchange Commission. Certain reclassifications and other
corrections for rounding have been made in prior period financial statements to
conform to the current period presentation. The consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries. All significant inter-company transactions and balances have been
eliminated in consolidation. Stock Based Compensation The Company has two incentive stock option plans wherein 24,000,000 shares of
the Companys common stock can be issued. The Company granted 700,000 fully
vested stock options during the six months ended June 30, 2004 with an exercise
price of $.05. The Company granted 500,000 fully vested stock options to an
officer during the six months ended June 30, 2003 with an exercise price of
$.01. In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, which established financial accounting
and reporting standards for stock-based compensation. This standard defines a
fair value method of accounting for an employee stock option or similar equity
instrument. In December 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 148, which revised certain
provisions of adopting a fair value method of accounting for stock options and
required certain additional disclosures regarding stock options. These
statements give entities the choice between adopting the fair value method or
continuing to use the intrinsic value method under Accounting Principles Board
(APB) Opinion No. 25 with footnote disclosures of the pro forma effects if the
fair value method had been adopted. The Corporation has opted for the latter
approach. The Company accounts for its stock options under Accounting Principles Board
(APB) Opinion No. 25 using the intrinsic value method. The Company has elected
not to adopt the provisions of Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation (FAS 123). In accordance with
Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, pro-forma net income, stock-based
compensation expense, and earnings per share using the fair value method are
stated as follows: Six Months Ended June 30,2004
    
    2003Net loss as, as reported
    
    $
    (4,693,319
    )
    
    $
    (485,229
    )Deduct: stock based compensation expense
determined under fair value method,
net of tax
    
    
    
    
    
    
    5,000Pro forma net loss
    
    $
    (4,693,319
    )
    
    $
    (490,229
    )Loss per share:Basic and diluted  as reported
    
    $
    (.05
    )
    
    $
    (.01
    )Basic and diluted  pro forma
    
    $
    (.05
    )
    
    $
    (.01
    )
 6




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Note 2. Going Concern Considerations. The Companys recurring losses from the Companys development-stage activities
in current and prior years raise substantial doubt about the Companys ability
to continue as a going concern. The financial statements do not include any
adjustments to reflect the possible effects on the recoverability and
classification of assets or amounts and classifications of liabilities that may
result from the possible inability of the Company to continue as a going
concern. The Company is attempting to raise additional capital to sustain
operations. However, there can be no assurance that these plans will be
successful. Note 3. Commitment Regarding Peregrine Stock. Peregrine Properties, LLC, a Utah limited liability company (Peregrine),
entered into an agreement to provide $500,000 to the Company to fund testing
and research steps necessary to continue development of MDI-P. The studies are
funded through an escrow agent. As of December 31, 2000, the Company had
deposited in escrow a single certificate for 5.5 million shares of common stock
for these purposes. Through June 30, 2004, Peregrine had funded $275,800 to
the escrow, of which $272,700 had been disbursed and recorded as research and
development expense on the financial statements of the Company. The remaining
$227,300 to be expended under the agreement has been recorded on the balance
sheet in equity under the caption escrow receivable. As expenditures are made
from the escrow for research and development, the expenses are recorded on the
books of the Company with a corresponding reduction in the escrow receivable.
Under the original agreement, upon completion of the studies, the escrow agent
was to disburse the 5.5 million shares to Peregrine and to disburse the
research results to the Company. On March 22, 2002, the parties entered into
an agreement the result of which was to partially close the escrow agreement to
the extent of Peregrines funding to date. On that date, 3,143,800 shares were
distributed to Peregrine and all research conducted to date was disbursed to
the Company. As of February 20, 2004, the Company held Peregrine in breach
with respect to its remaining funding obligation and terminated the Peregrine
research agreement. Subsequent to the period end, the Company and Peregrine
resolved the matter by the Company agreeing to grant Peregrine a warrant to
purchase 2,356,200 shares of restricted common stock at an exercise price of
$0.09 per share and exercisable at any time within 3 years. Note 4. Variable Option Expense. During the first quarter of 2004, the Company extended the expiration date of
options to purchase an aggregate amount of 18,403,000 shares of stock held by
certain directors, officers and consultants of the Company. As a result of
such extension, such options expire from between 2011 to 2013. With this
change in expiration date, these options are now subject to variable accounting
treatment and will be revalued at each quarter end until the options expire or
are exercised. The expense associated with the variable accounting treatment
for the second quarter of 2004 was $2,022,500. 
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. The purpose of this section is to discuss and analyze our consolidated
financial condition, liquidity and capital resources, and results of
operations. This analysis should be read in conjunction with the financial
statements and notes thereto at pages 2 through 6 and Managements Discussion
and Analysis of Financial Condition and Results of Operations contained in our
Annual Report on Form 10-KSB for the year ended December 31, 2003 (the 2003
10-KSB). This section contains certain forward-looking statements that involve risks and
uncertainties, including statements regarding our plans, objectives, goals,
strategies and financial performance. Our actual results could differ
materially from the results anticipated in these forward-looking statements as
a result of factors set forth under Cautionary Statement for Forward-Looking
Information and Factors Affecting Future Results below and elsewhere in this
report. Overview We are a development-stage bio-pharmaceutical company engaged in the research,
validation, development and ultimate commercialization of a patented
anti-infective technology. Our electrolyzed solution of free radicals
represents a novel approach to treating our initial target indications, Cystic
Fibrosis and HIV. We plan in the near 7




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future to conclude our pre-clinical work
and enter the clinic in our initial target indications. If our Cystic Fibrosis
or HIV clinical trials are successful, we plan to develop this therapy for
additional target indications. Our product, called MDI-P, appears to have the ability to destroy certain
viruses, bacteria and fungi without any associated toxicity both in animals and
in cell-based assays. We are committed to the development of MDI-P as an
anti-infective therapeutic product for in-vitro and in-vivo applications. Our
highest priorities are to develop and commercialize MDI-P as a pharmaceutical
for the treatment of Cystic Fibrosis and HIV. We are in the process of
completing pre-clinical development and plan to file an Investigative New Drug
application (IND) with the Food and Drug Administration (FDA) during the fourth
quarter of this year. If the FDA approves the IND for HIV, we will begin a
Phase I clinical test at the Harvard School of Medicine using a protocol
designed by Dr. Bruce Dezube. If our Cystic Fibrosis IND is approved, we will
likewise enter the clinic. We are currently developing the Cystic Fibrosis
protocol and exploring test site candidates. To date, we have not generated significant revenues from operations or realized
a profit. Through June 30, 2004, we had incurred a cumulative net loss since
inception of $18,835,082. We are currently attempting to secure capital
commitments to finance the completion of our pre-clinical analysis, file our
INDs for MDI-P as Cystic Fibrosis and HIV therapeutics, determine additional
potential indications for MDI-P, and to otherwise continue research and testing
of our technologies in order to secure required approvals to bring products to
market. In that we are a development stage company, we will increasingly
require additional funding to continue the development of our technology and to
finance submittal of our testing and trials to the appropriate regulatory
agencies in order to secure approvals for product development and sales. Recent Events Addition of Cystic Fibrosis as Lead Indication.On August 4, 2004, we
announced that our clinical development objectives have been broadened to
include Cystic Fibrosis (CF) as a lead indication, together with HIV. Both
Initial New Drug applications (INDs) are expected to be filed with the FDA in
Q4 of 2004 under a Drug Master File, which is a submission to the Food and Drug
Administration that may be used to provide confidential detailed information
about facilities, processes, or articles used in the manufacturing, processing,
packaging, and storing of one or more human drugs. The decision to elevate CF to a clinical development status on par with HIV has
come about for a number of reasons:  
    
    Unlike HIV, which has numerous existing therapeutics in the market, CF
has no existing life-extending therapies. The average age of mortality
is 31 years, and CF represents an FDA Orphan Indication, which could
mean 7 years of exclusivity in the U.S. and 10 years in the EU.
    
    Medical Discoveries now possesses pre-clinical data (a CF-like murine
model) from the University of Washington Medical School showing that
MDI-P provides exemplary pathogen-killing effect for the pulmonary
infections characteristic of CF patients. Equally important, MDI-P
appears to also process the mucus in CF-like lungs, allowing the
viscous-state mucus to be removed from the plugged airways. As a
result, MDI-P may represent a life-extending therapy for CF patients.
    
    While CF has an incidence of only 30,000 new cases/year in the U.S.,
there resides a surviving population approaching one million CF
patients, with a similar number in the EU. Therefore, the market
value of this indication may represent a multi-billion/year potential
for MDI-P, should clinical therapeutic results be sufficiently strong.
The unmet medical need of this CF population is substantial, with no
drugs currently in the market or to MDIs knowledge under development
which might offer a comparable life-extending effect.
    
    We expect an expedited FDA review and approval for Phase I clinical
trials in CF. It is possible that CF could be approved for human
clinical trials prior to us gaining similar approval for trials in
HIV, due to a general absence of competing, life-extending therapies
in CF. Therefore, the addition of CF as a lead indication should
serve as insurance that we will be allowed by the FDA to start trials
for at least one of these indications in Q1 of 2005. We will consider the option of retaining CF as an indication for full
development and marketing on our own, using a small detail sales force, given
the limited number of qualified CF sites (117 in the US, with only 18 primary
sites). 8




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Unlike other indications such as HIV and asthma, where we will most
likely pursue an out-licensing strategy, we could then retain all of the
profits from CF sales, which could begin in as little as 2.5 years. We believe this adoption of multiple indications is the most prudent strategy
to ensure timely start of clinical trials as early as possible in 2005. With
the addition of CF to the first priority status, together with HIV, we now have
improved our odds of starting at least one of these two indications in the
clinic in Q1 of 2005. A Drug Master File is a valuable vehicle and procedure for use when a potential
contractor or partner needs to review proprietary components involving the drug
MDI-P and the device which makes it. While the FDA must have all of our
proprietary information to consider one or more INDs, the DMF allows other
parties to reference part of this protected information without learning all of
it. Filing a DMF clears the way for us to develop and share our proprietary
information with others, while still providing all of our information to the
FDA in pursuit of clinical tests. Cystic Fibrosis Study Results.The decision to include CF as a co-lead
indication for MDI-P found its genesis in the third in a series of pre-clinical
research reports from Dr. Emil Chi, Chairman of the Department of
Histopathology at the University of Washington Medical School. This trial, the
results of which were announced on May 20, 2004, studied MDI-P as a potential
therapeutic agent for the treatment of the symptoms of CF. Results from this study showed that, 48 hours after treatment, MDI-P-treated
CF-like mice lungs evidenced: a) a 60% reduction in mucus secretion; b) a 49%
reduction in white blood cellular infiltration; and c) a 42% reduction in lung
edema, as contrasted with untreated CF-like mice. In MDI-P-treated mice, the
associated level of lung hemorrhage was reduced by 39%, the level of neutrophil
lung infiltration was reduced by 49%, and eosinophil lung infiltration was
reduced by 86%, as contrasted with untreated CF-like mice. The 100% MDI-P
solution provided a 100% host-sparing effect against this fatal CF-like
condition. No overt signs of toxicity were found in the primary organs (lungs,
liver, spleen, kidneys, brain) of mice treated with MDI-P. In this study of 48 mice, it was found that MDI-P is a useful agent to reduce
primary measures of disease in CF, including bacterial infection, mucus
secretion, cellular infiltration, lung edema (swelling with excess fluid), lung
hemorrhage, and lung infiltration by neutrophils and eosinophils, the principal
white blood cells responding to allergic and infectious pathogens. Excessive
presence of neutrophils and eosinophils can lead to cell death in surrounding
tissues, causing serious health problems from their over-expression. These findings were established in a new mucus overproduction mouse model
designed to more closely mimic the CF disease condition found in humans. This
mouse model starts with OVA-induced, chronic asthmatic mice, which are then
infected intranasally with P. aeruginosa to establish a lung disease state
comparable with CF patients. Almost all CF patients evidence P. aeruginosa
colonization at some time during the disease process, associated with
progressive deterioration of lung function in CF. With mice mimicking human
asthma in this model, the airway is filled with mucus occlusion and the airway
becomes infected following inoculation with P. aeruginosa. The data provided
evidence that MDI-P inhibits P. aeruginosa growth and colonization in this
mouse model with airway mucus hypersecretion. Infection with Pseudomonas aeruginosa, a common bacterium, plays a major role
in the pulmonary inflammation and injury associated with CF. Lung inflammation
may also lead to more widespread systemic effects on other organs, including
the pancreas. CF affects approximately 1 in 2,500 live births and qualifies as
an orphan indication with the FDA, with some 30,000 new cases reported
annually in the U.S. and an estimated 900,000 patients surviving up to age 30. Pharmacokinetics Report.On August 10, 2004, we announced our receipt of a
pharmacokinetics (PK) report, which studied the processes of bodily absorption,
distribution, metabolism, and excretion (ADME) of in rabbits. Pharmacokinetics
describes the time course of drug concentrations in plasma (and sometimes in
other fluids and tissues) resulting from a particular dosing regimen. This study indicates that MDI-P has an average half-life in-vivo of 17.3
minutes, within a range of 10-20 minutes. Compared with most drugs, where the
PK half-life thresholds typically range from many hours to days, this indicates
that MDI-Ps pathogen-killing activity is compressed within very short
timeframes. Furthermore, because toxicity is frequently associated with long
half-lives of drug residues in the liver, heart, brain and other vital organs,
the truncated half-life of MDI-P has very favorable characteristics associated
with lower toxicity profiles. 9




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One of the primary reasons cited for the failure of new drug candidates in FDA
clinical trials is the lack of a suitable pharmacokinetics (PK) profile. It
has been estimated that almost 40% of the attrition of all drug candidates is
linked
to poor PK. This important milestone report is required for our IND
submissions under a Drug Master File, set for Q4 2004. MDI-P proved not amenable to traditional radioactive tagging of active
ingredients to determine ADME. Consequently, MDI contracted through Clagett
Consulting with the University of Washingtons Mass Spectrometry Lab to design
and conduct novel, highly specialized, sensitive tests of MDI-P administered in
rabbits. These assays detect the presence of the solution in the peripheral
blood of the rabbits. ACP (Acyl-protected hydroxylamine), used frequently to detect oxygen radicals
in chemistry, was used as a surrogate marker for the reactive oxygen species
present in MDI-P, in a two-compartmental model of pharmacokinetics (from blood
plasma into tissue, and back into the blood). The methodology employed by the UW Mass Spectrometry Lab in this PK study used
a High Pressure Liquid Chromatography (HPLC) separator and UV absorption. The
measurements for PK were achieved at the picogram-nanogram per mL range, an
extraordinary level of sensitivity not previously reported in the literature
for reactive oxygen species. Pharmacokinetic statistical analysis was made by
Clagett Consulting using Summit Researchs established PK Solutions software
suite. Despite the valuable insights obtained from in vitro ADME screening assays, in
vivo drug exposure is still emphasized by drug discovery teams when making
decisions about molecules within a Structure-Activity Relationship (SAR), which
explores the correlations between chemical structure and measured activity.
Having reliable data on MDI-Ps absorption, distribution, metabolism and
excretion is thus an important benchmark in MDIs IND submissions to the FDA. Large Mammal Toxicity Report.On July 15, 2004, we announced our receipt from
Clagett Consulting of a large mammal toxicity report for MDI-P. The study
found no sign of any toxicity from MDI-P in the anatomy, behavior, clinical
chemical, hematological, or histopathological measures of adverse events. The
study was conducted in the rabbit species (New Zealand white rabbits) because
of their acknowledged hyper-reactivity to toxicity in drugs. These results,
when combined with our prior toxicological work, suggest that MDI-P should not
cause toxic events in humans. Also included in the Clagett Consulting report was a further genomic analysis
for toxicology of MDI-P performed at the University of Albanys Genomics
Laboratory. Over the past several years, genomic technologies have evolved
that enable the simultaneous analysis of the expression of hundreds to
thousands of genes. The analysis and evaluation of gene and protein expression
changes that modulate toxic responses can help supplement the mechanistic
understanding of how drug treatments in animals and humans possibly induce
toxicity in one or more tissues or organs. We wanted to determine whether
MDI-P affects the up-or-down-regulation of any controlling genes in toxicity or
immuno-regulation. Livers from the rabbit were used to isolate RNA and perform
such analyses using Affymatrix GeneChips. This genomics analysis indicated that MDI-P had no effect on any of the following:  
    
    bone marrow function
    
    hematocrit levels in peripheral blood
    
    serum levels for alanine aminotransferase levels (ALT) and aspartate aminotransferase
levels (AST), both of which provide sensitive measures of hepatic toxicity
    
    serum protein and albumin levels
    
    bound urinary nitrogen (Bun) levels
    
    serum calcium levels
    
    blood glucose levels In addition, this genomics analysis provided confirmation that various measures
of impact on the hundreds of genes controlling toxicity as well as the
immuno-regulatory system were neither up-or-down regulated by MDI-P. 10




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Results of Operations Revenues and Gross Profit.We did not book any revenue for the three- or
six-month periods ended June 30, 2004 or June 30, 2003. As we continue to
pursue pre-clinical and clinical testing of MDI-P as a pharmaceutical for the
treatment of Cystic Fibrosis and HIV as well as other pre-commercialization
testing of our technologies, we do not anticipate booking significant revenues
in the near future. Operating Expenses and Operating Loss.We incurred $132,335 in research and
development expenses for the quarter ended June 30, 2004, on preclinical tests
of MDI-P. We did not have any research and development expenses for the same
period of 2003. Our general and administrative expenses were $2,391,770 during
the second quarter of 2004, as compared to $211,132 during the quarter ended
June 30, 2003. The large general and administrative expenses for the second
quarter of 2004 was due to a non-cash charge of $2,022,500 as a result of
extending the expiration date of options earlier in 2004. In the absence of
the option expense, our general and administrative expenses for the second
quarter of 2004 were $369,270. The increase over the same period of 2003 was
due primarily to increased expenses from financing activities, patent filings,
and from our annual meeting of shareholders. As a result of the foregoing, we
sustained an operating loss of $2,524,105 for the quarter ended June 30, 2004,
as compared with an operating loss of $211,132 for the same period of 2003. For the six months ended June 30, 2004 we incurred $170,978 in research and
development expenses as compared with no such expenses during the same period
of 2003. Our general and administrative expenses for the first half of 2004
were $4,439,463 as compared with $358,333 for the first half of 2003, resulting
in operating losses of $4,610,441 through June 30, 2004 and $358,333 through
June 30, 2003. Other Income/Expense and Net Loss.We booked $1,426 in interest income and
incurred interest expenses of $33,048 for the quarter ended June 30, 2004, as
compared with no interest income and $68,933 in interest expenses for the same
period of 2003. The decreased interest expense is a result of our successful
efforts to convert high-interest debt to equity. The increase in interest
income relates to our higher cash position after successful capital raising
efforts. We also booked $720 in other income in the second quarter of 2004.
In sum, our net loss for the second quarter of 2004 was $2,555,077 or a loss of
$0.03 per fully diluted share. For the quarter ended June 30, 2003, we
incurred a net loss of $280,065, a loss of less than $0.01 per fully diluted
share. For the six months ended June 30, 2004, we booked $3,126 in interest income and
incurred interest expenses of $86,724, as compared with no interest income and
interest expenses of $126,966 for the comparable period of 2003. Our net loss
for the first half of 2004 was $4,693,319 or $0.05 per fully diluted share.
Our net loss for the first half of 2003 was $485,299 or $0.01 per fully diluted
share. Future Expectations.We expect to operate at a loss for several more years
while we continue to study, gain regulatory approval of and commercialize our
technologies. We will spend more in the remainder of 2004 in research and
development expenses over the prior year as we continue to implement our
commercialization strategy. Similarly, we expect our higher general and
administrative expenses for the first half of 2004 to continue as we increase
the size of our operations. As a result, we expect to sustain a greater net
loss in 2004, than we have in recent years. Liquidity and Capital Resources As of June 30, 2004, we had $346,929 in cash and had a working capital deficit
of $3,455,665. Since our inception, we have financed our operations primarily
through private sales of equity and the issuance of convertible and
non-convertible notes. We will require significant additional funding to
continue to develop, research and seek regulatory approval of our technologies.
We do not currently generate any cash from operations and have no credit
facilities in place or available. Currently, we are funding operations through
private issuances of equity. We are seeking to raise substantial additional funds in private stock offerings
in order to meet our near-term and mid-term funding requirements. While we are
optimistic that we can raise such funds, we cannot assure you we will be
successful. Given that we are still in an early development stage and do not
have revenues from operations, raising equity financing is difficult. In
addition, any additional equity financing will have a substantial dilutive
effect to our current shareholders. Pursuant to our commercialization strategy, we estimate we will need to expend
an additional $300,000 in research and development to file IND applications
with the FDA for MDI-P as a Cystic Fibrosis and HIV therapy. In addition, we
estimate we will need to expend an additional $220,000 in debt service and
general and administrative 11




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costs between now and when we hope to file the INDs
in Q4 2004. Given our current cash position, we are
approximately $300,000 short to advance our highest priority targets, Cystic
Fibrosis and HIV, to the next development milestone. Once an IND application is submitted, and assuming it is approved, we will need
additional capital to initiate Phase I clinical trials for each indication and
progress through FDA clinical testing toward the end of a drug that is approved
for marketing and sales. We estimate the cost to complete Phase I and Phase II
clinical trials to be several million dollars per indication and the cost to
complete Phase III testing and obtain approval of an NDA to be in the tens of
millions of dollars per indication. While our ability to obtain financing may improve in the event our IND
application is approved, we cannot give assurances that we will have the access
to the significant capital required to take a drug through regulatory approvals
and to market. We may seek a partner in the global pharmaceutical industry to
help us co-develop, license, or even purchase some or all of our technologies. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements as defined in Item 303(c) of
Regulation S-B. Cautionary Statement for Forward Looking Information Certain information set forth in this report contains forward-looking
statements within the meaning of federal securities laws. Forward looking
statements include statements concerning our plans, objectives, goals,
strategies, future events, future revenues or performance, capital
expenditures, and financing needs and other information that is not historical
information. When used in this report, the words estimates, expects,
anticipates, forecasts, plans, intends, believes and variations of
such words or similar expressions are intended to identify forward-looking
statements. Additional forward-looking statements may be made by us from time
to time. All such subsequent forward-looking statements, whether written or
oral and whether made by us or on our behalf, are also expressly qualified by
these cautionary statements. Our forward-looking statements are based upon our current expectations and
various assumptions. Our expectations, beliefs and projections are expressed in
good faith and are believed by us to have a reasonable basis, including without
limitation, our examination of historical operating trends, data contained in
our records and other data available from third parties, but there can be no
assurance that our expectations, beliefs and projections will result or be
achieved or accomplished. Our forward-looking statements apply only as of the
date made. We undertake no obligation to publicly update or revise
forward-looking statements which may be made to reflect events or circumstances
after the date made or to reflect the occurrence of unanticipated events. There are a number of risks and uncertainties that could cause actual results
to differ materially from those set forth in, contemplated by or underlying the
forward-looking statements contained in this report. Those risks and
uncertainties include, but are not limited to, our lack of significant
operating revenues and lack of profit to date, our need for substantial and
immediate additional capital, the fact that we may dilute existing shareholders
through additional stock issuances, the extensive governmental regulation to
which we are subject, the fact that our technologies remain unproven, the
intense competition we face from other companies and other products, and our
reliance upon potentially inadequate intellectual property. Those risks and
certain other uncertainties are discussed in more detail in the 2003 10-KSB.
There may also be other factors, including those discussed elsewhere in this
report, that may cause our actual results to differ from the forward-looking
statements. Any forward-looking statements made by us or on our behalf should
be considered in light of these factors. 
 ITEM 3. CONTROLS AND PROCEDURES (a) Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of our disclosure controls and procedures, as such term
is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act
of 1934, as amended (the Exchange Act), as of June 30, 2004. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures were effective as of June
30, 2004. 12




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(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph (a) above. 
 PART II
OTHER INFORMATION 
 ITEM 2. CHANGES IN SECURITIES (c) We sold the following unregistered securities during the period covered by
this report. None of the sales involved an underwriter. We believe these sales
were exempt from registration pursuant to Section 4(2) of the Securities Act of
1933 because the sales did not involve a public offering. 275,000 shares of restricted common stock at $0.11 per share. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held an Annual Meeting of Shareholders on May 21, 2004 at which the
shareholders considered and voted as follows on the items described below: 1. The shareholders considered whether to elect the following persons as
directors, each to serve until the 2005 annual meeting of shareholders and
until his or her respective successor shall have been duly elected and shall
qualify: Name of Nominee
    
    Votes For
    
    Votes Withheld/AbstentionsDavid R. Walker
    
    
    73,821,575
    
    
    
    371,264Judy M. Robinett
    
    
    73,787,656
    
    
    
    405,183Larry Anderson
    
    
    73,930,156
    
    
    
    262,683
 2. The shareholders considered whether to ratify the selection of Balukoff
Lindstrom 7 Co., P.A. as independent accountants of the Company for the fiscal
year ending December 31, 2004. There were 74,021,628 votes cast in favor,
23,821 votes cast against and 147,390 abstentions, which vote was sufficient
for approval. 3. The shareholders considered whether to amend and restate the Companys
Articles of Incorporation to increase the authorized shares of common stock of
the Company from 100 million to 250 million and to authorize 50 million shares
of undesignated preferred stock of the Company to be designated in the future
by the Board of Directors without further action by the shareholders. There
were 56,472,656 votes cast in favor, 354,842 votes cast against and 95,732
abstentions, which vote was sufficient for approval. 4. The shareholders considered whether to approved the Companys 2002
Stock Incentive Plan. There were 55,869,352 votes cast in favor, 753,538 votes
cast against and 300,340 abstentions, which vote was sufficient for approval. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. The following documents are furnished as exhibits to this Form 10-QSB. Exhibits
marked with an asterisk are filed herewith. The remainder of the exhibits
previously have been filed with the Commission and are incorporated herein by
reference. NUMBER
    
    EXHIBIT3.1
    
    Amended and Restated Articles of Incorporation of the Company (filed as
Exhibit 3.1 to the Companys Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1994, and incorporated herein by reference).3.2
    
    Amended Bylaws of the Company (filed as Exhibit 3.2 to the Companys
Annual Report on Form 10-
 13




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KSB for the fiscal year ended December 31, 1994,
and incorporated herein by reference).10.1
    
    Employment Agreement dated as of May 15, 2002 between Medical
Discoveries, Inc. and Judy M. Robinett (filed as Exhibit 10.4 to the
Companys Quarterly Report on Form 10-QSB for the quarter ended June 30,
2002, and incorporated herein by reference).10.2
    
    2002 Stock Incentive Plan adopted by the Board of Directors as of July
11, 2002 (filed as Exhibit 10.5 to the Companys Quarterly Report on Form
10-QSB for the quarter ended June 30, 2002, and incorporated herein by
reference).31
    
    Rule 13a-14(a) Certification, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002. *32
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.*
   *
    
    Filed herewith. (b) Reports on Form 8-K. The Company filed a Current Report on Form 8-K on May 20, 2004. Subsequent to
the period for which this report covers, the Company has also filed Current
Reports on Form 8-K on July 16, 2004, August 4, 2004 and August 10, 2004. 14




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SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized. MEDICAL DISCOVERIES, INC.
/S/ JUDY M. ROBINETTJudy M. Robinett
President and Chief Executive OfficerDate: August 16, 2004 15




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INDEX TO EXHIBITS NUMBER
    
    EXHIBIT3.1
    
    Amended and Restated Articles of Incorporation of the Company (filed as
Exhibit 3.1 to the Companys Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1994, and incorporated herein by reference).3.2
    
    Amended Bylaws of the Company (filed as Exhibit 3.2 to the Companys
Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994,
and incorporated herein by reference).10.1
    
    Employment Agreement dated as of May 15, 2002 between Medical
Discoveries, Inc. and Judy M. Robinett (filed as Exhibit 10.4 to the
Companys Quarterly Report on Form 10-QSB for the quarter ended June 30,
2002, and incorporated herein by reference).10.2
    
    2002 Stock Incentive Plan adopted by the Board of Directors as of July
11, 2002 (filed as Exhibit 10.5 to the Companys Quarterly Report on Form
10-QSB for the quarter ended June 30, 2002, and incorporated herein by
reference).31
    
    Rule 13a-14(a) Certification, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.*32
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.*
   *
    
    Filed herewith. 16