Q4 2023 Spectral AI Inc Earnings Call

Participants

Peter Martin Carlson; CEO & Director; Spectral AI, Inc.

Vincent Stanley Capone; CFO, General Counsel & Corporate Secretary; Spectral AI, Inc.

Carl Edward Byrnes; MD & Senior Research Analyst; Northland Capital Markets, Research Division

John D. Vandermosten; Senior Biotechnology Research Analyst; Zacks Investment Research, Inc.

Ryan Benjamin Zimmerman; MD & Medical Technology Analyst; BTIG, LLC, Research Division

Unidentified Analyst

Devin Sullivan; SVP; The Equity Group, Inc.

Presentation

Operator

Good afternoon, and welcome to the Spectral AI Fourth Quarter and Full Year 2023 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded.
I would now like to turn the conference over to Devin Sullivan, Managing Director of The Equity Group. Please go ahead.

Devin Sullivan

Thank you, Gary, and good afternoon, everyone. Thank you for joining us for Spectral AI's 2023 fourth quarter and full year financial results conference call. Our speakers for today will be Pete Carlson, Chief Executive Officer; and Vince Capone, the company's Chief Financial Officer.
Before we begin, I'd like to remind everyone that, during this call, certain statements may be made that constitute forward-looking statements within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995, including statements regarding the company's strategy, plans, objectives, initiatives and financial outlook. When used during these discussions, the words estimates, projected, expects, anticipates, forecasts, plans, intends, believes, seeks, may, will, should, future, propose, and variations of these words or similar expressions, or the negative versions of such words or expressions, are intended to identify forward-looking statements.
These forward-looking statements are not guarantees of future performance, conditions or results and involve a number of known and unknown risks, uncertainties, assumptions and other important factors, many of which are outside the company's control, that could cause actual results or outcomes to differ materially from those discussed in the forward-looking statements. As such, investors are cautioned not to place undue reliance on any forward-looking statements. Investors should carefully consider the foregoing factors and the other risks and uncertainties described in the Risk Factors section of the company's filings with the SEC, including registration statements and other documents filed by the company. These filings identify and address other important risks and uncertainties that could cause actual events and results to differ materially from those contained in the forward-looking statements.
With that said, I'd now like to turn the call over to Pete Carlson, Spectral AI's Chief Executive Officer. Pete, please go ahead.

Peter Martin Carlson

Thank you, Devin, and good afternoon, everyone. We appreciate you joining us today for our financial results conference call. For some of you, this may be the first time hearing from me as CEO of the company, and I'd like to take a moment to provide some background.
I joined Spectral AI this year as CFO in early January, and was appointed CEO on February 29. Most recently, I served as CFO of MiMedx Group, a company focused on managing the treatment of chronic and hard-to-heal wounds, including diabetic foot ulcers.
One of the key attributes that attracted me to Spectral AI, especially given my experiences on the wound treatment side of the equation at MiMedx, is my belief that the accurate and immediate wound care assessment provided by our DeepView System can deliver more efficient and more effective health care that reaches across the health care ecosystem, from patients to clinicians, to institutions and, of course, to payers.
For a combination of proprietary image capture hardware and software, a clinical database that now includes more than 340 billion clinically validated data points, and an ever-learning artificial intelligence algorithm, our DeepView System provides an accurate and immediate yes-or-no answer as to whether a wound will heal on its own or requires advanced medical intervention. To the best of our understanding, there is currently no existing diagnostic tool for burns that uses the breadth of light spectrum employed by DeepView and that can produce a validated, immediate and predictive assessment.
For burn wounds, DeepView has a clinically validated accuracy of 92%. What does all this mean? For the burn patient, this means reduced pain and suffering, a faster and more appropriate treatment plan, and reduced risk from complications such as infection that may arise from an inaccurate or delayed diagnosis.
For clinicians, DeepView supports an immediate and informed treatment decision, allowing them to act in the best interest of their patient quickly and with a high level of confidence. This is an important point when you consider that there are fewer than 250 burn specialists in the entire country. These individuals, despite years of training, have less than a 75% accuracy rate in determining whether a burn will heal on its own or require medical intervention.
For institutions, DeepView promotes a quality of care and ground-level efficiencies in allocating precious health care resources. There are approximately 125 burn centers in the United States which, by definition, makes them a limited resource and a scattered one at that. Most burn injuries present at local emergency departments where physicians with no burn training have a diagnostic accuracy rate of about 50%, equivalent to a coin flip. DeepView can place specialist burn expertise in the hands of all health care professionals regardless of rural or urban locations of the institution.
Finally, for payers, DeepView provides objective coverage support and eliminates unnecessary procedures while justifying clinician-driven decisions to treat patients sooner using the assistance provided by our technology. One example. Research indicates a typical stay in a burn center is 8 days. We believe that the use of DeepView can reduce that stay by as much as 3 days, a reduction of 37.5%.
For diabetic foot ulcers or DFUs, our largest market opportunity, similar benefits apply. Like our burn indication, as far as we know, there is no diagnostic tool to assess DFUs, which are complex, have a nonlinear healing trajectory, and can often result in amputation.
The standard of care for DFUs, which are often chronic in nature, is typically a 4-week wait-and-see approach using standard of care as outlined by payers, before the use of advanced wound care therapy such as bioengineered skin substitutes is provided. From our perspective, that's 4 weeks too long, and we believe the use of DeepView by clinicians can result in appropriate treatment commencing upon the first presentation of the wound.
That takes us to where we are in the process of developing and commercializing the DeepView platform. I use the word platform deliberately because of the inherent flexibility of the technology. As discussed, our current focus is burn and DFUs, however, we believe that the platform can over time, support multiple clinical indications.
Our goal remains for the DeepView System to become part of the clinical treatment flow at emergency departments, hospitals, burn centers and clinics for both diabetic foot ulcers and burn wounds. We have a well-defined business focus for 2024 and beyond and continue our -- to continue our research, development and clinical activities, while also driving DeepView from the clinical environment to commercialization.
I am pleased to say the team has made good progress along a number of fronts. I'll touch on a few of these. For burn, in September 2023, we were awarded the largest contract in our history from the U.S. government, Project BioShield, valued up to $150 million. This multiyear nondilutive contract includes an initial award of $54.9 million to fund continued research and development activities through the first quarter of 2026, leading to submission to the FDA of an application for de novo approval. This award brings total nondilutive support from the U.S. government to develop our burn indication to approximately $250 million.
In January 2024, we commenced enrollment for a pivotal study initiated in December to validate the DeepView System for burn, which is expected to be the final clinical trial before seeking FDA approval. This study is conducted in burn centers and emergency departments with an enrollment target of 240 subjects in both adult in pediatric patients.
In February, we received UKCA authorization to commence sales of our DeepView System for burn in the United Kingdom. We deployed our first burn device in March and expect to commence generating commercial revenues in the second half of 2024. This is a great milestone for the company and a significant validation of our technology.
In March, we received a new contract valued at $500,000 from the U.S. government that provides additional support for the development of the handheld version of our DeepView System, called DeepView Snapshot M. This new award brings total external nondilutive support for the DeepView Snapshot M to more than $6 million.
Now let me discuss our regulatory filing outlook. We continue to advance work under our current U.S. government contracts for our DeepView System burn indication and plan to submit regulatory filings for the approval of this indication in the U.S. in 2025. We are pursuing the commercialization of our DeepView System for the assessment of DFU in the U.S. and the U.K., and expect to submit regulatory filings for the approval of this indication in both countries later this year. Given the expected time frames associated with each of these filings, we would expect to be generating commercial revenues across 4 platforms, burn in the U.S. and U.K., and diabetic foot ulcer in the U.S. and U.K. by 2026.
I want to briefly discuss some recent announcements. As you know, one of the most valuable assets Spectral controls is our intellectual property, or IP, which our team has developed over the years. We have 20 allowed U.S. and international patents and 34 pending U.S. and international patents. Additionally, the useful life on our key patent protection of our core concepts exceeds 14 years.
Earlier this month, we announced the formation of a wholly-owned subsidiary called Spectral IP that will focus on developing or acquiring IP applicable to the broader artificial intelligence ecosystem, specifically within health care. We have received a $1 million investment from an affiliate of our largest shareholder, who is also a globally recognized IP industry leader. We believe that Spectral IP has the potential to add value to our shareholders by unlocking applications within our own IP library and through acquisitions, strategic partnerships and collaborations with AI technology providers, health care institutions and research organizations.
One final point that Vince will highlight in his remarks is our improved financial position, including last week's announcement about our capital raise with a long-only investor. This additional capital supports the strategic imperatives I have discussed, including our commercialization efforts.
With that, I will turn things over to our newly named Chief Financial Officer, Vince Capone. Vince?

Vincent Stanley Capone

Thanks, Pete, and thank you all for joining us today. I would like to remind everyone that our press release issued this afternoon contains additional detail of our operating results. We expect to file our 10-K with the SEC later this week. With that in mind, I will focus my remarks on select highlights and key items.
Starting with the fourth quarter 2023 results. Research and development revenue was $5.3 million, as compared to $6.1 million in the prior year period. This decrease reflects less activity during the quarter as we completed work under the BARDA Burn 2 contract. This decrease was expected as clinical trials were nearing completion at the end of the year.
As a reminder, especially for those of you who may be new to Spectral, R&D revenue is driven by our research and development activities. We invoice the government monthly to reflect our R&D expenditures with an added margin of approximately 62% to cover expenses such as labor, third-party contractors and consultants. We generally receive payment against these invoices from the government shortly after invoice submission, which produces a positive and predictable effect on our P&L and our cash flow.
Gross margin in the fourth quarter rose to 46.1%, as compared from 41.1% in the prior year period, due primarily to the increase in the new governmental contract reimbursement rate associated with the BARDA PBS contract as compared to the prior BARDA Burn 2 contract.
General and administrative expenses in the fourth quarter rose to $5.4 million, as compared to $4.3 million in the prior year period, primarily driven by an increase in our head count by almost 30% from 2022.
Moving on to our full year results. Research and development revenue in 2023 was $18.1 million, a 28.8% decrease from the $25.4 million reported in 2022. The year-over-year decrease reflects a wind-down in activity due to the completion of our work under the BARDA Burn 2 contract. During the fourth quarter, we initiated work on the BARDA Project BioShield contract, as Pete mentioned. The contract represents the largest in our company's history with a value of $150 million.
Gross margin rose to 43.6%, from 42.7% in the prior year period, despite a decrease in our gross profit. This increase in gross profit percentage was driven by the reimbursement rate under the BARDA PBS contract, which has a higher rate as compared to the BARDA Burn 2 contract, therefore, creating a favorable impact on the company's gross margin.
General and administrative expenses in 2023 were $20.9 million, as compared to $13.5 million in 2022, primarily driven by an increase in our head count as we continued to prioritize our investment in key personnel that will support the growth of our platform indications and our path towards commercialization.
Research and development expenses in 2023 decreased to $15.1 million, from $16.5 million in 2022. It's important to note that our total revenue and development activity is reflected both in our general and administrative expense and in our cost of revenue. As a result, the decrease in 2023 is driven by lower activity, particularly later in the year on our government contracts, consisting primarily of the winding down of the Burn 2 contract and the ramp-up of our Project BioShield contract.
As of December 31, 2023, cash and cash equivalents totaled $4.8 million, and the company continues to have no long-term debt. As of today, our cash position is approximately $10 million, not including an additional $1 million in our newly formed subsidiary, Spectral IP.
Regarding our liquidity, I would like to highlight the following: First, as Pete discussed, the Project BioShield contract awarded in September provides up to $150 million of nondilutive funding if all future options are exercised. The initial $55 million commitment and execution of the contract will fund development activities through the first quarter of 2026 for our DeepView System for burn, including our ongoing pivotal clinical trial.
Next, earlier this year, the company drew down under an existing committed equity facility, receiving net proceeds of approximately $2.8 million. This represented issuances of approximately 1.2 million shares at an average gross issuance price of $2.39 per share. The company may draw down an additional $3 million under the committed equity facility prior to implementing our new standby equity line of credit.
Finally, as announced last week, we entered into a prepaid advance and standby equity purchase agreement that has a total capacity of $30 million, consisting of a prepaid advance of $12.5 million, $5 million of which was funded March 20, 2024 at a fixed conversion price of $3.16. We expect to receive funds from the additional $7.5 million of the prepaid advances during the second quarter of 2024. Conversion prices for the additional advances are fixed at the time of the funding. For clarity, I want to remind you that any funding under the standby equity purchase agreement beyond the prepaid advances is solely at our discretion.
We believe that our recent financial agreements, in combination with our multiyear nondilutive funding provided by our U.S. government contracts, provides us with a sound financial foundation to pursue our strategic objectives. For 2024, we would like to reiterate our revenue guidance of approximately $28 million, an expected increase of about 55% from $18.1 million in 2023. Much of this growth will be derived from the PBS contract with additional contributions from the ongoing handheld contract.
Revenue from the commercialization of our DeepView AI burn in the United Kingdom, which we expect to commence in the second half of 2024, will be in addition to the $28 million guidance.
With that, I will turn it back over to Pete.

Peter Martin Carlson

Thank you, Vince. Before turning to your questions, I want to thank our team for their dedication and commitment to our promise to develop and commercialize our DeepView System. Their achievements to date and those on the horizon drive our success. The management team is excited to leverage the sound financial footing Vince described in supporting the team's efforts.
Gary, we can now open the call for questions.

Question and Answer Session

Operator

(Operator Instructions)
Our first question today comes from Ryan Zimmerman with BTIG.

Ryan Benjamin Zimmerman

Can you hear me okay?

Peter Martin Carlson

Yes, we hear you great, Ryan.

Ryan Benjamin Zimmerman

Good. Congrats. I'll start with the U.K. It's a good validation that you guys can execute. Maybe, Pete, we'll have to get your initial impressions about what you're seeing in the U.K., kind of how you're approaching it, where you expect to see adoption. And any other incremental color or anecdotal feedback you can provide at this point?

Peter Martin Carlson

Ryan, we have a series of locations lined up for deployment of the machine, as we sit here today 2 are in the field and -- beginning use. The initial feedback from that deployment is very positive, including an ease of use and a significantly reduced scale and operating complexity compared to a laser-directed tool that is in place there in the United Kingdom.
We've got a series more, 5 or 6 more locations, where we will deploy the device. And what's happening over these few months is a bit of field validation by these clinics. After that period of time is when we'll enter into the commercial arrangements with those clinics and they'll use the devices that they've had on site. So we are in the field, continuing our rollout, and looking to work with those institutions, those clinics as they gather data, and then pivot to this commercialization.
The benefit here is that is real-world data we will obtain. And that real-world data can be useful in many ways. It's not only information for us as we continue to improve our development or improve the device through our development activities, but it's also information we can use to help inform payers, institutions and others about the success of the tool.

Ryan Benjamin Zimmerman

Okay. Very helpful, Pete. And the BARDA guidance has been very clear, $28 million for this year. It's pretty well known. There's not a lot of changes to time lines in that given you kind of control your R&D efforts and then are rewarded by BARDA. But given maybe the incremental capital you've brought in, given the U.K. approval, has your outlook on spend or burn changed at all that we need to consider that allows you to maybe accelerate development of anything over the course of the next year as you're sitting here today?

Peter Martin Carlson

Ryan, we see these resources and financial foundation taking us well into 2025. So while our burn is there, we do feel like these resources support us for the next 12 to 15 months, 15 to 18 months maybe. And it does allow us to accelerate activity. We will increase some hiring. So our -- people will see our head count go up.
And the particular area will be our commercialization effort. So we've anticipated some of that in our time lines, and we're now going to execute on it. As time goes on, we may be able to accelerate other activities.

Ryan Benjamin Zimmerman

Okay. Last one for me and I'll hop back in queue. Just any feedback or updates on the progress of the burn trial that you can provide? Anything you've learned so far that maybe allowed you to become more efficient with the enrollment of that trial. We're coming up -- we're coming into the American Burn Association meeting. So just curious kind of what's top of mind there for you guys.

Peter Martin Carlson

Happy to take the questions. You mentioned the Burn Conference the week of April 8. That's a great gathering. And we will actually have all of our sites represented and hosting a breakfast that we'll -- we're looking forward to our opportunity to interact with all of our investigators.
At this point, our enrollment is moving along. We're not quite at 10%. We're between 5% and 10% of enrollment. And we expect by the end of April we will have almost half of our sites up and fully engaged, enrolling participants.
We've been pleased with the breakout of adults and pediatric participants. We have a commitment to get at least 25% of pediatric participants in the survey and potentially as many as 40%. And that's kind of -- that was the ask from the government to match up to the indication of burn in the marketplace, what we've seen across the country.
So we're pleased with the enrollment. We are looking forward to the other sites getting up and running, and continuing to learn from that.

Operator

(Operator Instructions) The next question is from Carl Byrnes with Northland Capital Markets.

Carl Edward Byrnes

Congratulations on your progress. I think most of my questions have been answered. But I'm wondering if you can provide a little more detail on the launch in the United Kingdom, specifically with respect to staffing and system deployment. I think you said you had 1 system deployed, you were looking to have 6, and then generating revenue in the second half of the year. So again, devices and staffing.
And then I just wanted to clarify, and I think as you said, the $28 million did not include any contribution from U.K. sales related to launch?

Peter Martin Carlson

Carl, that's correct. The $28 million is the research and development revenue. Admittedly, the commercial revenue from these deployments will not be overly significant. It is additive. We would -- 6 to 8 is the range of deployments we have initially lined up. Currently, we have a handful of staff in the U.K., and we don't see the need to significantly increase that to support this activity.
Sorry. The manufacturer of the devices is done here States side. We have the biomedical, we have a clinical -- clinician, and we have a sales resource there in country. So we don't see significant need. There'll be a little bit, but nothing significant.

Carl Edward Byrnes

Great. My other question was -- they were related to the DFU clinical trial, the ramp-up, you covered that. Congratulations again on the progress.

Operator

The next question is from John Vandermosten with Zacks.

John D. Vandermosten

Let me start out with a question. And Vince, you touched on this a bit in the -- in your prepared remarks, how the $55 million is allocated. I guess you do work and then you bill the government. Is that a monthly or quarterly event for that process?

Vincent Stanley Capone

Sure. No, [Jonathan], it's -- so we actually do it on a monthly basis. And we have a lot of experience with BARDA. And so for us, it's a process that we go through monthly, and we generally get paid within the following month. It's a few weeks. And so it's not quarterly. It's a monthly total on R&D expense as we progress through the year.

John D. Vandermosten

Okay. And regarding that program, is there a certain proportion of, I guess, total cost of advancing the candidate to approval that the program tries to cover? Or is it covering the whole amount?

Vincent Stanley Capone

Yes, it covers the clinical trial cost.

John D. Vandermosten

Okay. Plus that extra kind of overhead amount.

Vincent Stanley Capone

Yes. Correct.

John D. Vandermosten

Okay. Great. And then going to the U.K. again, in previous rollouts of devices in the U.K. I've seen that they do it by country, Wales. Northern Ireland, Scotland and England. They're all kind of a little bit separate as part of the NHS. I don't know if that applies here. But I was wondering if there are any more regulatory hoops or anything you need to jump through to get broader expansion into the U.K.

Peter Martin Carlson

Nothing significant, no. This is a U.K.-wide mark. The UKCA is a post-Brexit regulatory approval or access point, you would think of the broader known CE mark across the continent, and the U.K. had to have their own once they exited the European Union.

John D. Vandermosten

Okay. And then last question is on the way you structure the arrangement. I'm assuming that there's a subscription component to the AI part, which is always updating, I guess, with new information. Is that how that works?

Peter Martin Carlson

Yes. There's the opportunity for revenue on the device deployment itself, device sale, as well as annual annuity revenue, if you will. Really, there's 2 or 3 components. The largest is the license for the AI, but there's a service component and a maintenance component.
The run rate, the annuity is the annual fees.

John D. Vandermosten

Okay. And that part, I guess, that's driving the analysis of the images, is that constantly updating or like annually updating, or is there some periodicity to that?

Peter Martin Carlson

Right now, the device has been developed to be stand-alone. This is a requirement for the contract with the U.S. government. Remember that our government partner's primary motive is mass casualty event response. So they want the device to be able to be stand-alone. There's even a battery requirement for the device. And so at this point, we are looking at batch updates or annual updates to the AI model.
Again, we're already at 340 billion pixels or data points. So there's a very robust data set in there. But we do want to build on the machine learning over time.

Operator

Your next question is from [Cliff Racuso] with Partner Cap Group.

Unidentified Analyst

Yes. Two brief questions for you. The first, circling back to your regulatory authorization in the U.K. My understanding, correct me, obviously, if I'm mistaken, but my understanding is that quite often out of the Middle East, various regulatory authorities, health regulatory authorities, wait for the U.K. to authorize devices and procedures, and they go ahead and authorize the same. Are there any developments in the near to medium term that you guys can begin to allude to out of the Middle East in that regard?
And then the second question, very briefly, is in regard to the $28 million that you're forecasting for this fiscal year. Do you have any conception of what your margins, specifically gross and operating margins, might look like for fiscal '24?

Peter Martin Carlson

Cliff, good to talk. On the Middle East situation, you are correct, the GCC or Gulf Council Countries, are able to leverage the U.K. regulatory mark or approval for access into those regions. We are in discussion with parties in the Middle East about this. We have attended multiple conferences in the Middle East. It is an active market for wounds, particularly diabetic foot ulcers. And so we do see that as a market opportunity.
We haven't given any specific guidance or time line just given sort of the logistics over there. But we are in active -- actively pursuing that opportunity.
As far as the margins, the $28 million, they're going to be relatively consistent with what you've seen this year, particularly in the fourth quarter, maybe a touch higher.

Vincent Stanley Capone

Yes, I would echo that. I think we're going to be consistent with the numbers we presented in the fourth quarter, maybe slightly higher as we roll into the PBS contract for all of 2024.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Pete Carlson for any closing remarks.

Peter Martin Carlson

Thank you again for your participation and continued interest in Spectral AI. We're very pleased with the progress we have made and remain optimistic about our prospects for future growth. We hope to speak with you at future events, including the upcoming American Burn Association Annual Meeting in April in Chicago and various investor conferences that we will announce throughout the year. Thank you, and have a good evening.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.