Spectral AI, Inc. Q3 FY2023 Earnings Call

Good day, and welcome to the Spectral AI Third Quarter 2023 Financial Results Conference Call. Please note today's event is being recorded. I would now like to turn the conference over to Devin Sullivan of The Equity Group. Please go ahead, sir. Thank you, Rocco. Good morning, everyone, and thank you for joining us for Spectral AI's 2023 Third Quarter Financial Results Conference Call. Our speakers for today will be Wensheng Fan, Chief Executive Officer of Spectral AI; and Nils Windler, 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 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 other risks and uncertainties described in the risk factors section of the company's filings with the SEC, including the registration statement 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 forward-looking statements. Management will also be discussing non-GAAP financial metrics. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measures can be found in the company's press release. With that said, I'd now like to turn the call over to Wensheng Fan, Spectral AI's Chief Executive Officer, Wensheng, go ahead.

Thank you, Devin, and good morning to all. Thank you all for joining us today for our third quarter financial results conference call. This is our very first conference call as a NASDAQ-listed company. I want to thank our executive team, board members, advisers and investors for their support and allowing us to achieve our objective as a U.S. public listed company and for their continued belief in Spectral AI and our mission. I will turn things over to Nils shortly to discuss our financial results. For now, given that many of you may be new to our company, I would like to spend a few minutes discussing Spectral AI, our technology, our accomplishments and most importantly, the significant opportunities we're addressing to change the standard of care in wound assessment and treatments. Spectral AI is a Dallas, Texas-based company. We specialize in predictive analytics with a platform that uses proprietary artificial intelligence (AI) to predict if a wound will heal. The name of our technology and our product is DeepView, D-E-E-P-V-I-E-W with a current focus in predictive medical diagnostics. Our DeepView system is a platform technology that uses proprietary AI algorithms, combined with multispectral imaging technology to determine if a wound will heal under routine care or will require advanced wound products and treatments to do so. The imaging takes less than 200 milliseconds and the AI-powered assessment is delivered in seconds. DeepView sees what the naked human eye cannot; we think of it as a rapid response test that provides an immediate objective and statistically reproducible assessment of healing that allows the physician to make informed decisions regarding treatment. Right now, DeepView has two main areas of clinical indications: burn and Diabetic Foot Ulcer (DFU). Along with these two clinical indications, we're also working on the productization of our 3D wound size measurement tool for standardized digital documentation and compliance. In the case of a burn wound, DeepView helps determine the burnt wound area that will not heal, the area where the regeneration capacity is lost. This insight will assist the emergency department in making informed decisions on which patients should be transferred to burn centers for advanced care or kept in routine care. According to the American Burn Association, 1.1 million Americans suffer from burning injuries each year, with over 500,000 presenting to emergency departments and 40,000 recurring surgeries and hospitalizations. In contrast to this demand, only 2% of U.S. hospitals have burn centers, and there are only about 250 burn surgeons in the entire United States. The use of DeepView helps bridge this gap. We have conducted three large multisite clinical studies across the United States that have validated DeepView’s current accuracy for burn wounds at 92% for adults and 88% for children compared with the current physician accuracy of 50% to 70% at best human performance. In addition, there have been head-to-head clinical trials that have demonstrated DeepView's higher accuracy on burn wounds compared with both burn specialists and non-burn specialists in burn centers, as well as emergency medical professionals. Our initial studies also show that we can reduce the length of stay (LOS) by more than 3 days from the current average of 8 days. By offering a high accuracy assessment much earlier in the treatment flow, we can significantly lower costs, reduce treatment time, decrease the chances of infections and complications, and alleviate patient suffering. In mass casualty situations, such as the unfortunate event of a wildfire earlier this year, being able to save healthcare resources and greatly improve utilization in both emergency departments and burn centers is crucial. Regarding diabetic foot ulcers, the DeepView accuracy currently stands at 86%, based on our multiple clinical studies conducted in the U.S. and EU. In non-healing assessments, we justify the immediate use of advanced wound care products and therapies, including (but not limited to) Hyperbaric Oxygen Chambers, synthetic dressing, skin substitutes, and vascular interventions. Providing an objective assessment and statistically sound justifications early on, as opposed to the current wait-and-see approach that physicians and patients may endure for as long as 30 days to 45 days to determine if a DFU will heal, is crucial. This is necessary for payers to approve advanced wound care products and therapies. The challenges surrounding diabetes are only increasing. In fact, I just returned from Saudi Arabia and the UAE, where over 20% of the population is diabetic, and this rate is growing. Local hospital systems can benefit from DeepView during DFU healing assessments as diagnostic assistance right away. They also asked if DeepView could help on the prevention side. Using DeepView is akin to taking a snapshot, literally under 200 milliseconds for imaging and an AI result in seconds. It’s non-invasive, non-radiative, and touchless. It can also serve as a continuous monitoring tool for wounds, providing physicians and patients with feedback on therapies and compliance efforts, and thus help prevent recurring ulcers. The burn market has an estimated Total Addressable Market (TAM) of $3.7 billion through 2028, and DFUs affect more than 5.2 million patients per year in the U.S., U.K. and EU, with a global market exceeding $11 billion. DFU patients reportedly have an average of 15.5 doctor visits per year, leading to a cost of up to $63,000 per patient per year. Currently, there is no medical device capable of determining if a DFU will heal. It is ironic that we can walk into many hospitals and clinics and see an array of advanced treatment options for DFUs. Yet, new patients presenting with DFUs must wait approximately 30 days before gaining access to these advanced wound care products and therapies. Why? Because insurance companies require this waiting period before authorizing treatments. After 30 to sometimes 45 days of patient uncertainty, individuals face 30 days of unnecessary discomfort and the risk of infection, or even the threat of amputation. We believe this is unacceptable and, quite frankly, unnecessary. Our goal, following the receipt of necessary regulatory approvals, is for the DeepView platform to become part of the clinical treatment flow in ERs, hospitals, burn centers, and podiatric offices. We believe that using DeepView can lead to appropriate treatment commencing on day one, and the complementary aspect of DeepView's wound assessment capabilities alongside available effective healing therapies suggests significant potential partnership opportunities between Spectral AI and various therapeutic companies once DeepView achieves regulatory clearance. Regarding our regulatory pathway, we will first focus on DeepView for diabetic foot ulcer assessment, given the size of the market opportunity. We intend to submit applications for FDA, UKCA, and CE mark approval for DeepView regarding DFU indications as well as for 3D wound measurement capabilities in 2024, subject to the completion of ongoing studies. Potential product commercialization revenues from DeepView for DFU are also targeted for 2024. We anticipate FDA and CE mark approval for the burn indication in 2025. Notably, our DeepView platform received Breakthrough Device designation for the burn indication from the FDA in 2017, allowing us to prioritize reviews and maintain a dedicated line of communication with the FDA. Both DeepView Gen-1 and Gen-2 platforms were cleared by the FDA in 2017 and 2018, respectively, for our upcoming G3 platform with all the AI indications. Specifically, in this quarter (Q3), we held our Q7 meeting with the FDA to discuss our validation study design and data analysis needed for clearance. We genuinely believe in an open-book approach with the FDA and regard our plans toward clearance as essential to de-risking one of the crucial milestones on our roadmap toward commercialization. We have established a robust and scalable strategic partnership platform comprising clinical alliances in the U.S. and European Union, along with key external development and manufacturing relationships for the production and delivery of our DeepView systems when appropriate. We are continuing to expand and strengthen these relationships in anticipation of FDA clearance. In our press release, we have highlighted several recent accomplishments, all of which we’re very proud of. Before turning things over to Nils, I want to highlight one milestone in particular. In late September of this year, September 28, at 7:40 a.m. Eastern Time, we were awarded our largest contract to date from a U.S. federal agency called BARDA, valued at up to USD 149 million. Together with the previous contract, this brings the total U.S. government awards to the company since 2019 to over USD 246 million. This latest multiyear contract includes an initial award of nearly $55 million to support the clinical validation and FDA clearance of DeepView for commercial marketing and distribution purposes. This is a major milestone that positions our technology as a key component in the U.S. government's preparedness efforts for mass casualty events. The initial award of $55 million will place DeepView devices in various burn centers and emergency rooms to support ongoing clinical validation studies and facilitate the transition of DeepView as a device for routine care upon FDA clearance. The contract also encompasses an additional total value of approximately $95 million that can be exercised for further product development, procurement, and DeepView deployment initiatives. This contract falls under Project BioShield and includes the necessary clinical studies for FDA clearance. We are very excited about our prospects for continued growth. We are confident that we are on the verge of delivering a disruptive cutting-edge, AI-driven burn healing assessment platform with the potential to significantly improve the current standard of care across multiple indications. We also believe that DeepView presents wonderful diagnostic opportunities to build strategic partnerships with other wound care product companies. We acknowledge the benefits of DeepView for physicians, hospitals, patients, payers, and advanced wound care products, as well as all these relationships. With that, I will now turn things over to our CFO, Nils Windler. Nils, please proceed with the financial results.

Thank you, Wensheng. And thank you, everyone, for joining us today. I would also like to remind everyone that our press release issued yesterday evening and our Form 10-Q that will be filed with the SEC today contain a good amount of detail on our operating results. With that in mind, I'll focus my remarks on selected highlights and key items. Research and development revenue was $3.4 million compared to $7 million in last year's third quarter. This was primarily driven by the wind down of the BARDA Burn I contract, which was expected as clinical trials were nearing completion. Importantly, we have transitioned to work under the new BARDA BioShield contract, the largest in our history with a value of up to $149 million. The initial $55 million of this contract has been executed and will spread over a 30-month period ending in March 2026, with options valued at up to $95 million beyond that. We will see a full quarter of contribution from this new contract in the fourth quarter. As a reminder, especially for those who are new to Spectral AI, R&D revenue is driven by our research and development activities. We invoice the government monthly for our R&D expenditures, with an added margin to cover expenses such as labor and third-party contractors and consultants. We generally receive payments against these invoices from the government within 2 weeks after the invoice submissions, producing a positive and predictable effect on our P&L and cash flow. Our gross margin declined to 42.8% from 45.9%. This quarter's decline in gross margin was due to commencing the $4 million MTEC contract that was awarded to Spectral AI in the second quarter of 2023, which is scheduled to continue through the first quarter of 2025. This contract has a lower gross margin than our BARDA contract. However, given its modest size compared to the BARDA BioShield contract, we do not expect work performed under the MTEC contract to materially degrade overall gross margin in Q4 2023 as well as in 2024. The MTEC award supports the ongoing development of DeepView’s Snapshot M, a handheld fully portable version of our DeepView wound assessment system that would be used to triage burn victims in combat situations. This marks the first of several horizon applications we expect to add to our DeepView AI platform over time. General and administrative expenses in the third quarter were $5.6 million, compared to $3.5 million, reflecting increased headcount to support our growth, overall R&D initiatives, and product commercialization efforts, specifically ongoing clinical trials in support of planned regulatory submissions related to our DFU indication. As previously announced, we completed our business combination in September 2023, resulting in our NASDAQ listing. Nonrecurring transaction costs associated with the combination amounted to $7.6 million in the third quarter of 2023, compared to no such costs in last year's third quarter. The net loss for the quarter was $10.6 million or $0.77 per share and included $7.6 million in nonrecurring costs. This compared to a net loss of approximately $400,000 or $0.03 per share in last year's third quarter. Adjusted EBITDA loss was $3.9 million compared to an adjusted EBITDA of about $0 in last year's third quarter. As of September 30, 2023, cash and cash equivalents totaled $7.3 million, and the company had no long-term debt. We are reiterating our revenue guidance of approximately $17.4 million for the year 2023, suggesting an approximately 36% increase in revenue for the fourth quarter of 2023 compared to the $3.4 million we generated in the third quarter. For 2024, we are reiterating revenue guidance of approximately $28 million, representing an expected increase of roughly 60% from the estimated $17.4 million in 2023. The majority of this growth will derive from the BARDA BioShield contract. Regarding gross margin for Q4, we expect an improvement driven by the new BARDA contract, which carries higher margins. For 2024, gross margin is expected to further improve as we ramp up the BARDA BioShield contract. Lastly, on October 30, we filed an S-1 registration statement with the SEC to register 8.4 million shares of our common stock underlying the same number of warrants that we were issued in connection with our September 2023 business combination, as well as to register approximately 10 million shares of common stock issued to certain shareholders during the business combination. This filing was required as part of the business combination and the shares have been accounted for in our fully diluted share counts. Thank you for your attention, and I'll turn things back to Wensheng.

All right. Thank you, Nils. And Rocco, if it's okay, can we open the call for questions from analysts, please.

Today's first question comes from Ryan Zimmerman with BTIG.

Congrats on the first quarter here as a NASDAQ-listed company. I'm just curious what revenue composition you are contemplating for next year? It sounds like most of that is BARDA related, but I think it does assume some commercial sales. I'm just curious if you could comment specifically on the thinking there as it relates to DeepView.

Like I said, the majority of our 2024 revenue will come from the BARDA BioShield contract. A further source of revenue will be the continued MTEC contract, and we're also planning on starting commercial sales. But again, to reiterate, the majority of our 2024 revenue will come from BARDA.

And then my other question is just around the technology itself, and this is probably more directed toward Wensheng. But when you think about the accuracy rate of DeepView, they're very impressive right now. But you're going to add another component, which is a 3D Wound feature, I think, in the years ahead. So how do you think about what that can do for the technology Wensheng from an accuracy standpoint, if you can reach that accuracy level higher or what that could do either from an adoption perspective as you think about some of those features?

The 3D wound size measurement is actually a very complementary, almost an essential feature in my humble opinion to DeepView for its clinical adaptations. Why do I say that? For the past few years, I have always asked the question, how many imaging technologies do you think will be in the future of hospitals, ERs, and wound care clinics? My answer always comes back with just one. The wound size measurement is a fundamental compliance issue; clinics need to better document wound progression, regardless of any other perspective because it is required. Nurses and operators are very familiar with wound size measurement. Unfortunately, there are not many useful tools available today. Many clinics still rely on rulers and other basic technologies to measure wounds. Thankfully, there are already some imaging tools on the market that offer wound size measurement, and we appreciate their efforts in educating the market. I genuinely believe our 3D wound size measurement, based on our DeepView imaging technology, offers one of the most accurate, easy to use, and reliable measurements. It measures dimensions, areas, and 3D effects in volume, for instance, for the DeepView wound. This perspective provides current clinical users with familiarity—in analogy to the Internet. This essentially adds stickiness and user-friendliness to our AI prediction side. In my opinion, if we provide AI predictions as the true differentiating factor while complementing them with standardized and digital documentation through the 3D wound measurement, this will ensure the clinical adaptations of DeepView.

And then I'll just sneak one more in, and then I'll hop back in queue. You've mentioned the $55 million upfront on the $149 million contract. Can you just remind us what unlocks the remainder of that $149 million contract from a milestone or development perspective as we think about some revenue that could come in from BARDA in the years ahead? Congrats again on the first quarter here out of the gate.

For the up to $149 million contract, we've already received the $55 million, which is being drawn down monthly. The clear and central focus is the FDA clearance of DeepView’s burn indication. Once we achieve FDA clearance for DeepView’s AI burn assessment, the remaining $95 million will be triggered in a structured manner, enabling us to begin federal procurement and deployment of our DeepView systems into ERs and burn centers. That's how the contract is structured.

And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to the management team for closing remarks.

Thank you, Rocco, and thank you again for your participation and continued interest in Spectral AI. We are very pleased with our progress and look forward to keeping you updated. We hope to speak with some of you at our upcoming conference presentations, including the Benchmark Conference in December in New York City. We’ll also be in San Francisco in connection with the JPMorgan conference. Thank you all. Thank you for your support, and have a great day.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.