# Spectral AI, Inc.: Form 10-Q for the period ended Sep 30, 2023

- Company: [Spectral AI, Inc.](/companies/mdai.md) (CIK 1833498)
- Form: 10-Q
- Filed: 2023-11-14
- Accepted by EDGAR: Nov 14, 2023, 16:29 ET
- Period: 2023-09-30
- Accession: 0001213900-23-086995
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1833498/000121390023086995/f10q0923_spectral.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1833498/000121390023086995/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2023-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2023-07-01 to 2023-09-30 | $3.4m | us-gaap:Revenues |
| Revenue | 9 months, 2023-01-01 to 2023-09-30 | $12.8m | us-gaap:Revenues |
| Cost of revenue | 3 months, 2023-07-01 to 2023-09-30 | $2.0m | us-gaap:CostOfRevenue |
| Cost of revenue | 9 months, 2023-01-01 to 2023-09-30 | $7.3m | us-gaap:CostOfRevenue |
| Gross profit | 3 months, 2023-07-01 to 2023-09-30 | $1.5m | us-gaap:GrossProfit |
| Gross profit | 9 months, 2023-01-01 to 2023-09-30 | $5.4m | us-gaap:GrossProfit |
| Operating income | 3 months, 2023-07-01 to 2023-09-30 | −$4.2m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2023-01-01 to 2023-09-30 | −$10.1m | us-gaap:OperatingIncomeLoss |
| Income tax | 3 months, 2023-07-01 to 2023-09-30 | −$54.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2023-01-01 to 2023-09-30 | $32.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2023-07-01 to 2023-09-30 | −$10.6m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2023-01-01 to 2023-09-30 | −$17.3m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2023-07-01 to 2023-09-30 | −$0.77 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2023-01-01 to 2023-09-30 | −$1.29 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2023-07-01 to 2023-09-30 | −$0.77 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2023-01-01 to 2023-09-30 | −$1.29 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2023-07-01 to 2023-09-30 | 13,822,990 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2023-01-01 to 2023-09-30 | 13,410,287 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2023-01-01 to 2023-09-30 | −$10.9m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Cash and equivalents | at 2023-09-30 | $7.3m | us-gaap:Cash |
| Current assets | at 2023-09-30 | $11.4m | us-gaap:AssetsCurrent |
| Total assets | at 2023-09-30 | $12.3m | us-gaap:Assets |
| Current liabilities | at 2023-09-30 | $10.6m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2023-09-30 | $10.9m | us-gaap:Liabilities |
| Shareholders' equity | at 2023-09-30 | $1.5m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 41,627 characters.

*Unless otherwise indicated or the context otherwise requires, references in this section to “we,” “our,” “us” or other similar terms refer to the business and operations of Spectral AI, Inc., and its subsidiaries or Legacy Spectral, prior to its business combination with Spectral MD Holdings, Ltd. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited quarterly condensed financial statements and related notes included elsewhere in this Form 10-Q, as well as Legacy Spectral’s audited annual consolidated financial statements and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as of and for the years ended December 31, 2022 and 2021 included in our final prospectus, as amended, on Form S-4/A filed with the Securities and Exchange Commission (“SEC”) on August 10, 2023 (the ‘Prospectus”). In addition to historical data, this discussion contains forward-looking statements about our business, results of operations, cash flows, financial condition and prospects based on current expectations that involve risks, uncertainties and assumptions. Our actual results could differ materially from such forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those identified below and those discussed in the sections titled “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements” included in the Prospectus. Additionally, our historical results are not necessarily indicative of the results that may be expected for any period in the future.*

### Overview

We are an AI company focused on predictive medical diagnostics. We operate in one segment. We are devoting substantially all of our efforts towards research and development of our DeepView System, an internally developed multi-spectral imaging (“MSI”) device which has designated FDA breakthrough device designation (“BDD”) status. Our DeepView System uses proprietary algorithms to distinguish between damaged and healthy human tissue invisible to the naked eye, providing “Day One” healing assessments. DeepView’s output is specifically engineered to allow the physician to make a more accurate, timely and informed decision regarding the treatment of the patient’s wound. Our focus from 2013 through 2021 was on the burn indication. In 2022 and 2023, we expanded our focus to include the diabetic foot ulcer (“DFU”) indication.

In the case of DFUs, a non-healing assessment would provide the physician with an objective assessment to use an advanced wound care therapy on “Day One”, in seconds, as opposed to the current approach that involves waiting up to 30 days to see how the wound develops before making such clinical assessment.

For burn wounds, a non-healing assessment could aid the clinician in making an immediate and objective determination for appropriate candidates for surgery, as well as determining what specific areas of the burn wound will require excision and skin grafting. DeepView’s current accuracy for burn wounds is 92% for adults and 88% for pediatrics, compared with current physician accuracy of 50% to 75%, respectively, at best, according to industry literature.1 In addition, in head-to-head clinical trial evaluations, our DeepView System provided higher accuracy to “ground truth” on burn wound analysis than the accuracy of burn specialists, reporting at 70-80% accuracy, or non-burn specialist physicians, reporting at 50-60% accuracy.2 We have conducted three large clinical studies with multiple sites across the United States, enrolling 413 burn patients, including 329 adult and 84 pediatric patients. Through these studies, we were able to identify the burn assessment accuracy in both surgical and non-surgical treatment.

We have not generated any product revenue to date. We have received substantial support from the U.S. government for our DeepView System’s application for burn wounds, including from agencies such as the Biomedical Advanced Research and Development Authority (“BARDA”), which is part of the HHS Office of the Assistant Secretary for Preparedness and Response in the United States, established to aid in securing the United States from chemical, biological, radiological, and nuclear threats, as well as from pandemic influenza and emerging infectious diseases. We have also received funding from the National Science Foundation (the “NSF”), the National Institute of Health (the “NIH”) and the Defense Health Agency (the “DHA”). Since 2013, we have received approximately $279.0 million in funding commitments from government contracts, primarily from BARDA, which accounts for $271.9 million. This has allowed us to develop our technology and further our clinical trials.

1 Henk Hoeksema, Karlien Van de Sijpe, Thiery Tondu, Moustapha Hamdi, Koenraad Van Landuyt, Phillip Blondeel, Stan Monstrey, Accuracy of early burn depth assessment by laser Doppler imaging on different days post burn, Burns, Volume 35, Issue 1, 2009, Pages 36-45, ISSN 0305-4179. The above article was exploring laser doppler imaging as an objective technique to determine the depth of a burn wound and states “as has been demonstrated in several studies, a purely clinical, bedside evaluation of the burn depth in dermal burns is accurate only in about 50-75% of the cases.”

2 Rise of the (Learning) Machines: An Interim Analysis Assessing Burn Wound Healing; Jeffrey E. Carter, MD, FACS, et.al., *https://clinicaltrials.gov/ct2/show/NCT05023135.*

In September 2023, we executed our third contract with BARDA for a multi-year Project BioShield (“PBS”) contract, valued at up to approximately $149 million (the “PBS BARDA Contract”). This multi-year contract includes our initial award of nearly $55.0 million to support the clinical validation and FDA clearance of DeepView® for commercial marketing and distribution purposes. We are also currently completing our second contract with BARDA, referred to as the BARDA Burn II contract, which was signed in July 2019 and is due to be completed in July 2024. Under this contract, we expect to further the DeepView System design, refine the AI algorithm, and take the necessary steps to obtain FDA approval for our DeepView GEN 3 System. However, approval from the FDA or other regulatory agencies, foreign or domestic, cannot be guaranteed and may take longer than planned. In August 2022, we also received the Option 1B extension of the BARDA Burn II contract, which is valued at an additional $8.2 million, bringing the total funding received from Option 1 of the BARDA Burn II contract to $47.6 million, since July 2021, under Option 1A and 1B (including modification), to execute the adult and pediatric multi-center clinical training study. This grant funding is non-dilutive to our shareholders, and we believe it validates the important nature of our mission and technology.

In April 2023, we received a $4.0 million grant award from the Medical Technology Enterprise Consortium (“MTEC”), which, building on prior awards from DHA, is to be used to support military battlefield burn evaluation via a handheld DeepView (the “MTEC Agreement”). The MTEC Agreement extends the DHA Phase II contract for the development of the handheld device of the DeepView System. Under the terms of the MTEC Agreement, MTEC will pay us a firm fixed fee based upon our achievement of certain milestones described in the agreement through April 5, 2025. The milestone payment schedule is based on a three phased approach to the development of our handheld device. Phase 1 of the MTEC Agreement began in April 2023 and is scheduled to extend through at least July 2023 and is focused on the planning, design and testing of the handheld device for its intended applications. Phase 1 has a funding budget of $1.2 million. Once Phase 1 is completed, Phase 2 is intended to run through October 2024 and encompasses the development, design modification and build-out of the handheld device to the U.S. government standards as identified in the design and commercialization plans for the device. Phase 2 has a funding budget of $1.6 million. Phase 3 of the MTEC Agreement addresses the complete manufacturing of the device, the process validation of the production and completion of up to thirty handheld devices. Phase 3 begins following completion of Phase 2 and is intended to run through April 2025 with a funding budget of approximately $1.2 million.

We anticipate that the DeepView System will have two revenue streams, a SaMD (software as a medical device) model, and an imaging device component. The SaMD model applies a SaaS (software as a service) treatment for the DeepView System which will feature a software licensing fee that includes maintenance, image hosting, and access to algorithm updates. The proprietary imaging device accesses artificial intelligence algorithms and is a universal platform to house multiple clinical applications. Pricing for these components will be evaluated and strategically set per country and site-of-service for heightened customer adoption.

### Business Combination

On September 11, 2023, we consummated a business combination, pursuant to the business combination agreement dated April 11, 2023 (the “Business Combination Agreement”) by and among Spectral AI, Inc. (Previously, Rosecliff Acquisition Corp I (“Rosecliff”)), Ghost Merger Sub I (a wholly owned subsidiary of Rosecliff), Ghost Merger Sub II (a wholly owned subsidiary of Rosecliff) and Spectral MD Holdings, Ltd. (“Legacy Spectral”). Upon the closing of the Business Combination (the “Closing”), in sequential order: (a) Ghost Merger Sub I merged with and into Legacy Spectral, with Legacy Spectral continuing as the surviving company as our wholly owned subsidiary (the “Spectral Merger”) and then, (b) Legacy Spectral merged with and into Ghost Merger Sub II (the “SPAC Merger”, together with the Spectral Merger (the “Business Combination”)), with Ghost Merger Sub II (renamed Spectral MD Holdings LLC) surviving the SPAC Merger as our direct wholly-owned subsidiary. Upon the Closing, we changed our name from Rosecliff Acquisition Corp I to Spectral AI, Inc. (“Spectral AI”, the “Company” or the “Combined Company”). In addition, the Company cancelled the redeemable warrants that it issued to Rosecliff Acquisition Sponsor I LLC, a Delaware limited liability company (the “Sponsor”), in a private placement (the “Private Warrants”) in connection with the Company’s initial public offering on February 17, 2021 (the “Initial Public Offering”) at Closing, with the 8,433,333 redeemable warrants issued to the public in the Initial Public Offering (the “Public Warrants”) remaining outstanding.

Prior to the Business Combination, Rosecliff had 280,485 shares of Class A common stock, par value $0.0001 per share, issued and outstanding and held by public shareholders (the “Public Shares”) and 6,325,000 shares of Class B common stock, par value $0.0001 per share, issued and outstanding and held by the Sponsor (the “Sponsor Shares”). Upon the Closing, 5,445,000 of the Sponsor Shares were forfeited, in accordance with a letter agreement with the Sponsor, and the remaining 880,000 Sponsor Shares and 280,485 Public Shares, no longer designated Class A and Class B, were included in shares of the Company’s common stock, par value $0.0001 per share (the “Company Common Stock”).

Prior to the Business Combination, Legacy Spectral's shares of common stock, par value $0.001 per share (“Legacy Spectral Common Stock”) were listed on the AIM market on the London Stock Exchange (delisted on September 7, 2023). In September 2023, prior to the Closing, Legacy Spectral issued 7,679,198 shares of Legacy Spectral Common Stock to certain investors in a private placement, in exchange for $3.4 million (the “Equity Raise”).Upon the Closing, all of Legacy Spectral’s issued and outstanding 145,380,871 shares of Legacy Spectral Common Stock, including the shares from the Equity Raise, were exchanged for 14,094,450 shares of Company Common Stock at an exchange ratio of 10.31 (the “Exchange Ratio”), meaning that the Company issued one share of Company Common Stock in exchange for 10.31 shares of Legacy Spectral Common Stock.

On September 12, 2023, the Company began trading its shares of the Company Common Stock and the Public Warrants on the NASDAQ Capital Market (the “NASDAQ”) under the symbols “MDAI” and “MDAIW”, respectively. Prior to the Business Combination, the Company’s shares of Company Common Stock and Public Warrants were listed on the NASDAQ under the symbols “RCLF” and “RCLFW”, respectively.

In September 2023, prior to the Closing, Legacy Spectral issued 7,679,198 shares of Legacy Spectral Common Stock, which was converted to 744,667 shares of Company Common Stock based on the Exchange Ratio, for $3.4 million (the “Equity Raise”).

The Business Combination was accounted for as a reverse recapitalization in accordance with GAAP. Under the guidance in Accounting Standards Codification (“ASC”) 805, Business Combinations, Rosecliff, which is the legal acquirer, has been treated as the “acquired” company for financial reporting purposes and Legacy Spectral has been treated as the accounting acquirer. This determination was primarily based on the following:

(i) Legacy Spectral’s former shareholders has a majority of the voting power of Spectral AI;

(ii) Legacy Spectral’s senior management comprises all of the senior management of Spectral AI;

(iii) Legacy Spectral selected five of the six of the directors for the Board of Directors of Spectral AI;

(iv) Legacy Spectral’s relative size of assets and operations compared to Rosecliff; and

(v) Legacy Spectral’s operations comprised the ongoing operations of Spectral AI.

Accordingly, for accounting purposes, the Business Combination was treated as the equivalent of a capital transaction in which Legacy Spectral issued stock for the net assets of Rosecliff prior to the Closing. Upon the Closing, the net assets of Rosecliff are stated at fair value, with no goodwill or other intangible assets recorded. All historical financial information presented in the unaudited condensed consolidated financial statements represents the accounts of Legacy Spectral at their historical cost as if Legacy Spectral is the predecessor to the Company. The unaudited condensed consolidated financial statements following the Closing reflect the results of the Combined Company’s operations.

### Public Company Costs

Upon consummation of the Business Combination, Spectral AI has continued as an SEC-registered and NASDAQ-listed company. We expect to hire additional staff and implement new processes and procedures to address public company requirements in anticipation of and following the completion of the Business Combination. We also expect to incur substantial additional expenses for, among other things, directors’ and officers’ liability insurance, director fees, internal control compliance, and additional costs for investor relations, accounting, audit, legal and other functions.

### Key Operating and Financial Metrics

We regularly review a number of metrics, including the following key operating and financial metrics, to evaluate our business, measure our performance, identify trends in our business, prepare financial projections and make strategic decisions. We believe the operating and financial metrics presented are useful in evaluating our operating performance, as they are similar to measures by our public competitors and are regularly used by security analysts, institutional investors, and other interested parties in analyzing operating performance and prospects. Adjusted EBITDA is a non-GAAP measure, as it is not a financial measure calculated in accordance with GAAP and should not be considered as a substitute for net (loss) income, calculated in accordance with GAAP. See “Non-GAAP Financial Measures” for additional information on adopted non-GAAP financial measures and a reconciliation of these non-GAAP measures to the most comparable GAAP measures.

The following table sets forth these metrics for the three and nine months ended September 30, 2023 and 2022:

*(In thousands)*

|  | Three Months Ended September 30, 2023 | 2022 | Nine Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: | ---: | ---: |
| Research and development revenue | $3,440 | $7,038 | $12,769 | $19,272 |
| Gross Profit | 1,472 | 3,227 | 5,444 | 8,329 |
| Gross margin | 42.8% | 45.9% | 42.6% | 43.2% |
| Operating loss | (4,166) | (251) | (10,055) | (878) |
| Net loss | (10,629) | (380) | (17,308) | (1,173) |
| Adjusted EBITDA | (3,885) | (4) | (9,073) | 2 |

See “Non-GAAP Financial Measures” below for a reconciliation of net loss to Adjusted EBITDA.

### Research and development revenue

We define research and development revenue as revenue generated from the research, testing and development of the DeepView System as utilized in connection with our burn indication. This research and development revenue reflects applied research and experimental development costs relating to our burn application as developed in connection with our BARDA, MTEC and DHA contracts.

### Gross Profit and Gross Margin

We define gross profit as research and development revenue, less cost of revenue, and define gross margin, expressed as a percentage, as the ratio of gross profit to revenue. Gross profit and margin can be used to understand our financial performance and efficiency and as we begin commercialization, it will allow investors to evaluate our pricing strategy and compare against our competitors. Our management uses these metrics to make strategic decisions, pricing decisions, identifying areas for improvement, set targets for future performance and make informed decisions about how to allocate resources going forward.

### Adjusted EBITDA

We define adjusted earnings before interest, tax, depreciation and amortization (“Adjusted EBITDA”) as net loss excluding income taxes, depreciation of property and equipment, net interest income, stock compensation, transaction costs and any non-operating financial income and expense. See “— Non-GAAP Financial Measures” for a reconciliation of GAAP net loss to Adjusted EBITDA.

### Key Factors that May Influence Future Results of Operations

Our financial results of operations may not be comparable from period to period due to several factors. Key factors affecting our results of operations are summarized below.

*Revenue Sources.* As a pre-commercialization company, we currently generate revenue almost exclusively from two U.S. governmental agencies. We are highly dependent upon the continuation of the existing U.S. governmental contract awards, as well as future governmental procurement or other awards. Our operating results may not be comparable between periods as the timing and amount of awards or procurements from the U.S. government may be inconsistent with the timing of prior awards, and due to the phasing of the development study schedules. Our revenues may continue to be almost exclusively dependent upon the terms of those awards.

*Gross Margin.* As we begin commercial sales of the DeepView System, we may need to determine lower pricing and incentives to accelerate adoption and implementation of the DeepView System, which may negatively impact future revenue and gross margin percentages.

*Managing our Supply Chain.* We are reliant on contract manufacturers and suppliers to produce our components. While we have not been subject to any disruptions in our current production, there remain global supply chain challenges and logistics constraints, including component shortages, which may cause delays in critical components and inventory, longer lead times, increased costs and delays in product shipments. Our ability to grow depends, in part, on the ability of our contract manufacturers and suppliers to provide high quality services and deliver components and finished products on time and at reasonable costs. While we do not maintain sole-source suppliers, there is a concentration of suppliers which could lead to supply shortages, long lead times for components and supply changes. In the event we are unable to mitigate the impact of delays and/or price increases in raw materials, electronic components and freight, it could delay the manufacturing and installation of our products, which would adversely impact our cash flows and results of operations, including revenue and gross margin.

### Components of Consolidated Statements of Operations

### Research and Development Revenue

Our primary source of revenue is research and development revenue. Currently, we are highly dependent upon the reimbursements from BARDA for the burn diagnostic testing of our DeepView System. Our research and development revenue is affected by the amount of research and development that is expended each month with respect to our contract with BARDA and other U.S. governmental contract awards. During 2023, we received a grant under the MTEC Agreement which we earn based on the achievement of milestones. Our revenue growth is dependent on a number of factors including expanding the research and development expense under the BARDA contract, research and development reimbursed expenses relating to other contract awards from U.S. governmental agencies and the intended future commercial sales of our DeepView System.

### Cost of Revenue

Our cost of revenues consists primarily of direct and indirect costs associated with the research and development expenses relating to the BARDA and MTEC contracts. Our revenue costs are affected by the extent of research and development expenses as well as expansion of work on other U.S. governmental projects and the expanded applications for our DeepView System.

### Gross Profit

Gross profit may vary from period-to-period and is primarily affected by the current reimbursement rates under the BARDA contract and other U.S. governmental contract awards, as well as the percentage of revenue related to the BARDA contract as compared to the MTEC project. These reimbursement rates are fixed under each contact award. Our gross profit represents this reimbursement rate plus a variable component relating to non-reimbursed expenses incurred in connection with the work completed on these contracts.

### Operating Costs and Expenses

Operating costs and expenses consist of general and administrative expense. These expenses primarily relate to salaries and related costs of our organization’s support and operations staff, consulting fees, rent, insurance and office expenses, and our non-revenue generating research and development expenses, primarily related to salaries and related costs and consulting fees.

### Other income (expense)

Other income (expense) primarily consists of transaction costs, primarily related to the Business Combination, net interest income, change in fair value of warrant liabilities and foreign exchange transaction gains/losses. Historic foreign exchange transaction loss primarily relates to changes in the exchange rate between the U.S. dollar and the British pound sterling for our deposit accounts that are denominated in British pound sterling. In addition, this amount includes costs associated with buying British pound sterling for payment of our employees and vendors in the UK.

### Results of Operations

The following table sets forth a summary of our consolidated statements of operations for the periods presented:

*(In thousands)*

|  | Three Months Ended September 30, 2023 | 2022 | Nine Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: | ---: | ---: |
| **Research and development revenue** | $3,440 | $7,038 | $12,769 | $19,272 |
| **Cost of revenue** | (1,968) | (3,811) | (7,325) | (10,943) |
| **Gross profit** | 1,472 | 3,227 | 5,444 | 8,329 |
| **Operating costs and expenses:** |  |  |  |  |
| General and administrative | 5,638 | 3,478 | 15,499 | 9,207 |
| **Total operating costs and expenses** | 5,638 | 3,478 | 15,499 | 9,207 |
| **Operating loss** | (4,166) | (251) | (10,055) | (878) |
| **Other income (expense):** |  |  |  |  |
| Net interest income | 42 | 2 | 128 | 1 |
| Change in fair value of warrant liability | 1,069 | 22 | 1,004 | 50 |
| Foreign exchange transaction loss | (24) | (51) | (11) | (255) |
| Transaction costs | (7,604) | - | (8,342) | - |
| Other income | - | (17) | - | - |
| **Total other expense, net** | (6,517) | (44) | (7,221) | (204) |
| **Loss before income taxes** | (10,683) | (295) | (17,276) | (1,082) |
| Income tax benefit (provision) | 54 | (85) | (32) | (91) |
| **Net loss** | $(10,629) | $(380) | $(17,308) | $(1,173) |

### Research and development revenue

*(In thousands, except percentages)*

|  | Three Months Ended September 30, 2023 | 2022 | Change in $% |  | Nine Months Ended September 30, 2023 | 2022 | Change in $% |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Research and development revenue | $3,440 | $7,038 | $(3,598) | (51.1)% | $12,769 | $19,272 | $(6,503) | (33.7)% |

Research and development revenue decreased by 51.1% and 33.7%, respectively, or approximately $3.6 million and $6.5 million, respectively, for the three and nine months ended September 30, 2023, as compared to the comparable periods in 2022, primarily due to decreased research and development work performed pursuant to the BARDA Burn II contract as clinical trials under this contract were nearing completion. New patient enrollments in our BARDA clinical study decreased in the three months ended September 30, 2023 compared to the three months ended September 30, 2022 as the Company is completing enrollment and transitioning to the closeout phase of the study.

For the three and nine months ended September 30, 2023 and 2022, the Company’s revenues disaggregated by the major sources was as follows:

*(In thousands, except percentages)*

|  | Three Months Ended September 30, 2023 | 2022 | Change in $% |  | Nine Months Ended September 30, 2023 | 2022 | Change in $% |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| BARDA | $3,055 | $6,903 | $(3,848) | (55.7)% | $12,018 | $18,866 | $(6,848) | (36.3)% |
| Other U.S. governmental authorities | 385 | 135 | 250 | 185.2% | 751 | 406 | 345 | 85.0% |
| Total research and development revenue | $3,440 | $7,038 | $(3,598) | (51.1)% | $12,769 | $19,272 | $(6,503) | (33.7)% |

### Cost of Revenues and Gross Profit

*(In thousands, except percentages)*

|  | Three Months Ended September 30, 2023 | 2022 | Change in $% |  | Nine Months Ended September 30, 2023 | 2022 | Change in $% |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Cost of revenue | $1,968 | $3,811 | $(1,843) | (48.4)% | $7,325 | $10,943 | $(3,618) | (33.1)% |
| Gross profit | 1,472 | 3,227 | (1,755) | (54.4)% | 5,444 | 8,329 | (2,885) | (34.6)% |
| Gross margin | 42.8% | 45.9% |  |  | 42.6% | 43.2% |  |  |

Cost of revenue for the three and nine months ended September 30, 2023 compared to the comparable periods in 2022 decreased by 48.4% and 33.1%, respectively, or approximately $1.8 million and $3.6 million, respectively, primarily due to decreased activity to fulfill our U.S. governmental contracts, which is consistent with decreased research and development revenue.

Gross margin for the three months ended September 30, 2023 decreased 3.1% as compared to the comparable period in 2022 primarily due to beginning the MTEC contract, which has a lower gross margin, during 2023. Gross margin was relatively consistent for nine months ended September 30, 2023, as compared to the comparable periods in 2022.

### General and Administrative Expense

*(In thousands, except percentages)*

|  | Three Months Ended September 30, 2023 | 2022 | Change in $% |  | Nine Months Ended September 30, 2023 | 2022 | Change in $% |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| General and administrative expense | $5,638 | $3,478 | $2,160 | 62.1% | $15,499 | $9,207 | $6,292 | 68.3% |

General and administrative expense increased by 62.1% and 68.3%, respectively, or approximately $2.2 million and $6.2 million, respectively, for the three and nine months ended September 30, 2023, as compared to the comparable periods in 2022. The increase was primarily due to an increase in our administrative staffing since 2022. Our headcount grew from 63 employees as of September 30, 2022 to 83 full-time employees as of September 30, 2023 resulting in an increase in general and administrative expense of approximately $0.7 million and $3.5 million, respectively, for the three and nine months ended September 30, 2023. Additionally, non-revenue generating research and development activities, primarily related to salaries and related costs and consulting fees, have increased by approximately $1.2 million and $2.8 million, respectively, in the three and nine months ended September 30, 2023 compared to the comparable periods in 2022.

### Other income (expense)

|  | Three Months Ended September 30, |  | Change in Nine Months Ended September 30, |  | Change in |
| --- | ---: | ---: | ---: | ---: | ---: |
|  | **2023** | **2022** | **$2023** | **2022** | **$** |
|  | **(In thousands, except percentages)** |  |  |  |  |
| Net interest income | $42 | $2 | $40 $128 | $1 | $127 |
| Change in fair value of warrant liability | 1,069 | 22 | 1,047 1,004 | 50 | 954 |
| Foreign exchange transaction loss | (24) | (51) | 27 (11) | (255) | 244 |
| Transaction costs | (7,604) | - | (7,604) (8,342) | - | (8,342) |
| Other income | - | (17) | 17 - | - | - |
| Total other expense, net | $(6,517) | $(44) | $(6,473) $(7,221) | $(204) | $(7,017) |

Net interest income for the three and nine months ended September 30, 2023 primarily relates to cash interest received by us from our deposit accounts.

Change in fair value of warrant liability increased by approximately $1.0 million for each of the three and nine months ended September 30, 2023, as compared to the comparable period in 2022. The income during the three and nine months ended September 30, 2023, was primarily due to the decrease in the fair value of the Public Warrants from the closing of the Business Combination to September 30, 2023.

Foreign exchange transaction loss for the three and nine months ended September 30, 2022 relates to the decreased exchange rate between the U.S. dollar and the British pound sterling during the third quarter of 2022 for our deposit accounts that are denominated in British pound sterling. In addition, this amount includes costs associated with buying British pound sterling for payment of our employees and vendors in the UK. Foreign exchange transaction loss for the three and nine months ended September 30, 2023 is immaterial due to much lower balances in our deposit accounts and accounts payable denominated in British pound sterling and less fluctuation in the exchange rate between the U.S. dollar and the British pound sterling.

Transaction costs for the three and nine months ended September 30, 2023 primarily relate to non-recurring legal, accounting and consulting costs expended for the Business Combination.

### Non-GAAP Financial Measures

We use Adjusted EBITDA as a non-GAAP metric when measuring performance, including when measuring current period results against prior periods’ Adjusted EBITDA. This non-GAAP financial measure should be considered in addition to results prepared in accordance with GAAP and should not be considered as a substitute for, or superior to, GAAP results. In addition, Adjusted EBITDA should not be construed as an indicator of our operating performance, liquidity or cash flows generated by operating, investing and financing activities, as there may be significant factors or trends that it fails to address.

Because of their non-standardized definitions, non-GAAP measures (unlike GAAP measures) may not be comparable to the calculation of similar measures of other companies. We caution investors that non-GAAP financial information, by its nature, departs from traditional accounting conventions. Supplemental non-GAAP measures are presented solely to permit investors to more fully understand how Spectral AI’s management assesses underlying performance.

### Adjusted EBITDA

We define Adjusted EBITDA as net loss excluding income taxes, depreciation of property and equipment, net interest income, stock compensation, transaction costs and any non-operating financial income and expense.

The following table presents our Adjusted EBITDA for the three and nine months ended September 30, 2023 and 2022:

*(In thousands)*

|  | Three Months Ended September 30, 2023 | 2022 | Nine Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: | ---: | ---: |
| Net loss | $(10,629) | $(380) | $(17,308) | $(1,173) |
| Adjust: |  |  |  |  |
| Depreciation expense | 2 | - | 7 | 6 |
| Provision for income taxes | (54) | 85 | 32 | 91 |
| Net interest income | (42) | (2) | (128) | (1) |
| **EBITDA** | **(10,723)** | **(297)** | **(17,397)** | **(1,077)** |
| Additional adjustments: |  |  |  |  |
| Stock-based compensation | 279 | 247 | 975 | 874 |
| Change in fair value of warrant liability | (1,069) | (22) | (1,004) | (50) |
| Foreign exchange transaction gain | 24 | 51 | 11 | 255 |
| Transaction costs | 7,604 | - | 8,342 | - |
| Other income | - | 17 | - | - |
| **Adjusted EBITDA** | **$(3,885)** | **$(4)** | **$(9,073)** | **$2** |

### Liquidity and Capital Resources

### Sources of Liquidity

As of September 30, 2023 we had approximately $7.3 million in cash, and an accumulated deficit of approximately $29.2 million.

We have historically funded our operations through the issuance of notes and the sale of preferred stock and common stock. Together with the new PBS BARDA Contract, executed in September 2023, for a total value of up to $149 million, our total potential support from BARDA is nearly $250 million if all future options are executed. The base phase of the PBS BARDA Contract, valued at $55 million, was exercised concurrently with the contract award in September 2023. To date, for our 2013 and 2019 BARDA contracts, we have committed funding of $101 million of which we have received $99 million. In April 2023, we received a $4.0 million grant under the MTEC Agreement. See “*Research and Development Revenue”* above. With the PBS BARDA Contract and the MTEC Agreement, the Company believes it will have sufficient working capital to fund operations for at least one year beyond the release date of the condensed consolidated financial statements.

Our future capital requirements will depend on many factors, including the revenue growth rate, the success of future product development and capital investment required, and the timing and extent of spending to support further sales and marketing and research and development efforts. In addition, we expect to incur additional costs as a result of operating as a U.S. public company. There can be no assurance that we will be successful in raising any additional capital. If additional financing is required from outside sources, we cannot be sure that any additional financing will be available to us on acceptable terms, if at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition could be adversely affected.

### Cash Flows

The following table summarizes our cash flows for the nine months ended September 30, 2023 and 2022:

*(In thousands)*

|  | Nine Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: |
| Net cash used in operating activities | $(10,865) | $(863) |
| Net cash provided by (used in) financing activities | 4,039 | (651) |

#### Cash Flows Used in Operating Activities

Net cash used in operating activities increased by approximately $10.0 million for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022 primarily driven by (a) increased spending on general and administrative expenses of approximately $3.5 million for our increased staff and approximately $2.8 million for our higher non-revenue generating research and development costs, (b) decreased gross profit of approximately $2.9 million from less research and development work performed pursuant to the BARDA Burn II contract as clinical trials under this contract were nearing completion, partially offset by cash receipts in excess of cash payments, and (c) cash paid for transaction costs for the Business Combination of $1.0 million.

#### Cash Flows Provided by (Used in) Financing Activities

Net cash provided by (used in) financing activities increased approximately $4.7 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. This was primarily attributable to the proceeds of $3.4 million from the Equity Raise and operating cash received upon closing of the Business Combination of $0.7 million.

### Current Indebtedness

In September 2023, we entered into a financing arrangement for a portion of our insurance premium for approximately $0.6 million (the “Note”). The Note bears interest at 8.6% per annum and is payable in equal monthly payments of principal and interest, maturing in June 2024. As of September 30, 2023, we owed $0.6 million for the Note.

### Related Party Transactions

For the nine months ended September 30, 2023 and 2022, we did not have any transactions with related parties.

### Off-Balance Sheet Arrangements

During the periods presented, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

### Critical Accounting Policies

There have been no material changes to the Company’s critical accounting policies and estimates discussed in Legacy Spectral’s Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies for the years ended December 31, 2022 and 2021 included in the Prospectus.

### Recent Accounting Pronouncements

See Note 2, Summary of Significant Accounting Policies, of the notes to our condensed consolidated financial statements included elsewhere in this Form 10-Q for recently adopted accounting standards and recently issued accounting standards as of the dates of the statement of financial position included in this Form 10-Q.

### Emerging Growth Company

We are an emerging growth company, as defined in the JOBS Act. The JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. This provision allows an emerging growth company to delay the adoption of some accounting standards until those standards would otherwise apply to private companies. We have elected to use the extended transition period under the JOBS Act for the adoption of certain accounting standards until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies that comply more promptly with new or revised accounting pronouncements as of public company effective dates.

### Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risks in the ordinary course of our business. These risks primarily include interest rate, foreign exchange, credit and inflation risks.

### Interest Rate Sensitivity

We maintain a large amount of our assets in cash. Our cash is held primarily in cash deposits. The fair value of our cash would not be significantly affected by either an increase or decrease in interest rates due mainly to the short-term nature of these instruments. Additionally, changes to interest rates will impact on the cost of any future borrowings. With respect to our current borrowings, the interest rate on the Note for insurance premiums is fixed. Changes in prevailing interest rates could have a material impact on our results of operations.

### Foreign Currency Risk

Our revenue is denominated in U.S. dollars. Our expenses are generally denominated in the currencies in which our operations are located, which is primarily in the United States and UK, with an insignificant portion of expenses incurred in our wholly owned subsidiaries in the UK and denominated in British pound sterling.

### Credit Risk

Financial instruments that subject us to concentrations of credit risk consist primarily of cash and accounts receivable. The vast majority of our cash is held in U.S. financial institutions which, at times, exceed federally insured limits. We have not recognized any losses from credit risks on such accounts. We believe we are not exposed to significant credit risk on cash.

Additional credit risk is related to our concentration of receivables and revenues. One customer (which is a U.S. government agency) represents the majority of our research and development revenue and accounts receivable.

### Inflation Risk

The recent increase in inflation partially contributed to the increase in the cost of our research and development as well as operating costs. If the cost of our products, employee costs, or other costs continue to be subject to significant inflationary pressures, such inflationary pressure may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expense. As a result, our inability to quickly respond to inflation could harm our cash flows and results of operations in the future.

## Controls and procedures

As filed, 3,660 characters.

### Evaluation of Disclosure Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on management’s evaluation as of the quarter ended September 30, 2023, our Chief Executive Officer and Chief Financial Officer have concluded that, as a result of the material weaknesses in our internal control over financial reporting as described below and in Part II, Item 1A. Risk Factors, our disclosure controls and procedures were not effective as of September 30, 2023. In connection with the preparation of our consolidated financial statements for the quarter ended September 30, 2023, we identified material weaknesses in our internal control over financial reporting related to deficiencies in our controls over the accounting for complex equity arrangements, and in the design and operation of internal controls involving accruals and unbilled revenue.

Notwithstanding the identified material weaknesses, our management believes the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial condition, results of operations and cash flows as of and for the periods presented in accordance with U.S. GAAP

### Remediation Plan for Material Weaknesses

Remediation generally requires making changes to how controls are designed and implemented and then adhering to those changes for a sufficient period of time such that the effectiveness of those changes is demonstrated with an appropriate amount of consistency. In response to the material weaknesses, we implemented, and are continuing to implement, measures designed to improve our internal control over financial reporting. These efforts include:

- engaging a professional accounting services firm to help us assess and commence documentation of our internal controls for complying with the Sarbanes-Oxley Act of 2002;
- strengthening, formalizing, documenting and testing accounting processes and internal controls, specifically regarding accrued expenses and contract reviews; and
- engaging consultants to provide additional technical accounting expertise.

The measures we are implementing are subject to continued management review supported by confirmation and testing, as well as audit committee oversight. Management and the Audit Committee remain committed to the implementation of remediation efforts to address the material weaknesses. We will continue to implement measures to remedy our internal control deficiencies, though there can be no assurance that our efforts will be successful or avoid potential future material weaknesses. In addition, until remediation steps have been completed and are operated for a sufficient period of time, and subsequent evaluation of their effectiveness is completed, the material weaknesses previously disclosed, and as described above, will continue to exist.

Changes in Internal Control over Financial Reporting

Except for the remediation measures in connection with the material weaknesses described above, there were no other changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 9,079 characters.

Factors that could cause our actual results to differ materially from those in this Quarterly Report include the risk factors described in our Annual Report on Form 10-K filed with the SEC on March 31, 2023 and in the Registration Statement on Form S-4 filed with the SEC on May 2, 2023, as amended. Any of those factors could result in a significant or material adverse effect on our results of operations or financial condition. Additional risk factors not presently known to us or that we currently deem immaterial may also impair our business or results of operations. As of the date of this Quarterly Report, there have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K filed with the SEC on March 31, 2023 and in the Registration Statement on Form S-4 filed with the SEC on May 2, 2023, as amended, except as listed below. We may disclose changes to such factors or disclose additional factors from time to time in our future filings with the SEC.

**Our internal controls over financial reporting currently do not meet all of the standards contemplated by Section 404 of the Sarbanes-Oxley Act of 2002, as amended (“SOX”), and failure to achieve and maintain effective internal controls over financial reporting in accordance with Section 404 of SOX could impair our ability to produce timely and accurate financial statements or comply with applicable regulations and have a material adverse effect on our business. In the future, our disclosure controls and procedures may not prevent or detect all errors or acts of fraud.**

As a public company, we are subject to certain reporting requirements of the Exchange Act and have significant requirements for enhanced financial reporting and internal controls. Our disclosure controls and procedures are designed to reasonably assure that information required to be disclosed by us in reports we file or submit under the Exchange Act is accumulated and communicated to management, recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments, and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. If we are unable to maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations on a timely basis, result in material misstatements in our consolidated financial statements, and harm our operating results. We believe that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements or insufficient disclosures due to error or fraud may occur and not be detected. In addition, we are required, pursuant to Section 404 of the Sarbanes–Oxley Act of 2002, as amended (“SOX”), to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting in our Annual Report on Form 10-K. This assessment includes disclosure of any material weaknesses identified by our management in our internal control over financial reporting. The rules governing the standards that must be met for our management to assess our internal control over financial reporting are complex and require significant documentation, testing, and possible remediation. Testing and maintaining internal controls may divert management’s attention from other matters that are important to our business. As an emerging growth company, our independent registered public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 until our annual report for any fiscal year following such date that we are no longer an emerging growth company. If we are not able to complete our initial assessment of our internal controls and otherwise implement the requirements of Section 404 of SOX in a timely manner or with adequate compliance, our independent registered public accounting firm may not be able to certify as to the adequacy of our internal controls over financial reporting. Additionally, when required, an independent assessment of the effectiveness of our internal controls over financial reporting could detect problems that our management’s assessment might not. Undetected material weaknesses in our internal controls over financial reporting could lead to financial statement restatements and require us to incur the expense of remediation. Matters impacting our internal controls may cause us to be unable to report our financial information on a timely basis and thereby subject us to adverse regulatory consequences, including sanctions by the SEC or violations of applicable stock exchange listing rules, which may result in a breach of the covenants under existing or future financing arrangements. There also could be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our consolidated financial statements. Confidence in the reliability of our consolidated financial statements also could suffer if we or our independent registered public accounting firm report a material weakness in our internal controls over financial reporting. In connection with the preparation of our consolidated financial statements for the quarter ended September 30, 2023, we identified material weaknesses in our internal control over financial reporting related to deficiencies in our controls over the accounting for complex equity arrangements, and in the design and operation of internal controls involving accruals and unbilled revenue.

We have implemented, and are continuing to implement, measures designed to improve our internal control over financial reporting to remediate these material weaknesses. These measures include formalizing our processes and internal control documentation, strengthening supervisory reviews by our financial management, and engaging financial consultants to enable the implementation of internal control over financial reporting. We expect to incur additional costs to remediate the control deficiencies identified, though there can be no assurance that our efforts will be successful or avoid potential future material weaknesses. If we are unable to successfully remediate our existing or any future material weaknesses in our internal control over financial reporting, or if we identify any additional material weaknesses, the accuracy and timing of our financial reporting may be adversely affected, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports in addition to applicable stock exchange listing requirements, investors may lose confidence in our financial reporting, and our stock price may decline as a result. We also could become subject to investigations by the National Association of Securities Dealers Automated Quotations (“NASDAQ”), the SEC or other regulatory authorities. Our internal resources and personnel may in the future be insufficient to avoid accounting errors and there can be no assurance that we will not have additional material weaknesses in the future. Any failure to develop or maintain effective controls or any difficulties encountered implementing required new or improved controls could harm our operating results or cause us to fail to meet our reporting obligations and may result in a restatement of our consolidated financial statements for prior periods. Any failure to implement and maintain effective internal control over financial reporting also could adversely affect the results of periodic management evaluations and annual independent registered public accounting firm attestation reports regarding the effectiveness of our internal control over financial reporting that we will eventually be required to include in our periodic reports that will be filed with the SEC. Ineffective disclosure controls, procedures, and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of our common stock. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on NASDAQ.

Filed Nov 14, 2023.
Source: SEC EDGAR, the filing index for accession 0001213900-23-086995. Last ingested by Listed: Oct 24, 2026, 15:15 ET. No prices; not investment advice.