Spectral AI, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations . You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K (the “Annual Report”). Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in the section titled “Risk Factors,” our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Overview We are an artificial intelligence (“AI”) company focused on predictive medical diagnostics. We operate in one segment. Currently, we are devoting substantially all of our efforts towards research and development of our DeepView ® System, an internally developed multi-spectral imaging device that has previously received FDA breakthrough device designation status for an earlier version. Given our recent receipt of the UKCA mark for burn indication on our DeepView System, we expect to begin commercialization activities in the United Kingdom in 2025. 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 has been on the burn indication which is supported by the BARDA PBS contract. 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. 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 quantify the burn assessment accuracy in patients undergoing both surgical and non-surgical treatment. In December 2023, we initiated a pivotal clinical study seeking enrollment of 240 patients, including 180 adult and 60 pediatric patients through multiple sites across the United States in both burn center and emergency departments. By the end of 2024, the Company had completed the enrollment of the pivotal clinical study with 267 patients, including 146 at burn centers, 121 at emergency departments across 22 sites across the United States. As part of the total 267 patients enrolled, 42 pediatric patients were included from burn centers and another 42 pediatric patients were included from emergency departments. 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, particularly from 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 $281.9 million in funding awards from government contracts, primarily from BARDA, which accounts for $272.9 million. This has allowed us to develop our technology and further our clinical trials. In September 2023, we executed our third contract with BARDA for a multi-year Project BioShield (“PBS”) agreement, valued at up to approximately $150.0 million (the “PBS BARDA Contract”). This multi-year contract includes an initial award of nearly $54.9 million to support the clinical validation and FDA clearance of DeepView® for commercial marketing and distribution purposes, which we expect to continue through the first quarter of 2026. This contract funding is non-dilutive to our shareholders, and we believe it validates the important nature of our mission and technology. In addition to our PBS BARDA Contract, we received a $4.0 million grant award from the Medical Technology Enterprise Consortium (“MTEC”) in April 2023, which, building on prior awards from DHA, is to be used to support military battlefield burn evaluation via a handheld version of the DeepView ® System (the “MTEC Agreement”). In August 2024, the MTEC award was increased to $4.9 million and is currently intended to run through December 2025 with funding dependent on various milestones. In March 2024, we received an additional $0.5 million award from the DHA to further this development, for a total contract value of approximately $2.8 million. Once commercialized, 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. 61 Business Combination On September 12, 2023, following completion of the Business Combination, the Company began trading its shares of the Company Common Stock and the Public Warrants on the Nasdaq Global Market (the “Nasdaq”) under the symbols “MDAI” and “MDAIW”, respectively. Financial Operations Overview Research and Development Revenue To date we have not generated any revenues from the sale or license of our products. 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 and other U.S. government awards. 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, such as our grant under the MTEC Agreement which we earn based on the achievement of milestones. Our revenue growth is dependent upon a number of factors including expanding the research and development activities 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. See “Liquidity and Capital Resources” for additional information. Cost of Revenue Our cost of revenues consists primarily of direct and indirect costs associated with the research and development activities relating to the BARDA and MTEC contracts. Our cost of revenue is affected by the extent of research and development activities 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. These reimbursement rates are fixed under the BARDA contract. Under the BARDA contract our gross profit represents this reimbursement rate plus a fixed fee component relating to non-reimbursed expenses incurred in connection with the work completed. Under the other fixed fee U.S. governmental contract awards our gross profit corresponds to the achievement of pre-determined milestones. Operating Expenses Operating costs and expenses consist of general and administrative expenses. 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) In 2024, other income (expense) consists of fees incurred in connection with the Yorkville transaction and B. Riley purchase agreement, net interest income, borrowing related costs related to the Yorkville convertible notes, including the 8% original issue discount and 7% repayment premium as may be applicable per each Pre-Paid Advance, change in fair value of notes payable, change in fair value of warrant liabilities, changes in fair value of derivatives, and foreign exchange transaction gains/losses. In 2023, other income (expense) consists of transaction costs related to the Business Combination, net interest income, change in fair value of warrant liabilities and foreign exchange transaction gain/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 currency translation costs associated with purchasing British pound sterling for payment of our employees and vendors in the UK. 62 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. Comparison of Years Ended December 31, 2024 and 2023 The following table summarizes these metrics for the years ended December 31, 2024 and 2023 (in thousands): Year Ended December 31, 2024 2023 Change Research and development revenue $ 29,581 $ 18,056 $ 11,525 Gross profit 13,274 7,880 5,394 Gross margin 44.9 % 43.6 % 1.2 % Operating loss (6,582 ) (12,984 ) 6,402 Net loss (15,315 ) (20,854 ) 5,539 Adjusted EBITDA (5,540 ) (11,732 ) 6,192 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 our 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 gross 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, identify 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 the phasing of the development study schedules may be different. Our revenues may continue to be almost exclusively dependent upon the terms of those awards. 63 Gross Margin. When 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 limited production, we may be subject to 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. Results of Operations The following table summarizes our results of operations for the years ended December 31, 2024 and 2023 (in thousands): Year Ended December 31, 2024 2023 Change Research and development revenue $ 29,581 $ 18,056 $ 11,525 Cost of revenue (16,307 ) (10,176 ) (6,131 ) Gross profit 13,274 7,880 5,394 Operating costs and expenses: General and administrative 19,856 20,864 (1,008 ) Total operating costs and expenses 19,856 20,864 (1,008 ) Operating loss (6,582 ) (12,984 ) 6,402 Other income (expense): Net interest income 14 172 (158 ) Borrowing related costs (2,965 ) - (2,965 ) Change in fair value of warrant liability (4,633 ) 335 (4,968 ) Change in fair value of notes payable (220 ) - (220 ) Foreign exchange transaction loss (43 ) (24 ) (19 ) Transaction costs (615 ) (8,342 ) 7,727 Total other expense, net (8,462 ) (7,859 ) (603 ) Loss before income taxes (15,044 ) (20,843 ) (5,799 ) Income tax provision (271 ) (11 ) (260 ) Net loss $ (15,315 ) $ (20,854 ) $ (5,539 ) Research and development revenue Year Ended December 31, Change in 2024 2023 $ %   Research and development revenue $ 29,581 $ 18,056 $ 11,525 63.8 % 64 Research and development revenue was $29,581 for the year ended December 31, 2024, an increase of 63.8% compared to the comparable period in 2023, reflecting more activity as we completed work under the PBS BARDA Contract and in the awards and work performed under the Company’s other U.S. governmental contracts. For the year ended December 31, 2024 and 2023, the Company’s revenues disaggregated by the major sources was as follows: Year Ended December 31, Change in 2024 2023 $ % BARDA $ 27,903 $ 17,027 $ 10,876 63.9 % Other U.S. governmental authorities 1,678 1,029 649 63.1 % Total research and development revenue $ 29,581 $ 18,056 $ 11,525 63.8 % Cost of Revenues and Gross Profit Year Ended December 31, Change in 2024 2023 $ % Cost of revenue $ 16,307 $ 10,176 $ 6,131 60.2 % Gross profit 13,274 7,880 5,394 68.5 % Gross margin 44.9 % 43.6 % Cost of revenue for the year ended December 31, 2024 was $16.3 million, an increase of 60.2% compared to the comparable period in 2023, due to increased development activity to fulfill our U.S. governmental contracts, consistent with increased research and development revenue. Gross margin for the year ended December 31, 2024 was 44.9%, an increase from 43.6% as compared to the comparable period in 2023, due to more direct labor attributed to the PBS BARDA Contract as a component of the overall development activity and the higher reimbursement rate under the PBS BARDA Contract, executed in September 2023, than the rate in the BARDA Burn II contact. General and Administrative Expense Year Ended December 31, Change in 2024 2023 $ % General and administrative expense $ 19,856 $ 20,864 $ (1,008 ) (4.8 )% General and administrative expense was $19.9 million, for the year ended December 31, 2024, a decrease of 4.8% as compared to the comparable period in 2023. Non-revenue generating research and development activities have decreased by approximately $2.1 million for the year ended December 31, 2024 compared to the comparable period in 2023 due to an overall increase in the percentage of work performed on the PBS BARDA Contract in 2024. The reduction was offset by an increase of approximately $1.1 million related to other administrative expenses for the year ended December 31, 2024, compared to the comparable period in 2023. This expense also reflects the consistent headcount at the Company from the prior year. 65 Other income (expense) Year Ended December 31, Change in 2024 2023 $ Net interest income $ 14 $ 172 $ (158 ) Borrowing related costs (2,965 ) — (2,965 ) Change in fair value of warrant liabilities (4,633 ) 335 (4,968 ) Change in fair value of notes payable (220 ) — (220 ) Foreign exchange transaction loss, net (43 ) (24 ) (19 ) Other income (expenses), including transaction costs (615 ) (8,342 ) 7,727 Total other income (expense), net $ (8,462 ) $ (7,859 ) $ (603 ) Net interest income for the year ended December 31, 2024 primarily relates to cash interest received or (paid) by us from our deposit accounts. Borrowing related costs increased $3.0 million for the year ended December 31, 2024, as compared to the comparable period in 2023 due to debt issuance costs and payments of the discount and premium related to the Yorkville Convertible Notes that were expensed during fiscal year 2024. Change in fair value of warrant liabilities decreased by approximately $5.0 million for the year ended December 31, 2024 as compared to the comparable period in 2023. The decrease reflects changes in the fair value of the Public Warrants, which were issued in September 2023 and repriced in December 2024. Change in fair value of notes payable decreased by approximately $0.2 million for the year ended December 31, 2024, as compared to the comparable period in 2023, which reflects the total change in the fair value of the Yorkville notes issued in 2024. Foreign exchange transaction loss for the year ended December 31, 2024 is immaterial due to 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. Foreign exchange transaction loss for the year ended December 31, 2023 relates to the decreased exchange rate between the U.S. dollar and the British pound sterling during 2023 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. Other income (expenses), including transaction costs for the year ended December 31, 2024 primarily relate to legal, professional, and service fees incurred in connection with the Yorkville transaction and B. Riley purchase agreement. Other income (expenses), including transaction costs for the year ended December 31, 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. 66 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 years ended December 31, 2024 and 2023 (in thousands): Year Ended December 31, 2024 2023 Net loss $ (15,315 ) $ (20,854 ) Adjust: Depreciation expense 10 9 Provision for income taxes 271 11 Net interest expense (14 ) (172 ) EBITDA (15,048 ) (21,006 ) Additional adjustments: Stock-based compensation 1,032 1,243 Borrowing related costs 2,965 - Change in fair value of warrant liability 4,633 (335 ) Change in fair value of notes payable 220 - Foreign exchange transaction (gain) loss 43 24 Other (income) expenses, including transaction costs 615 8,342 Adjusted EBITDA $ (5,540 ) $ (11,732 ) Liquidity and Capital Resources Sources of Liquidity As of December 31, 2024, we had approximately $5.2 million in cash, notes payable of $2.8 million, and no long-term debt. We had an accumulated deficit of approximately $48.1 million. The Company incurred a net loss of $15.3 million during the year ended December 31, 2024 and had working capital (current assets less current liabilities) of approximately ($7.5) million as of December 31, 2024. Net cash used in operating activities was $9.1 million for the year ended December 31, 2024. In November and December 2024, the Company issued 3,896,781 shares for gross proceeds of approximately $4.5 million to certain institutional investors through at-the market equity issuances, stock option exercises and the conversion of the Company’s wholly-owned subsidiary, Spectral IP, Inc. (“Spectral IP”), convertible promissory note into shares of the Company’s common stock. On December 26, 2023, we entered into a Common Stock Purchase Agreement and related Registration Rights Agreement with B. Riley Principal Capital II, LLC (“B. Riley”). Upon the terms and subject to the satisfaction of the conditions set forth in the Common Stock Purchase Agreement, the Company has the right, in our sole discretion, to sell to B. Riley up to $10.0 million in aggregate gross purchase price of newly issued shares of the Company’s Common Stock (the “ELOC”). The Company maintained the right to raise up to $3,000,000 of shares of its Common Stock from the B. Riley transaction upon execution of the SEPA with Yorkville, which is described in more detail below. 67 On March 20, 2024, the Company also entered into a Standby Equity Purchase Agreement (“SEPA”) with YA II PN, LTD, a Cayman Islands exempt limited partnership (“Yorkville”) pursuant to which the Company has the right to sell to Yorkville up to $30.0 million of its shares of Common Stock, subject to certain limitations and conditions set forth in the SEPA. In connection with the SEPA, and subject to the conditions set forth therein, Yorkville has agreed to advance to the Company in the form of convertible promissory notes an aggregate principal amount of up to $12.5 million (the “Pre-Paid Advance”), which will be paid in three tranches. The first Pre-Paid Advance was disbursed on March 20, 2024 in the amount of $5.0 million with a fixed conversion price of $3.16. The Company received $4.6 million in cash, net of the 8% original issue discount. On May 14, 2024, the shareholders voted to approve the reservation and issuance of shares to Yorkville to exceed the 19.99% of the shares of Common stock outstanding immediately prior to the execution of the SEPA (the “Exchange Cap”) and the second Pre-Paid Advance was disbursed on May 16, 2024 in the amount of $4.6 million, which is the $5.0 million second Pre-Paid Advance net of $0.4 million of the 8% original issue discount, with a fixed conversion price of $2.03. The third Pre-Paid Advance was disbursed on July 17, 2024 in the principal amount of $2.3 million, which is the $2.5 million third Pre-Paid Advance net of the $0.2 million of the 8% original issue discount. As of December 31, 2024, $7.8 million of the outstanding balance of the Pre-Paid Advances was paid in cash and $2.4 million was paid in shares of the Company issued under the SEPA. The Company still has access to the remaining funds under the SEPA. The sales of the shares of Common Stock to Yorkville under the SEPA, and the timing of any such sales, are at the Company’s option. We have historically funded our operations through the issuance of notes and the sale of common stock, along with payments under governmental contracts for research and development activity. In September 2023, the Company executed its third contract with BARDA for a multi-year PBS BARDA Contract, valued at up to approximately $150.0 million. This multi-year contract includes an initial award of nearly $54.9 million to support the clinical validation and FDA clearance of DeepView for commercial development and distribution purposes. The Company completed the second contract with BARDA, referred to as BARDA Burn II, which was signed in July 2019 and completed in November 2023. Under this contract, the Company furthered the DeepView System design, developed the AI algorithm, and took steps to obtain FDA approval. In April 2023, the Company received a $4.0 million grant under the MTEC Agreement, which was increased to $4.9 million in August 2024 and is currently intended to run through December 2025. The MTEC Agreement is for the development of a handheld version of the DeepView® System which is to be used to support military battlefield burn evaluation. The project has three phases, beginning with planning, design and testing; followed by development, design modification and buildout of the handheld device; and then the manufacturing of the handheld device. Based on our current operating plan, we believe that our cash and cash equivalents, together with the PBS BARDA Contract, the MTEC Agreement, the B. Riley ELOC, and the Yorkville Transaction, will be sufficient to fund operations for at least one year beyond the release date of these consolidated financial statements. We have based this determination on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. The Company may continue to conserve our working capital and to focus our efforts primarily on the burn indication. Changing circumstances could also cause us to consume capital significantly faster than we currently anticipate, and we may need to raise capital sooner or in greater amounts than currently expected because of circumstances beyond our control. Changes in the current equity markets may also limit our ability to utilize the B. Riley ELOC and Yorkville SEPA as currently structured. To the extent additional capital is necessary, there are no assurances that we will be able to raise additional capital on favorable terms or at all, and therefore we may not be able to execute our business plans and the continued work on indications beyond expanding our burn indication. 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. 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 years ended December 31, 2024 and 2023 (in thousands): Year Ended December 31, 2024 2023 Net cash used in operating activities $ (9,199 ) $ (13,240 ) Net cash provided by financing activities 9,575 3,844 68 Cash Flows Used in Operating Activities Net cash used in operating activities decreased by approximately $4.0 million for the year ended December 31, 2024, as compared to the year ended December 31, 2023 primarily driven by changes in operating liabilities including accrued expenses and deferred revenue, partially offset by a decrease in net loss. The lower net loss is a result of higher research and development revenue due to increased BARDA activity and lower non-operating transaction costs in the year ended December 31, 2024 compared to the year ended December 31, 2023. Cash Flows Provided by Financing Activities Net cash provided by financing activities increased approximately $5.7 million for the year ended December 31, 2024 compared to the year ended December 31, 2023. This was primarily attributable to the proceeds of $2.7 million from the ELOC, proceeds of $13.1 received from the sale of the Company’s Common Stock and the principal amount of the notes payable from the Pre-Paid Advances under the SEPA, partially offset by $7.8 million of repayments of notes payable as compared to proceeds of $3.4 million from the issuance of Common Stock and operating cash received upon closing of the Business Combination of $0.7 million during the year ended December 31, 2023. Current Indebtedness On March 20, 2024, the Company entered into the SEPA with Yorkville pursuant to which the Company has the right to sell to Yorkville up to $30.0 million of its shares of Company Common Stock, subject to certain limitations and conditions set forth in the SEPA, from time to time during the term of the SEPA (such transaction, the “Yorkville Transaction”). In connection with the SEPA, and subject to the conditions set forth therein, Yorkville has agreed to advance to the Company in the form of convertible promissory notes (the “Convertible Notes”) an aggregate principal amount of up to $12.5 million (the “Pre-Paid Advance”), which will be paid in three tranches. The first Pre-Paid Advance was disbursed on March 20, 2024 in the amount of $5.0 million with a fixed conversion price of $3.16. The Company received $4.6 million in cash, net of the 8% original issue discount. On May 14, 2024, the shareholders voted to approve the reservation and issuance of shares to Yorkville to exceed the Exchange Cap and the second Pre-Paid Advance was disbursed on May 16, 2024 in the amount of $4.6 million, which is the $5.0 million second Pre-Paid Advance net of $0.4 million of the 8% original issue discount, with a fixed conversion price of $2.03. The third Pre-Paid Advance was disbursed on July 17, 2024 in the principal amount of $2.3 million, which is the $2.5 million third Pre-Paid Advance net of the $0.2 million of the 8% original issue discount, with a fixed conversion price equal to 120% of the average VWAP during the three trading days immediately prior to the issuance of the note. The purchase price for the Pre-Paid Advance is 92.0% of the principal amount of the Pre-Paid Advance. Interest shall accrue on the outstanding balance of any Pre-Paid Advance at an annual rate equal to 0%, subject to an increase to 18% upon an event of default as described in the Convertible Notes. Beginning on the forty-fifth (45th) day following the issuance date of the Convertible Note issued in connection with the first Pre-Paid Advance, and continuing on the same day of each successive month thereafter, (each, an “Installment Date”), the Company shall repay a portion of the outstanding balance of the Pre-Paid Advance in an amount equal to (i) $1,750,000, plus (ii) the a payment premium of 7% of such Installment Principal Amount, and (iii) accrued and unpaid interest hereunder as of each Installment Date. The maturity date of the Convertible Notes issue in connection with each Pre-Paid Advance will be 12 months after the issuance date of such Convertible Notes. In October 2024, the Company and Yorkville agreed to amend the dates and the allocation of installment amounts to be paid pursuant to the Pre-Paid Advances, such that the outstanding balance of the Pre-Paid Advances is to be paid by February 2025. As of December 31, 2024, the Company has made aggregate installment payments on the Pre-Paid Advances in the amount of $10.2 million, of which $7.8 million was settled in cash and $2.4 million was settled in shares. Of the aggregate installment payments, $9.4 million relates to the repayment of the principal, $0.8 million relates to the 8% original issue discount and $0.6 million relates to the 7% payment premium. As of December 31, 2024, $7.8 million of the outstanding balance of the Pre-Paid Advances was paid in cash and $2.4 million has been paid in shares of the Company issued under the SEPA. The Company still has access to the remaining funds under the SEPA. The sales of the shares of Common Stock to Yorkville under the SEPA, and the timing of any such sales, are at the Company’s option. 69 Related Party Transactions On March 7, 2024, the Company formed a new wholly-owned subsidiary, Spectral IP, to be utilized to acquire artificial intelligent intellectual property with a specific emphasis on healthcare. On March 19, 2024, the Company announced that Spectral IP received a $1.0 million investment from an affiliate of its largest shareholder for the development of its artificial intelligence intellectual property portfolio. The investment is structured as a note payable with a one-year maturity, an interest rate of 8%, and requiring earlier prepayment if the Company spins off Spectral IP to the Company’s shareholders or if Spectral IP is sold to a third party. On October 1, 2024, the note was amended to (i) reduce the annual interest rate from 8% to 4%, (ii) extend the term of the Note through the second anniversary of the issuance date, March 18, 2026, (iii) include a conversion feature at the option of either the holder or Spectral IP to convert the then outstanding principal and accrued but unpaid interest into shares of the Company at any time (into such number of shares calculated by taking a five percent (5.00%) discount to the closing price of the Company’s common stock on the day prior to the date of notice to the Company of the exercise of the conversion right) and at maturity, respectively, and (iv) provide for registration rights of any shares of the Company issued in satisfaction of the outstanding obligations. On October 1, 2024, Spectral IP amended its existing $1,000,000 promissory note to extend the term from one to two years, reduce the interest rate from 8.00% to 4.00% per annum and to provide a conversion feature for shares of the Company’s common stock in satisfaction of the outstanding principal and accrued but unpaid interest. The holder of the Spectral IP Note exercised a number of conversion rights throughout the fourth quarter of 2024 for the full conversion of the Spectral IP Note in exchange for a total of 540,996 shares of the Company’s common stock, which represents a 5.00% discount to the closing price of the Company’s shares of Common Stock on the day prior to the date of notice of the holder’s exercise of its conversion right. For the year ended December 31, 2023, 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 Our significant accounting policies are described in Note 2 to our audited consolidated financial statements included elsewhere in this Annual Report. We believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our consolidated financial statements. Accrued Research and Development Expenses As part of the process of preparing our consolidated financial statements, we are required to estimate our accrued research and development expenses as of each balance sheet date. This process involves reviewing open contracts and purchase orders, communicating with our applicable personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of actual costs. The majority of our service providers invoice us in arrears for services performed, on a pre-determined schedule or when contractual milestones are met; however, some require advance payments. We make estimates of our accrued expenses as of each balance sheet date in the consolidated financial statements based on facts and circumstances known to us at that time. We periodically confirm the accuracy of the estimates with the service providers and make adjustments if necessary. 70 Determination of the Fair Value of Equity-Based Awards We measure stock options and other stock-based awards granted to directors, employees, and non-employees based on their fair value on the date of the grant and recognize the corresponding compensation expense of those awards over the requisite service period, which is generally the vesting period of the respective award. We have issued stock options, restricted stock awards and restricted stock units with time-based vesting conditions and record the expense for these awards using the ratable method. We have also issued restricted stock units that vest upon the achievement of certain market conditions. We determine the fair value of time-based vesting restricted stock awards granted based on the fair value of our common stock. We estimate the fair value of stock option awards granted using the Black-Scholes option-pricing model, which uses as inputs the fair value of our common stock and subjective assumptions we make, including the expected stock price volatility, the risk-free interest rate and expected dividends, and the contractual term as the expected term of the award. We determine the fair value of restricted stock units that vest upon the achievement of certain market conditions using a Monte Carlo simulation model, which uses as inputs the fair value of our common stock and subjective assumptions we make, including the expected stock price volatility, the expected term of the award, the risk-free interest rate and expected dividends. Due to insufficient trade history of our common stock, we are unable to estimate the future volatility of our share price and instead estimate our expected volatility from the historical volatility of a representative group of publicly traded companies for which historical information is available. The historical volatility is generally calculated based on a period of time commensurate with the expected term assumption. We use the simplified method to calculate the expected term for options granted to employees and directors, which is based on the average of the time-to-vesting and the contractual life of the options. We utilize this method as we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term. For grants to non-employees, the relevant accounting literature allows entities to use the expected term to measure non-employee options or elect to use the contractual term as the expected term, on an award-by-award basis. The risk-free interest rate is based on a U.S. treasury instrument whose term is consistent with the expected term of the stock options. The expected dividend yield is assumed to be zero as we have never paid dividends and do not have current plans to pay any dividends on our common stock. See Note 11 to our audited consolidated financial statements included elsewhere in this Annual Report for information concerning certain of the specific assumptions we used in applying the Black-Scholes option pricing model to determine the estimated fair value of our stock options granted in the years ended December 31, 2024 and 2023. Recent Accounting Pronouncements See Note 2, Summary of Significant Accounting Policies, of the notes to our consolidated financial statements included elsewhere in this Form 10-K 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-K. Emerging Growth Company and Smaller Reporting Company Status We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012 (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. In addition, as an emerging growth company, we may take advantage of specified reduced disclosure and other requirements that are otherwise applicable generally to public companies. These provisions include: ● being permitted to present only two years of audited consolidated financial statements in addition to any required unaudited interim consolidated financial statements, with correspondingly reduced disclosure in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; ● an exception from compliance with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, as amended; ● reduced disclosure about our executive compensation arrangements in our periodic reports, proxy statements and registration statements; ● exemptions from the requirements of holding non-binding advisory votes on executive compensation or golden parachute arrangements; and 71 We may take advantage of these provisions until the last day of the fiscal year ending after the fifth anniversary of our initial public offering or such earlier time that we no longer qualify as an emerging growth company. We will cease to qualify as an emerging growth company on the date that is the earliest of: (i) December 31, 2026; (ii) the last day of the fiscal year in which we have more than $1.235 billion in total annual gross revenues; (iii) the date on which we are deemed to be a “large accelerated filer” under the rules of the SEC, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the prior June 30th and we have been a public company for at least 12 months and have filed one annual report on Form 10-K; or (iv) the date on which we have issued more than $1.0 billion of non-convertible debt over the prior three-year period. We may choose to take advantage of some but not all of these reduced reporting burdens. Accordingly, the information contained herein may be different than you might obtain from other public companies in which you hold equity interests. We are also a “smaller reporting company.” If we are a smaller reporting company at the time we cease to be an emerging growth company, we may continue to rely on exemptions from certain disclosure requirements that are available to smaller reporting companies. Specifically, as a smaller reporting company, we may choose to present only the two most recent fiscal years of audited consolidated financial statements in our Annual Report and, similar to emerging growth companies, smaller reporting companies have reduced disclosure obligations regarding executive compensation. Item 7.A. Quantitative and Qualitative Disclosures about Market Risk Not required.