Zacks Small Cap Research – MDAI: Initiating Coverage – Technologist

By John Vandermosten, CFA

NASDAQ:MDAI

READ THE FULL MDAI RESEARCH REPORT

We are initiating coverage of Spectral AI, Inc. (NASDAQ:MDAI) and assign a valuation of $5.00 per share. This valuation is based on our estimates for sale of the DeepView system to evaluate burn injury and to assist in diagnosis and triage. DeepView is an imaging device that uses artificial intelligence (AI) and machine learning (ML) to predict a wound’s capacity to heal. Spectral has received $280 million of non-dilutive US government funding to advance its imaging technology and burn predictive analytics over the last decade and is seeking clearance to market the device in both Europe and the United States. Efforts are also underway to introduce DeepView into the Australian market. In the UK, DeepView has received the UKCA mark allowing for sales to start in Britannia. Spectral is also developing a handheld version of its DeepView system, called SnapShot M, that is for use in the field. Clinical trials are also underway for diagnostic prediction of diabetic foot ulcer (DFU).

Wounds are a common health concern and can be as diverse as trauma requiring amputation to blast injuries that present penetrating wounds, burns and blunt force trauma. With a limited number of specialists in the field and the need for rapid diagnosis, new tools are needed to triage, diagnose and treat wounds based on their characteristics. Data generated to date shows that an assistive tool can improve the predictive ability of a general practitioner and a specialist. The gold standard for diagnosing burn wounds and DFUs is an evaluation by specialists or surgeons in those specific fields. However, there are a limited number of experts who reside in a finite number of burn and diabetes centers. In response, Spectral has developed an imaging tool that is able to diagnose wounds with a high degree of accuracy. The tool employs AI and ML to identify those factors which are most closely aligned with healing and to determine a score that allows for optimal triage, diagnosis and treatment.

Chronic wounds affect over 10 million people in the United States every year and around 2.5% of the global population. Two of the dominant areas of wounds include burn wounds and DFUs. In the United States, sources identify 400,000 burn wounds receiving medical treatment every year with about 7% requiring burn hospital admissions. These are treated at an estimated 127 burn centers and 4,500 emergency rooms. Around the globe there are an estimated 11 million new burns annually with the poor bearing the greatest burden. DFUs impact 1.6 million individuals in the US and around the world this number rises to 18.6 million with about half becoming infected and 20% requiring amputation.

With proper treatment, many of these wounds will heal. We anticipate that the use of new imaging technologies combined with AI will help improve diagnosis and treatment as well as reduce healthcare costs. Guided by payor mandates, in many cases patients with wounds must wait from 21 to 30 days before their wounds can be properly diagnosed to receive advanced wound care. During this time, the severity of the wound may increase, treating it may become more difficult and patients may suffer longer. DeepView has demonstrated accuracy from 86% (DFU) to 92% (Burn) for predicting healing, which compares favorably to clinical accuracy of 50% to 75%. A highly accurate healing prediction can allow for advanced treatment immediately when needed which can result in cost savings which Spectral estimates to range from $24,000 to $63,000 per hospital stay.

Spectral is conducting clinical trials for its AI-guided DeepView multispectral imaging device in burn and DFU. The burn indication has received financial support from the Biomedical Advanced Research and Development Authority (BARDA), a US Department of Health and Human Services office responsible for the procurement and development of medical countermeasures. Data from the 240-patient pivotal trial is expected to support an FDA application in 2025. The DFU indication has been funded by investors and is also the subject of validation trials in the US and UK.

Spectral expects to generate first revenues from sales in the UK from DeepView by 2H:24. In the United States, the company is completing the pivotal clinical trial in the burn indication and expects to submit a De Novo application for FDA approval in 2025 as a Class II device. Revenues are forecast in 2026 for the United States. Regulatory work is also planned for the EU in 2025 to obtain the CE Mark and European Medicines Agency (EMA) approval leveraging data generated in the US trials. This may lead to sales in the United States in 2026 and in the European region the following year. Spectral has joined with PolyNovo in Australia to deploy DeepView for burn down under. The collaborators will work together to obtain Special Access in order to deploy two DeepView systems in leading hospitals.

Spectral’s research and development for its burn indication has been materially supported by grants from BARDA, the National Science Foundation, National Institute of Health and Defense Health Agency. These funds have reached almost $300 million in total with additional amounts available for additional product development and procurement. These public entity partnerships have not only provided support for product development but are also expected to aid in the regulatory submission process and purchase the approved product to deploy around the United States in facilities that would most benefit from this diagnosis tool.

For 2024, management has guided towards research and development revenues of $28 million, which does not include DeepView product or service sales. We expect much of the research and development cost to be supported by the research and development revenues along with overhead. As of the end of March 2024, Spectral carried over $10 million in cash on the balance sheet and has access to other funding sources including a $10 million common stock repurchase agreement and a $12.5 million standby equity purchase agreement.

Key reasons to own Spectral AI shares:

➢ DeepView System pursuing large indications with unmet need in diagnosis

o Burn

▪ Cleared for sale in the UK with UKFC classification award

▪ Seeking FDA approval following pivotal trial completion

o Diabetic Foot Ulcer (DFU)

➢ DeepView SnapShot M Expands Use into New Applications

o Military & Combat

o Forward Deployed and Mobile Emergency

o Home Health

➢ BARDA, DoD and other government agency grant funding support

o Committed ~$300 million to date and $28 million expected in 2024

➢ Provides only diagnostic tool that translates raw image into wound healing assessment

o 340 billion pixels of proprietary burn and diabetic foot ulcer data driving AI algorithm

➢ High degree of diagnosis accuracy vs. human practitioner

o Day 1 prediction vs. 21 – 30 days for specialist time to decision

o Healing prediction accuracy of 92% vs. 50-75%

o Reduce unnecessary patient transfers. time to surgery and associated costs¹

➢ International growth opportunities

o United Kingdom – approved, reimbursement in process

o European Union

o Other developed economies including Australia

➢ Nine families of active patents

o Imaging

o Wound assessment

This initiation report provides a review of wounds and the tools used to evaluate and diagnose them. It further summarizes epidemiological details of wounds including incidence and prevalence as well as causes, symptoms, diagnosis and treatment of burn and DFU. We look at where these wounds are treated and how many related facilities there are. Spectral’s clinical trials and findings are then discussed. The following section presents the DeepView and SnapShot M systems, explains the technology behind the devices, details BARDA’s support for development and evaluates the key patents protecting the technology.

Peers and competitors are reviewed in the imaging and wound space along with a focus on related wound products. We also provide a historical review of Spectral and summarize key events as the company transitioned from private, to UK-listed and now a NASDAQ-listed company including the latest financial results. Key senior management are introduced and risks for life sciences companies in general and for Spectral specifically are discussed. We wind down our initiation with a discussion of the assumptions supporting our valuation model. We only value one small component of what could be a long-term growth story where a technology with several additional indications, mobile opportunities and geographies around the world can contribute to the company’s future. Based on the company’s early stage, our target price assumes DeepView service revenues only for the United Kingdom and the United States in the burn indication. We initiate Spectral AI, Inc. with a valuation of $5.00 per share.

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