Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources
Our primary sources of liquidity and capital resources have been cash provided from operations and financing activities. Our primary requirements for liquidity and capital arise from employee-related expenditures, inventory purchases, capital expenditures, leasing of facilities, general operating expenses, and interest and principal repayments related to our outstanding indebtedness.
Net cash used in operating activities was $1,249,819 for 2025, compared with net cash used in operating activities of $521,485 for 2024.
In 2025 and 2024, we invested approximately $0.5 million and $0.7 million, respectively, in computer software development, website development, and manufacturing tooling. We expect to continue our investing activities, including planned capital expenditures.
Net cash provided by financing activities in 2025 was $1.3 million, compared to approximately $0.9 million in net cash provided by financing activities in 2024. In 2025, financing activities primarily consisted of $1,500,000 in proceeds from convertible notes, partially offset by approximately $173,000 used to repurchase common stock to satisfy tax withholding obligations. In 2024, financing activities primarily consisted of $974,000 in proceeds from convertible notes and approximately $24,000 from the exercise of stock options. These proceeds were offset by the acquisition of common stock for tax withholding obligations, totaling approximately $95,000.
We can borrow under the existing $1.0 million revolving credit facility, which matures on July 31, 2026. On December 31, 2025, the Company had no outstanding drawings against the revolving credit facility.
The primary factors affecting our liquidity include the amount and timing of revenues, the collection of receivables from customers, payments to suppliers, and capital expenditures. We believe our existing cash balances and capital resources, including available borrowing capacity under our revolving credit facility and potential convertible note financing, are sufficient to meet our anticipated capital requirements, fund operations, and support growth initiatives. However, our cash requirements may change as business conditions evolve.
Critical Accounting Policies
Our significant accounting policies are described in Note 1, Organization and Summary of Significant Accounting Policies, of the Notes to Financial Statements included in our Annual Reports on Form 10-K for the years ended December 31, 2025 and 2024. The application of these policies requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on a combination of historical experience and reasonable judgment applied to other facts. Actual results may differ from these estimates, and such differences may be material to the financial statements. In addition, the use of different assumptions or judgments may result in different estimates. We believe our critical accounting policies that are subject to these estimates are: Accounts Receivable Reserves, Revenue Recognition and Reserve for Future Returns, Inventory Valuation and Reserve, Stock-Based Compensation, Intangible Assets, Impairment of Long-Lived Assets, and Income Taxes.
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Accounts Receivable Allowances
Trade accounts receivables are recorded at the net invoice value and are not interest bearing. The Company estimates the amount of uncollectible accounts receivable at the end of each reporting period based on the aging of the receivable balance, current and historical customer trends, and communications with its customers. Amounts are written off only after considerable collection efforts have been made and the amounts are determined to be uncollectible.
Revenue Recognition and Deferred Revenue
With the adoption of ASC 606 “Revenue from Contracts with Customers” in 2017, the Company recognizes revenue on sales to distributors when shipping of product is completed and title transfers to the distributor, less a reserve for estimated product returns (sales and cost of sales). The reserves are based on estimates of future returns calculated from actual return history, primarily from stock rotations, plus knowledge of pending returns outside of the norm.
The Company generally recognizes revenues on sales to customers other than distributors upon shipment provided that contract with the customer is identified, performance obligations in the contract are satisfied, and the price is determined. Most of our customers other than distributors do not have a right of return except under a warranty.
The Company also generates revenue through its SocketCare services program, which offers extended warranty and accidental breakage coverage for select products. The service, which can be purchased at the time of product acquisition, provides coverage for three-year and five-year terms. Revenue from the SocketCare services program is recognized ratably over the duration of the extended warranty contract. The amount of unrecognized SocketCare service revenue is classified as deferred service revenue and presented on the Company’s balance sheet in both short-term and long-term components.
Inventories
Inventories consist principally of raw materials and sub-assemblies stated at the lower of standard cost, which approximates actual costs (first-in, first-out method), or market. Market is defined as replacement cost, but not in excess of estimated net realizable value or less than estimated net realizable value less a normal margin. We purchase or have manufactured the component parts by our engineering bill of materials. The timing and quantity of our purchases are based on order forecast, the lead time requirements of our vendors, and economic order quantities. At the end of each reporting period, the Company compares its inventory on hand to its forecasted requirements for the next twelve-month period and reserves the cost of any inventory that is surplus, less any amounts that the Company believes it can recover from the disposal of goods or that the Company specifically believes will be saleable past a twelve-month horizon. The Company’s sales forecasts are based upon historical trends, communications from customers, and marketing data regarding market trends and dynamics. Changes in the amounts recorded for surplus or obsolete inventory are included in cost of revenue.
Stock-Based Compensation Expense
The Company has incentive plans that reward employees with stock options and shares of restricted stocks. The amount of compensation cost for these stock-based awards is measured based on the fair value of the awards as of the grant date. The fair values of stock options are generally determined using a binomial lattice valuation model which incorporates assumptions about expected volatility, risk-free interest rate, dividend yield, and expected life. Compensation cost for stock-based awards is recognized on a straight-line basis over the vesting period, which is usually the service period.
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Intangible Assets
The Company’s intangible assets consist of completed technologies and acquired license rights. Intangible assets are amortized over their estimated useful lives based upon the estimated economic value derived from the related intangible assets. Amortization is computed using the straight-line method over the estimated useful lives of the assets.
Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment annually and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future net undiscounted cash flows expected to be generated by the asset. If such assets are impaired, the impairment recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value.
Income Taxes
Effective December 31, 2025, the Company recorded a full valuation allowance of $10,663,419 against our deferred tax assets. In assessing the realizability of deferred tax assets, we considered all available positive and negative evidence, with significant weight given to objectively verifiable negative evidence, including cumulative losses in recent years. Based on this evaluation and in accordance with ASC 740, we concluded that it is more likely than not that our deferred tax assets will not be realized as of December 31, 2025.
The Company accounts for uncertain tax positions in accordance with ASC 740. We recognize the tax benefit from a tax position only if it is more likely than not that the position will be sustained upon examination by the relevant taxing authorities, based on the technical merits of the position. The amount of benefit recognized is measured as the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement. The Company records interest and penalties related to uncertain tax positions as a component of income tax expense. As of December 31, 2025, the Company had unrecognized tax benefits of approximately $991,000.
Results of Operations for Years Ended December 31, 2025 and 2024
Revenues
Revenue for 2025 was $15.1 million, representing a decrease of 20% compared to revenue of $18.8 million for 2024. The decline was primarily attributable to a challenging macroeconomic environment, including reduced customer spending and longer sales cycles, as well as continued headwinds within our distribution channels, which resulted in lower order volumes.
Gross Margins
The annual gross margins on revenue decreased to 49.7% in 2025 from 50.4% in 2024. The decline primarily reflects lower sales volumes, which reduced absorption of fixed costs, partially offset by disciplined cost management and operational efficiency initiatives. Despite these headwinds, our focus on optimizing production processes and controlling direct costs helped maintain resilient gross margins.
Research and Development Expenses
For the years ended December 31, 2025 and 2024, our research and development expenses were approximately $4.4 million and $4.7 million, respectively, representing a decrease of approximately $370,000, or 8%. The decrease was primarily driven by cost management initiatives, including reduced employee-related expenses, as we focused R&D efforts on high-priority projects and optimized resource allocation. These actions allowed us to maintain progress on key product development initiatives while improving operational efficiency.
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Research and development expenses as a percentage of revenue were 29% in 2025 and 25% in 2024. We believe that a continued investment in R&D is essential to maintaining or achieving a leadership position for our existing products, delivering innovative new product offerings, and providing engineering support for key customers. In addition, our ability to accelerate time to market for new products is critical to driving revenue growth. Accordingly, we expect to continue making significant R&D investments in the future. The level of investment as a percentage of revenue may fluctuate depending on revenue levels and investment cycles.
Sales and Marketing Expenses
Sales and marketing expenses in 2025 were approximately $4.0 million, a decrease of approximately 10% compared to $4.4 million in 2024. The decrease was primarily driven by reductions in employee-related costs, as we optimized the sales and marketing workforce and aligned resources with strategic priorities. These actions improved operational efficiency while continuing to support revenue growth initiatives.
General and Administrative Expenses
General and administrative expenses in 2025 were $2.4 million, representing a decrease of approximately $413,000 or 15% compared to $2.8 million in 2024. The decrease was primarily driven by reductions in employee-related costs and professional services, as we optimized administrative resources and implemented cost management initiatives. These actions improved operational efficiency while maintaining the support necessary for critical business functions and corporate operations.
Interest Expense, net of Interest Income
Interest expense and other, net of interest income and other, was approximately $497,000 in 2025 compared to approximately $331,000 in 2024. Interest expense in both 2025 and 2024 was primarily related to the subordinated convertible notes (see Note 4, Secured Subordinated Convertible Notes Payable, of the Notes to Financial Statements included in this Annual Report on Form 10-K for further information).
Interest income reflects the interest earned on cash balances. Interest income was nominal in each of the comparable periods.
Income Taxes
We recorded an income tax expense of $10.7 million in 2025, compared to an income tax benefit of $551,000 (an effective tax rate of 19.7%) in 2024. The change was primarily attributable to the establishment of a full valuation allowance against our deferred tax assets in 2025.
Quarterly Results of Operations
The following table sets forth a summary of quarterly statements of operations data for each of the quarters in 2024 and 2023. This unaudited quarterly information has been prepared on the same basis as the annual information presented elsewhere herein, and, in our opinion, includes all adjustments (consisting only of normal recurring entries) necessary for a fair presentation of the information for the quarters presented. The operating results for any quarter are not necessarily indicative of results for any future period.
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Quarter Ended
(unaudited)
(Amounts in thousands, except per share amounts)
Mar 31,
Jun 30,
Sep 30,
Dec 31,
Mar 31,
Jun 30,
Sep 30,
Dec 31,
Summary Quarterly Data:
Revenue
Cost of revenue
Gross profit
Operating expenses:
Research and development
Sales and marketing
General and administrative
Total operating expenses
Interest expense, net
Income tax (expense) benefit
Net income (loss)
Basic net income (loss) per share
Fully diluted net income (loss) per share
Our quarterly revenue and operating results depend on the volume and timing of orders received, which are difficult to forecast. Historically, we have recognized a substantial portion of our revenue in the last month of the quarter. Operating results may also fluctuate due to factors such as the demand for our products, the size and timing of customer orders, the introduction of new products and product enhancements by us or our competitors, product mix, the timing of software enhancements, manufacturing supply shortages, changes in the level of operating expenses, and competitive conditions in the industry. Because our staffing and other operating expenses are based on anticipated revenue, a substantial portion of which is not typically generated until the end of each quarter, delays in the receipt of orders can cause significant variations in operating results from quarter to quarter.
Contractual Obligations
Our contractual obligations as of December 31, 2025 are outlined in the table shown below:
Payments Due by Period
Contractual Obligations
Total
1 year
years
years
More than
5 years
Unconditional purchase
obligations with contract
manufacturers
Operating leases
Total contractual obligations
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Off-Balance Sheet Arrangements
As of December 31, 2025, we had no off-balance sheet arrangements as defined in Item 303 of Regulation S-K.
Recent Accounting Pronouncements
See Note 1, Organization and Summary of Significant Accounting Policies, of the Notes to Financial Statements included in this Annual Report on Form 10-K for additional information regarding the status of recent accounting pronouncements.
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