Note 2 — Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying consolidated financial statements of the Company and its wholly owned subsidiaries are prepared in conformity with United States (“U.S.”) generally accepted accounting principles (“GAAP”) and regulations of the U.S. Securities and Exchange Commission (“SEC”). All intercompany transactions and balances have been eliminated upon consolidation.

Reclassifications

The Company has reclassified certain prior-year amounts to conform to the current-year presentation.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Actual results may differ materially from those estimates. Significant estimates reflected in the consolidated financial statements include, but are not limited to revenue recognition, inventory classification, useful life of fixed assets, allowance for credit losses, warranty reserves, amortization of internal-use software, share-based compensation, contingencies and income taxes.

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Fair Value 

The Company uses valuation approaches that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. A three-tiered hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value. This hierarchy requires that the Company use observable market data, when available, and minimize the use of unobservable inputs when determining fair value: 

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Level 1: observable inputs such as quoted prices in active markets; 

Level 2: inputs other than the quoted prices in active markets that are observable either directly or indirectly; and 

Level 3: unobservable inputs in which there is little or no market data, which requires that the Company develop its own assumptions. 

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Cash, Cash Equivalents and Restricted Cash 

The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. The carrying values of cash and cash equivalents approximate their fair values due to the short-term nature of these instruments. Cash in the Company’s bank accounts may exceed federally insured limits. Restricted cash represents amounts that the Company is unable to access for operational purposes.

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Hardware Warranties 

The Company provides a warranty for the repair or replacement of any defective hardware within one year of purchase. Estimated future warranty costs are accrued and charged to cost of goods sold in the period that the related revenue is recognized. These estimates are derived from historical data and trends of product reliability and costs of repairing and replacing defective products. 

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Accounts Receivable 

Accounts receivables are stated at net realizable value. The allowance for credit losses is determined through an evaluation of the aging of the Company’s accounts receivable balances, and considers such factors as the customer’s creditworthiness, the customer’s payment history and current economic conditions. A provision is recognized to bad debt expense and the allowance for credit losses for accounts determined to be uncollectible. Bad debt written-off and any recovery of bad debt write-off is applied to the allowance for credit losses. 

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Inventory

The cost of inventory is determined using the weighted-average cost method and includes costs incurred to purchase and distribute inventory. Inventory is stated at the lower of cost and net realizable value (“NRV”). NRV is based upon an estimated average selling price reduced by the estimated costs of disposal. The determination of net realizable value involves certain judgments including estimating average selling prices based on recent sales. The Company reduces the value of its inventory for estimated obsolescence or lack of marketability by the difference between the cost of the affected inventory and the NRV.

The valuation of inventory requires the Company to evaluate whether inventory held is in excess of future estimated market demand or has become technologically obsolete. The Company believes the risk of technological obsolescence of hardware is not significant, as device technology and functionality is stable and the devices that the Company has in its inventory are deployable with the Company’s integrated solutions offerings.  The Company’s excess and obsolescence analysis is therefore focused on assessing the extent to which inventory is in excess of future estimated market demand. The determination of excess inventory is estimated based on a comparison of the quantity and cost of inventory on hand to the Company’s forecast of customer demand, which is dependent on various internal and external factors requiring the use of judgment.

The Company evaluates the short-term and long-term classification of hardware and component inventory quarterly using the Company’s forecast of customer demand, which is dependent on various internal and external factors requiring the use of judgment. The Company classifies as short-term inventory as hardware or components that are expected to be sold in the subsequent twelve months.  The Company classifies as long-term inventory as hardware or components that are not expected to be sold in the following twelve months but for which ones there is an active market and the Company has not identified any indicator of impairment.

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Property, Plant and Equipment 

Property, plant, and equipment is recorded at cost and is depreciated on the straight-line basis over its estimated useful life. Upon retirement or sale, the cost of assets disposed, and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to operating income (loss). Expenditures for major additions and improvements are capitalized and minor replacements, maintenance, and repairs are charged to expense as incurred. All property, plant, and equipment is depreciated (to the extent of estimated salvage values) on the straight-line method based on estimated useful lives of the assets as follows: 

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Revenue Recognition

Revenue is recognized net of any sales taxes collected from customers. Revenue is accounted for under ASC 606, Revenue from Contracts with Customers through the following steps:

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Hardware

The Company’s sensor hardware covers a large range of the electromagnetic and mechanical spectrums, encompassing visible-light imagers, shortwave, midwave, and longwave infrared imagers, ultraviolet imagers, acoustic imagers, and tunable diode laser emitter-detector pairs for laser absorption spectrometry. The Company's infrared cameras are available in multiple configurations, from lower resolution models suitable for basic equipment monitoring to high-resolution cameras that provide detailed thermal images crucial for detecting subtle anomalies in complex machinery. Each camera model also offers different field of view options, enabling precise targeting and comprehensive coverage, essential for effective predictive maintenance. Revenue is recognized when control of the hardware is transferred to the customer. In accordance with the Company’s sales policy, the Company does not accept returns of hardware once sold after a ten day return window.

Software

MSAI Connect is an innovative platform that enables predictive asset reliability and process control in industrial environments, available both as cloud-based subscription service and as an on-premises deployment.  MSAI Connect, when deployed and connected to the cloud, is a subscription service and is contracted for a period of 12 to 48 months. Subscription payments are generally collected in advance and revenue is recognized ratably over the subscription period. MSAI Connect, when deployed on-premises, is sold as both a term-based software license, which generally provides access to the software for a period of 12 months and as a perpetual license. Revenue for the software licenses are recognized upfront upon delivery of the software license.

Services

The Company offers installation services that cover on-site hardware mounting, sensor commissioning, and connectivity into the MSAI Connect platform. MSAI Solution Architects configure camera views, assists with establishing initial alerting thresholds and defining regions of interest so customers can quickly realize the full benefits of the MSAI Connect platform. The Company also performs

calibrations and maintenance on hardware. The Company previously performed training through August 2025 and inspections through September 2025. Services are recognized at the point in time when service is completed.

Costs to Obtain Contracts

The Company’s costs to obtain contracts, primarily commissions to its salesforce, are capitalized when the period of benefit is longer than a year. These costs are amortized over the requisite period of benefit. When the period of benefit is less than one year, the costs are expensed as incurred.

Contracts with Multiple Performance Obligations

Contracts with our customers may include various combinations of hardware, subscriptions and services. Our hardware has significant standalone functionalities and capabilities. Accordingly, hardware is distinct from our subscriptions and services as the customer can benefit from the product without these subscriptions or services and such subscriptions and services are separately identifiable within the contract. The amount of consideration we expect to receive in exchange for delivering on the order is allocated to each performance obligation based on its relative standalone selling price.

We establish standalone selling price using the prices charged for a deliverable when sold separately. If the standalone selling price is not observable through past transactions, we estimate the standalone selling price based on our pricing model. As our business offerings evolve over time, we may be required to modify our estimated standalone selling prices, and as a result the timing and classification of our revenue could be affected.

Contract Liabilities

Contract liabilities include advances from customers related to hardware, subscriptions, and services for which the Company has not yet recognized revenue.

Software Development Costs

Internal-use software includes software developed to deliver our cloud-based subscription offerings to our end-customers. These capitalized costs consist of internal compensation-related costs and external direct costs incurred during the application development stage. Capitalized software development costs is included in property, plant and equipment and is amortized on the straight-line method once development is complete.

Impairment of Long-Lived Assets 

The Company reviews the carrying value of property, plant and equipment and other long-lived assets for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable. If a long-lived asset is tested for recoverability and the undiscounted estimate future cash flows expected to result from the use and eventual disposition of the asset is less than the carrying amount of the asset, the asset cost is adjusted to fair value and an impairment loss is recognized as the amount by which the carrying amount of a long-lived asset exceeds its fair value.

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Leases 

Leases are accounted under ASC 842, Leases. Some leases have the option to extend or terminate the lease and the Company recognizes these terms when it is reasonably certain that the option will be exercised. As a lessee, the Company determines if an arrangement is a lease at commencement. The Right-of-Use (“ROU”) lease assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments related to the lease. Operating lease ROU assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. We use incremental borrowing rates based on information available at the commencement date to determine the present value of our lease payments.  We elected the practical expedient to exclude leases with terms of 12 months or less in which we are not reasonably certain that our renewal option will be exercised from the balance sheet and recognize expense on a straight-line basis over the lease term.

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Share-Based Compensation

Compensation expense related to share-based transactions is measured at fair value on the grant date. The Company recognizes share-based compensation expense for awards with only service conditions on a straight-line basis over the requisite service period. The Company recognizes share-based compensation expense for awards with market conditions and awards with performance conditions on a straight-line basis over the requisite service period for each separately vesting portion of the award. The Company recognizes share-based compensation expense for awards with performance conditions when it is probable that the performance condition will be achieved. The Company accounts for forfeitures of all share-based payment awards when they occur.

Income Taxes

The Company accounts for income taxes under the asset and liability method in accordance with ASC 740, Income Taxes (“ASC 740”). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company recognizes a net deferred tax asset or liability based on the tax effects of the differences between the book and tax basis of assets and liabilities. Enacted changes in tax rates and laws are recognized in the period in which they occur. Deferred income tax expense results from the change in the net deferred tax asset or liability between periods. The deferred tax asset is reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not some portion or all of a deferred tax asset will not be realized.

The Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. The Company does not have any uncertain tax positions that require recognition or measurement in the Company’s consolidated financial statements. The Company recognizes interest and penalties related to unrecognized tax benefits on the income tax expense line in the accompanying consolidated statements of operations. Accrued interest and penalties are included on the related tax liability line in the consolidated balance sheets.

ASC 740 requires the Company to reduce its deferred tax assets by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that all or a portion of a deferred tax asset will not be realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that all or a portion of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income of appropriate character during the periods in which those temporary differences become deductible. Management considers the weight of available evidence, both positive and negative, including the scheduled reversal of deferred tax assets and liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax planning strategies in making this assessment. To the extent the Company believes that it does not meet the test that recovery is more likely than not, it establishes a valuation allowance. To the extent that the Company establishes a valuation allowance or changes this allowance in a period, it adjusts the tax provision or tax benefit in the consolidated statement of operations. Management uses its best judgment in determining provisions or benefits for income taxes, and any valuation allowance recorded against previously established deferred tax assets.

Loss Contingencies 

The Company accrues costs relating to litigation claims and other contingent matters when such liabilities become probable and reasonably estimable. Such estimates may be based on advice from third parties or on management’s judgment, as appropriate. Revisions to contingent liabilities are reflected in the consolidated statements of operations in the period in which different facts or information become known or circumstances change that affect the Company’s previous judgments with respect to the likelihood or amount of loss. Amounts paid upon the ultimate resolution of contingent liabilities may be materially different from previous estimates and could require adjustments to the estimated reserves to be recognized in the period such new information becomes known. In circumstances where the most likely outcome of a contingency can be reasonably estimated, the Company accrues a liability for that amount. Where the most likely outcome cannot be estimated, a range of potential losses is established and if no one amount in that range is more likely than others, the low end of the range is accrued. 

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New Accounting Pronouncements

Recently Adopted Accounting Standards

In December 2023, the Financial Accounting Standards Board (“FASB”) issued ASU 2023-09 to expand the disclosure requirements for income taxes, specifically related to the rate reconciliation and income taxes paid. ASU 2023-09 is effective for our annual periods beginning January 1, 2025, with early adoption permitted. The Company adopted ASU 2023-09 for the year ended December 31, 2025 on a prospective basis and accordingly, the Company’s income tax disclosures for the year 2024 have not been recast under this guidance.

Recently Issued Accounting Standards Not Yet Adopted

In November 2024, the FASB issued ASU 2024-03 that requires disaggregation of specific expense categories in disclosures within the footnotes to the consolidated financial statements on an annual and interim basis. ASU 2024-03 is effective for annual reporting periods beginning after December 15, 2026, and interim reporting periods beginning after December 15, 2027. Early adoption is permitted. We are currently evaluating the potential effect that the updated standard may have on our consolidated financial statement disclosures.

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In September 2025, the FASB issued ASU No. 2025-06 that amends certain aspects of the accounting for and disclosure of software costs under ASC 350-40. The new standard is effective for annual periods beginning after December 15, 2027, and interim reporting periods within those annual reporting periods. Early adoption is permitted. The new standard may be applied prospectively, retrospectively, or via a modified prospective transition method. The Company is currently evaluating the impact of this new standard on our consolidated financial statements and related disclosures.