Executive Summary / Key Takeaways

• ZSpace is a specialized provider of augmented and virtual reality (AR/VR) solutions for the K-12 and Career Technical Education (CTE) markets, leveraging unique headset-free, stylus-based technology for immersive learning.
• The company's Q1 2025 results showed a 14% revenue decline year-over-year, primarily driven by a 26% drop in hardware sales due to K12 funding uncertainty and potential tariff impacts, partially offset by strong 43% growth in higher-margin services revenue and stable software revenue with improved margins.
• Despite improved gross margins across segments, ZSPC continues to incur significant operating losses and negative cash flow, leading management to express substantial doubt about the company's ability to continue as a going concern without additional financing.
• A critical Senior Secured Convertible Note Financing of $13.0 million (with potential for an additional $7.0 million) closed in April 2025, addressing immediate liquidity needs, repaying existing debt, and restructuring other obligations, but introducing new debt and potential equity dilution dynamics.
• Key risks include ongoing liquidity requirements, reliance on strategic manufacturing partners, long sales cycles in the education sector, intense competition from larger tech giants like Meta and Microsoft, and unaddressed material weaknesses in internal financial controls.

The Immersive Classroom: ZSpace's Vision and Journey

ZSpace, Inc., founded in 2006, set out with an ambitious goal: to break the traditional barriers between students and digital content, fundamentally reinventing the learning experience through augmented and virtual reality. Headquartered in San Jose, California, the company has positioned itself as a developer of full-service AR/VR solutions specifically tailored for the K-12 and Career Technical Education (CTE) markets. Its journey began with Original Edition (OE) products utilizing proprietary polarized displays and lightweight eyewear, evolving over time to the more advanced, headset-free Inspire and Imagine laptop lines, culminating in the January 2025 introduction of the Imagine Learning Solution aimed at elementary education.

The core of ZSpace's offering lies in its differentiated technology. Unlike many AR/VR solutions that rely on bulky headsets, ZSpace's platform delivers a 3D stereo visualization experience without the need for eyewear on its latest Inspire and Imagine laptops. This is coupled with a patented stylus that allows users to interact with and manipulate virtual objects projected out of the screen as if they were real. This headset-free, stylus-based approach is designed to foster a more natural, collaborative, and interactive learning environment. The company believes this technology leads to deeper content understanding, increased student motivation and engagement, and improved preparedness for the workforce. The introduction of the Imagine line specifically for elementary students and the integration of AI tools like Career Coach AI™ demonstrate the company's ongoing R&D efforts aimed at expanding its market reach and enhancing the educational value of its platform. While specific quantitative performance metrics for these technological benefits (like percentage improvement in learning outcomes or engagement compared to alternatives) are not detailed, the strategic intent is clearly to provide a more accessible and effective AR/VR learning tool for the classroom.

ZSpace employs a dual go-to-market strategy, selling directly to U.S. school districts and community colleges while leveraging a network of over 25 resellers for international expansion across more than 50 countries. This approach has resulted in significant penetration within the U.S. K-12 market, with the platform implemented in over 3,500 districts, including over 80% of the largest 100 by enrollment. CTE solutions have also seen adoption in approximately 73% of served districts and 2% of U.S. community/technical colleges.

Navigating the Competitive Currents

The AR/VR education technology market is a dynamic landscape where ZSpace competes against a range of players, from specialized edtech firms to global technology giants. Direct competitors include major players like Meta Platforms (META), Microsoft (MSFT), and Apple (AAPL), who offer broader AR/VR hardware and software ecosystems that are increasingly finding applications in education. Indirect competitors encompass traditional edtech providers like Google Classroom (GOOGL) and emerging AI-driven learning platforms that do not rely on immersive technologies.

ZSpace's competitive positioning is primarily built around its unique, headset-free technology and its focused approach to the education sector. While giants like Meta offer highly immersive VR experiences via Quest headsets and Microsoft provides enterprise-grade mixed reality with HoloLens, ZSpace differentiates itself by prioritizing accessibility and ease of use in a classroom setting, avoiding the potential discomfort or management challenges associated with head-mounted displays. The stylus interaction offers a precise method for manipulating 3D objects, which the company positions as highly beneficial for subjects like science and technical training. Competitive analysis suggests ZSpace's system may offer advantages like 20-30% faster lesson creation and 25% lower power consumption per session compared to some alternatives, although it may lag in raw immersion or ecosystem integration depth compared to Meta or Microsoft.

However, ZSpace faces significant challenges competing with the scale, financial resources, and established ecosystems of these larger players. Meta and Microsoft, despite their AR/VR segments potentially operating at negative margins (like Meta's Reality Labs at -20%), benefit from robust overall profitability (Meta's overall gross margin ~75%, Microsoft's ~70%) and massive cash flow generation, allowing them to invest heavily in R&D and potentially undercut smaller competitors on price or bundle offerings with existing widely adopted platforms (like Microsoft's integration with Teams). ZSpace's smaller scale means its R&D investment, while high relative to its revenue (10-15%), is significantly smaller in absolute terms, potentially making it vulnerable to being outpaced in certain technological advancements or integration capabilities. Furthermore, ZSpace's reliance on strategic PC OEM partners and a single stylus manufacturer in China introduces supply chain risks that larger, more diversified competitors may be better equipped to handle. Competitive analysis notes that ZSPC's R&D dependency results in 10-15% higher operating costs than some competitors, potentially exposing it to rivals' superior efficiency (e.g., Microsoft's 20% better ROIC).

Despite these challenges, ZSpace's deep focus on the K-12 and CTE markets, its established relationships with school districts, and its specialized technology provide a niche competitive advantage. The company's strategy to acquire software companies and IP is aimed at increasing its software revenue, which typically carries higher margins (ZSPC's software gross margin was 66% in Q1 2025), potentially improving overall profitability and strengthening its offering against competitors whose educational content may be less tailored.

Performance Under Pressure: Analyzing Recent Financials

ZSpace's financial performance in the first quarter of 2025 reflects both the challenges in its core hardware market and promising trends in its higher-margin segments. Total revenue for the three months ended March 31, 2025, decreased by 14% to $6.76 million, down from $7.84 million in the same period of 2024. This decline was primarily driven by a significant 26% decrease in hardware revenue, which fell from $5.20 million to $3.83 million. Management attributed this weakness to uncertainty surrounding K12 funding sources, leading to elongated sales cycles and delayed order fulfillment, as well as potential impacts from tariff volatility.

Despite the revenue decline, ZSpace demonstrated notable improvements in gross profitability. Total cost of goods sold decreased by a more substantial 31%, falling from $5.14 million to $3.55 million. This led to an overall gross profit increase of 19%, from $2.70 million to $3.21 million, and a significant expansion in the overall gross margin from 34% to 47%. This margin improvement was evident across all segments:

• Hardware gross margin increased from 27% to 37%, partly due to reductions in the bill of materials costs for the new Inspire 2.0 laptop.
• Software gross margin saw a dramatic rise from 49% to 66%, driven by decreased costs associated with third-party point-in-time software and success in acquiring software applications previously subject to revenue share agreements.
• Services gross margin remained relatively stable, increasing slightly from 51% to 53%, despite a 43% increase in services revenue (from $0.69 million to $0.98 million) due to higher sales of extended warranty and technology support services.

While gross profitability improved, operating expenses remained substantial, totaling $8.59 million in Q1 2025, down significantly from $14.09 million in Q1 2024. However, this reported decrease was primarily due to a $6.20 million reduction in stock-based compensation expense related to large grants in March 2024. Excluding stock-based compensation, adjusted operating expenses actually increased by 9.7% year-over-year, reflecting increased personnel and professional costs associated with operating as a public company and additional selling and marketing activities.

The combination of decreased revenue and high operating expenses resulted in a loss from operations of $5.38 million in Q1 2025, a substantial improvement from the $11.39 million loss in Q1 2024 (again, heavily influenced by the stock compensation difference). Net loss for the quarter was $5.83 million, compared to $12.25 million in the prior year period. Interest expense decreased by 31% to $0.50 million, primarily due to the conversion of convertible loans into common stock during the December 2024 IPO.

Key operational metrics provided by management offer further insight. Bookings decreased slightly by 6.3% to $8.34 million in Q1 2025. While K-12 bookings share increased, CTE bookings share decreased. International bookings also saw a decline in their share of total bookings. Software subscription renewable revenue metrics showed mixed results: Annualized Contract Value (ACV) improved by 10% to $11.6 million, but the Net Dollar Retention Rate (NDRR) for customers with at least $50,000 ACV decreased from 112% to 97%, indicating some contraction or attrition within the existing large customer base over the trailing twelve months.

Addressing Liquidity and Charting the Future

ZSpace has historically faced significant liquidity challenges, reporting operating losses and negative cash flows since inception. As of March 31, 2025, the company's cash, cash equivalents, and restricted cash stood at a critical $1.13 million, down from $4.86 million at the end of 2024. Operating activities used $4.64 million in cash during Q1 2025. These factors led management to conclude that substantial doubt exists about the company's ability to continue as a going concern for at least the next twelve months without securing additional funding and refinancing existing debt.

In a crucial development post-quarter, ZSpace completed a Senior Secured Convertible Note Financing on April 11, 2025. This transaction provided gross proceeds of $13.0 million, with the potential for an additional $7.0 million subject to certain conditions. The Note, with an original principal amount of $13.98 million (reflecting an original issue discount), matures on April 11, 2027, accrues interest at 6% per annum (guaranteed through maturity), and is secured by a first priority security interest in substantially all of the company's assets, including intellectual property. The terms include monthly repayments of $665,643 (principal and interest) starting 90 days after closing, payable in cash or, under certain conditions, common stock at the company's option. The note is convertible into common stock at an initial conversion price of $12.39 per share, subject to a floor price of $1.98, and includes provisions for conversion at a discount under certain circumstances, including events of default. The investor also has the right to accelerate monthly repayments by receiving shares. Between April 25 and May 12, 2025, the investor converted $0.70 million of principal and interest into 94,871 shares of common stock at prices ranging from $7.10 to $7.74 per share.

The proceeds from this financing were immediately used to fully repay approximately $10.18 million in outstanding principal and accrued interest under existing loan agreements with Itria Ventures LLC. Additionally, the company amended its loan agreements with Fiza Investments Limited. The Fiza 1.00 Agreement maturity was extended to December 31, 2027, with repayments deferred until the latter of that date or when the new Convertible Note is fully repaid. The Fiza 2.00 and 3.00 Agreement interest rate was reduced from 25% to 20%, with interest-only payments until the Convertible Note repayment date, followed by 12 months of principal and interest. An intercreditor agreement was also established, subordinating Fiza's security interest to the new Investor's and limiting Fiza's cash receipts.

This financing provides ZSpace with much-needed capital to address immediate obligations and fund working capital, alleviating the most pressing going concern risk in the short term. However, it introduces new debt obligations with significant principal and interest payments starting in mid-2025 and the potential for substantial equity dilution if the note is converted, particularly at discounted prices upon certain events.

Looking ahead, management expects software applications revenue to grow faster than hardware or services revenue, aiming to accelerate the shift in revenue mix towards software through customer retention and expansion. Strategic growth vectors include scaling in the U.S., international expansion, continued R&D, and software acquisitions intended to be accretive and materially increase software revenue. The company estimates a large total addressable market (TAM) exceeding $68 billion globally across K-12 and CTE, based on assumptions about school lab purchases and software renewal rates.

Despite the strategic vision and market opportunity, ZSpace faces significant risks beyond liquidity. These include the inherent uncertainties of the technology industry, the ability to gain broader customer acceptance, the dependency on reseller partnerships internationally, the potential impact of tariffs and trade disputes on supply chain and pricing, and the ongoing challenges in remediating material weaknesses in internal financial controls identified as of December 31, 2023. The company is actively working to address these control deficiencies, but full remediation is not guaranteed by the targeted timeline and could impact financial reporting accuracy and investor confidence. Furthermore, pending litigation related to a terminated merger agreement adds another layer of uncertainty.

Conclusion

ZSpace operates at the intersection of promising AR/VR technology and the vast, yet often challenging, education market. The company's unique headset-free approach and specialized educational content offer a compelling value proposition designed to enhance student engagement and learning outcomes. While recent financial performance in Q1 2025 highlighted headwinds in hardware sales driven by external market factors, it also demonstrated encouraging improvements in gross margins across all segments and strong growth in services revenue, signaling potential operational efficiencies and demand for support offerings.

The successful completion of the April 2025 Convertible Note Financing is a critical step in addressing the company's immediate liquidity concerns and restructuring its debt profile, providing a runway to execute its strategy. However, the path forward remains challenging, marked by the need to achieve consistent revenue growth, particularly in the higher-margin software segment, manage new debt obligations, navigate competitive pressures from well-resourced tech giants, and successfully remediate internal control weaknesses. The investment thesis hinges on ZSpace's ability to leverage its differentiated technology and market focus to capture a meaningful share of the large education TAM, accelerate its shift towards a higher-margin software mix, and ultimately achieve sustainable profitability, overcoming the significant financial and operational hurdles that remain. Investors should closely monitor the company's progress on revenue growth, margin expansion, cash flow generation, and the effective integration of its recent financing into its long-term capital structure.