SOLESENCE, INC. (SLSN) FY 2024 MD&A

Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The
following discussion and analysis should be read in conjunction with risks discussed in the financial statements and related notes
thereto appearing elsewhere in this Form 10-K. When used in the following discussions, the words “anticipates,” “believes,”
“estimates,” “expects,” “plans,” “intends” and similar expressions are intended
to identify forward-looking statements. Such statements are subject to certain risks, uncertainties and contingencies that could
cause actual results, performance or achievements to differ materially from those expressed in, or implied by, such statements.
See the “Forward Looking Statements” section in Part 1, Item 1, of this Form 10-K.

Overview

Solésence
is a health-oriented, science-driven company, focused on various skin health and beauty markets. Our primary skin health products
are fully developed prestige skin care formulations with mineral-based UV protection enabled by our proprietary Active Pharmaceutical
Ingredients (“APIs”), which are also marketed as APIs for sale to manufacturers of other types of skin health products,
including sunscreens and daily care products. Additionally, we continue to sell products in legacy markets including medical diagnostics,
architectural coatings, industrial coating applications, abrasion-resistant additives, and plastics additives applications—
all of which currently fall into the advanced materials product category.

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Critical
Accounting Estimates

Management
also monitors the value of inventory for the effects of aging, obsolescence, and seasonality. Consistent with the provisions in
FASB ASC 330-10-35, we adjust inventory valuation upon management’s determination that the potential for obsolete materials
exist. The majority of the reserve is done by specific identification. Factors include inventory in quarantine, aging finished
goods or obsolete materials as identified by management. In the application of this policy in 2024, management deemed a portion
of inventory will likely experience such an impairment and elected to apply a $1,987,000 inventory reserve in anticipation. Some
of the materials in question are nearing expiration and therefore more difficult to sell, some represent soon-to-be obsolete products,
and some are raw materials that we no longer use regularly.

Certain
assumptions are necessary to assess the impact of risks and uncertainties on the financial information, such as cash flow projections,
availability of capital if needed to support the ongoing operations of the business, and our expected compliance with contractual
commitments. Any changes in those plans or assumptions could have a material impact on our liquidity and financial condition.
While we have seen costs continue to increase on an inflationary basis as we enter 2025, it is our belief that we will be able
to offset much of this cost as we gain greater production efficiencies and seek to increase our pricing where possible.

Results
of Operations

Years
Ended December 31, 2024 and 2023

Total
revenue increased to $52,347,000 in 2024, compared to $37,297,000 in 2023. A substantial majority of our revenue for each year
is from our largest customers, in particular, sales to our largest customer in skin care and sunscreen applications, finished
skin health products marketed through our consumer products. Product revenue, the primary component of our total revenue, increased
to $51,890,000 in 2024, compared to $36,641,000 in 2023. This increase was due to an increase in revenue from our consumer products
partially offset by decreased personal care ingredients and advanced materials products.

Current
Significant Customers

Cost
of revenue generally includes costs associated with commercial production and customer development arrangements. Cost of revenue
increased to $36,159,000 in 2024, compared to $29,472,000 in 2023. The increase in cost of revenue was primarily driven by higher
materials and direct labor costs related to the increased sales volume. Also contributing to the higher cost of revenue was increased
costs associated with supply chain and maintenance activities costs due to the increased sales volume. We expect to continue new
materials development and dispersion technologies for personal care applications and for our formulated Solésence products
during 2025 and beyond, as part of our business model. At current revenue levels we have generated a positive gross margin, though
margins can be impeded by the cyclicality of our demand, often leading to the Company not having enough revenue to efficiently
absorb manufacturing overhead that is required to work with current customers and expected future customers. We believe that our
current fixed manufacturing cost structure is sufficient to support higher levels of revenue volume. The extent to which margins
grow, as a percentage of total revenue, will be dependent upon revenue mix, revenue volume, our ability to cut costs and pass
commodity market-driven raw materials increases on to customers, and the speed and efficiency with which we are able to scale
up production for our Solésence products. We expect that, as product revenue volume increases, our fixed manufacturing
costs will be more efficiently absorbed, which should lead to increased margins as we grow. We expect to continue to focus on
reducing controllable variable product manufacturing costs, with potential variability related to the commodity metals markets
and cost and wage inflation but may or may not realize gross margin percentage growth through 2025 and beyond, dependent upon
the factors discussed above.

Research
and development expense, which includes all expenses relating to the technology and advanced engineering groups, primarily consists
of costs associated with the development or acquisition of new finished product formulations for skin care, new product applications
for our skin care ingredients, advancement of our medical diagnostics ingredient knowledge, and the cost of enhancing our manufacturing
processes. This includes legal fees related to intellectual property development, protection, and maintenance. As an example,
we are currently focusing the bulk of our resources on developing new product formulations, and related new technologies, as we
expand marketing and sales efforts relating to our Solésence products. This work has led to several new products and additional
potential new products. Our efforts in research and development, cosmetic formulating, process engineering and advanced engineering
groups are focused in three major areas: 1) application development for our products; 2) creating or obtaining additional core
materials technologies and/or materials that have the capability to serve multiple skin health-related markets; and 3) continuing
to improve our core technologies to improve manufacturing operations and reduce costs.

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Research
and development expense remained the same in 2024, totaling $3,837,000, the same as in 2023. In 2024 labor costs were higher than
2023 which were offset by lower legal and consulting costs in 2024 compared to 2023. We expect expenses for research and development
to increase slightly in 2025 depending on growth in our Solésence line of products, and related technologies. This expense
growth will be dependent upon the success we have in developing new products, which adds significantly to outside testing fees
to both enhance product development and comply with regulatory requirements.

Selling,
general and administrative expense decreased to $7,219,000 in 2024, compared to $7,534,000 in 2023. The net decrease was largely
attributed to a decrease in legal costs. We expect 2025 expenses in this area to be slightly higher due to expanding parts of
our administrative functions, including related staffing additions. The extent to which this increase occurs will be dependent
upon growth.

Interest
expense decreased to $670,000 in 2024, compared to $838,000 in 2023, due to lower interest rates in 2024 and decreased usage of
the debt facilities. The interest expense for 2024 and 2023 related to interest paid relating to our revolving lines of credit
for working capital funding and term loans supporting some of our equipment.

In
Company-wide operations, we believe inflation has not had a material effect on our operations or financial position for 2024,
although we have seen increases in our costs. We expect supplier price increases and wage and benefit inflation, both of which
represent a significant component of our costs of operations, may have a material effect on our operations and financial position
in 2025 and beyond. We will apply our best efforts to pass through cost increases to our customers. If we are unable to pass through
any increases due to contractual limitations or conditions in our markets specifically, this could reduce margins and net income.

Liquidity
and Capital Resources

Cash,
cash proceeds and use of cash for 2024 and 2023 were:

The
$3,977,000 year-over-year increase in cash provided by operating activities for the year ended December 31, 2024 was mainly due
to the Company earning $4,235,000 in net income in 2024 compared to $4,390,000 in net loss in 2023. Cash capital expenditures
amounted to approximately $4,558,000 and $1,051,000 for the years ended December 31, 2024 and 2023, respectively. We did not dispose
of or sell any assets during 2024 or 2023.

The
Company maintains a credit agreement with Libertyville to support our obligations under our leased manufacturing and warehouse
space in Bolingbrook, Illinois. As of December 31, 2024 there was no outstanding borrowings on this line of credit. This credit
agreement has a maturity of December 22, 2025.

On
January 28, 2022, to support the working capital demands created by the commercial growth of the Company and its wholly owned
subsidiary, Solésence, LLC, the Company entered into (i) an Amended and Restated Business Loan Agreement (the “A&R
Loan Agreement”), which amends and restates the Master Agreement, (ii) a Business Loan Agreement (the “New Term Loan
Agreement”) with Strandler, LLC, (iii) a Business Loan Agreement (the “New Revolving Loan Agreement” and together
with the A&R Loan Agreement and the New Term Loan Agreement, the “Loan Agreements”) with Beachcorp, LLC, and (iv)
three promissory notes in order to evidence the loans pursuant to the Loan Agreements (the “Notes”). Beachcorp, LLC
and Strandler, LLC are affiliates of Mr. Bradford T. Whitmore, who beneficially owns a majority of the Company’s common
stock and is the brother of Ms. R. Janet Whitmore, a director of the Company and the chair of the Company’s board of directors.

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The
Loan Agreements changed the terms of both the Company’s asset-based revolving loan facility (the “A/R Revolver Facility”)
and the secured advance (the “Term Loan”, which was assigned from Beachcorp, LLC to Strandler, LLC) under the Master
Agreement and provide a new asset-based revolving loan facility based on inventory (the “Inventory Facility”). The
maximum borrowing amount under the A/R Revolver Facility increases from $6,000,000 to $8,000,000, with a borrowing base consisting
of qualified accounts receivable of the Company. The maximum borrowing amount under the Inventory Facility is $4,000,000, with
a borrowing base consisting of up to 50% of the value of qualified inventory of the Company. The Loan Agreements also extended
the date for which all principal and accrued interest under the A&R Revolver Facility and the Term Loan are due from March
31, 2023 and March 31, 2022, respectively, to March 31, 2024, which was also the maturity date for the Inventory Facility. The
Loan Agreements reduce interest on outstanding borrowings under the A/R Revolver Facility and the Term Loan from the prime rate
plus 2% and 5.25% per year, to a floating rate equal to the prime rate plus 0.75%, which is also the interest rate for borrowings
under the Inventory Facility. The amount of the Term Loan remains $1,000,000. The A/R Revolver Facility, the Inventory Facility
and the Term Loan are all secured by all the unencumbered assets of the Company and subordinated to the Company’s revolving
line of credit with Libertyville Bank & Trust.

On
November 13, 2023 to support working capital demands the Company entered into (i) a new Promissory Note (“Bridge Note”)
with Strandler, LLC, with a maximum borrowing amount of $2,000,000, interest rate at the prime rate plus 0.75%, and set to mature
on May 13, 2024, and (ii) amendments to the Loan Agreements increasing the principal amount of the Inventory Facility to $5,200,000,
increased the borrowing base to 55% of eligible inventory, up from 50% and extending the maturity date under the Loan Agreement
to March 31, 2025. The Bridge Note was repaid in full in connection with the Purchase Agreement referred to below.

On
March 1, 2024, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”), between the Company
and Strandler, LLC (“Strandler”).

Pursuant
to the Purchase Agreement, the Company issued to Strandler 15,000 shares of the Company’s Series X Preferred Stock (the
“Series X Preferred Stock”) at a purchase price per share of $400, for total consideration of $6,000,000, in a transaction
exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(a)(2) thereof. The terms of the Preferred
Stock are set forth in the Company’s Certificate of Designations to its Certificate of Incorporation, filed with the Secretary
of State of the State of Delaware on March 4, 2024 (the “Certificate of Designations”).

Under
the Purchase Agreement, the Company granted Strandler customary registration rights with respect to shares of the Company’s
common stock, par value $0.01 per share (the “Common Stock”), it may receive in connection with any conversion of
Series X Preferred Stock into Common Stock, as described below. For so long as any amount of Preferred Stock is outstanding, the
Purchase Agreement also (i) prevented the Company from paying any dividend on any shares of the Company’s capital stock
(other than dividends consisting solely of Common Stock or rights to purchase Common Stock), (ii) prevented the Company from repurchasing
any Common Stock, and (iii) subject to certain permitted exceptions, restricted the Company’s ability to permit any lien
or other encumbrance on Company assets.

At
any time and from time to time, in whole or in part, following the Company properly filing an amendment (the “Certificate
Amendment”) to its Certificate of Incorporation to increase the number of authorized shares of its Common Stock from 60,000,000
to 95,000,000, each share of Series X Preferred Stock was convertible, at the option of the holder, into 1,000 shares of Common
Stock at no additional cost. If the Company had not properly filed, upon shareholder approval, the Certificate Amendment on or
before August 1, 2024, then each share of Series X Preferred Stock would have been redeemable at the holder’s option, in
whole or in part, without penalty or premium, at a redemption price equal to $420 per share (each, a “Redemption”).
If the Company had failed to fully pay any Redemption within five days of receiving notice, all unpaid amounts will have born
interest at a rate of 10% per annum. In addition, in the event of a Change in Control (as defined in the Certificate of Designations)
of the Company, each share of the Series X Preferred Stock would have been redeemable at the option of the holder, without penalty
or premium, at a redemption price equal to $420 per share. Upon any conversion of Preferred Stock into Common Stock by Strandler,
Strandler is required to hold the Common Stock received in the conversion for a period of 12 months.

Holders
of Series X Preferred Stock (i) were not entitled to receive dividends, subject to customary anti-dilution protections, (ii) have
no voting rights, and (iii)receive a liquidation preference of $400 per share. The Series X Preferred Stock ranks senior in right
of payment to all securities designated as junior securities, including Common Stock.

On
June 18, 2024, the Company held a special meeting of stockholders where the Certificate Amendment was approved. The Certificate
Amendment was filed with the State of Delaware on June 19, 2024. On June 20, 2024, Strandler converted its 15,000 shares of Series
X Preferred Stock to 15,000,000 shares of Common Stock.

In
connection with the Company’s entry into the Purchase Agreement, the Company also entered into (i) a Second Amendment to
Business Loan Agreement (the “Term Loan Agreement Amendment”) with Strandler, LLC, (ii) a Second Amendment to Business
Loan Agreement (the “A&R Loan Agreement Amendment”) with Beachcorp, LLC, which is also an affiliate of our controlling
shareholder, Bradford T. Whitmore (“Beachcorp”), and (iii) a Second Amendment to Business Loan Agreement with Beachcorp
(the “Revolving Loan Agreement Amendment” and together with the Term Loan Agreement Amendment and the A&R Term
Loan Agreement Amendment, the “Loan Agreement Amendments”). The Loan Agreement Amendments extend the maturity date
under each respective loan agreement from March 31, 2025 to October 1, 2025. As of December 31, 2024, the Company’s A/R
Revolver, Inventory Facility and New Term Loan matured on October 1, 2025. Since then, the Company’s related party debt
holder for the A/R Revolver, Inventory Facility and New Term Loan has committed to refinancing the debt with a new maturity date
after April 1, 2026.

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On
December 31, 2024, the balance on the Term Loan was $1,000,000, the balance on the A/R Revolver Facility was $0, the balance on
the Inventory Facility was $4,000,000. On December 31, 2023, the balance on the Term Loan was $1,000,000, the balance on the Bridge
Load was $2,000,000, the balance on the A/R Revolver Facility was $2,810,000, and the balance on the Inventory Facility was $5,000,000.

For
more information regarding the New Business Loan Agreement, see Note 3 to our Financial Statements referred to in Part II, Item
8 of this Annual Report on Form 10-K.

Our
actual future capital requirements in 2025 and beyond will depend on many factors, including customer acceptance of our current
and potential consumer products, APIs sold as ingredients in to the skin health markets, medical diagnostics ingredients, and
other engineered materials, applications, and products, continued progress in research and development activities and product
testing programs, the magnitude of these activities and programs, and the costs necessary to increase and expand our manufacturing
capabilities and to market and sell these products and ingredients. Other important issues that will drive future capital requirements
will be the development of new markets and new customers as well as the potential for significant unplanned growth with existing
customers. Depending on the success of certain projects, we expect that capital spending relating to currently known capital needs
for 2025 will be between $6 million and $8 million, to be funded by profit from operations, our existing loans and lines of credit,
and possible new financing. If those projects are delayed or ultimately prove unsuccessful, or if we fail to be able to support
the additional cost of funding them in the near term, we expect our capital expenditures may fall below the lower end of the range.
Similarly, substantial success in business development projects may cause the actual 2025 capital investment to exceed the top
of this range.

We
have federal net operating loss carryforwards for tax purposes of approximately $42 million on December 31, 2024 Because the Company
may experience “ownership changes” within the meaning of the U.S. Internal Revenue Code (“IRC”) in connection
with any future equity offerings, future utilization of this carryforward may be subject to certain limitations as defined by
the IRC. If not utilized, $36 million of this loss carryforward will expire between 2025 and 2037. Given changes to the IRC, net
operating loss carryforwards generated after January 1, 2018 do not expire, therefore, $6.8 million in net operating losses generated
since January 1, 2018 do not expire. We have Illinois net loss deduction carryforwards for tax purposes of approximately $18.2
million on December 31, 2024. Due to the provisions of Illinois Public Act 102-0669 signed November 16, 2021, Illinois net loss
deductions expire between 2030 and 2043.

As
a result of the annual limitation and uncertainty as to the amount of future taxable income that will be earned prior to the expiration
of the carryforward, we have concluded that it is likely that some portion of this carryforward will expire before ultimately
becoming available to reduce income tax liabilities.