Quantum Computing Inc.: Form 10-K/A for the period ended Dec 31, 2023

The discussion and analysis set forth below in this Item 7 has been amended and restated to reflect the restatement of our consolidated financial statements as described in the Explanatory Note and in Note 3 of the Notes to Consolidated Financial Statements included elsewhere in this Amendment.

The following discussion and analysis of the results of operations and financial condition for the years ended December 31, 2023 and 2022 should be read in conjunction with our consolidated financial statements and the notes to those consolidated financial statements that are included elsewhere in this Amendment. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors. See “Forward-Looking Statements.”

Overview

QCi is a development stage company with limited operations and revenue. The Company is developing quantum and ancillary non-quantum products for high-performance computing applications based on proprietary photonics technology. QCi’s products are designed to operate at room temperature and low power at an affordable cost in the areas of high-performance computing, sensing and imaging, and quantum cybersecurity. The Company has generated some revenue based on sales of products and related services to date and is expanding its sales and marketing efforts. The Company’s development team includes optical engineers, mathematicians, physicists, and software developers.

Results of Operations

The following table summarizes the Company’s consolidated net loss (in thousands, except percentages).

(1) As described in Note 3 to the Consolidated Financial Statements appearing elsewhere in this Amendment, we have restated the Consolidated Financial Statements.

Revenues

The Company’s revenues consist of (in thousands):

Revenues for the year ended December 31, 2023, were $358 thousand compared to $136 thousand for the year ended December 31, 2022, an increase of $222 thousand, or 163%. Revenue was derived from sales of hardware products and professional services in 2023, and solely from professional services in 2022. In each year, services were provided to multiple commercial and government customers under multi-month contracts; the year-over-year change was driven by increases in short-term contractual service revenue. In 2023, QCi continued to execute its business strategy to provide quantum-ready solutions for solving real-world problems. While we have made significant progress toward this overarching objective, the generation of revenue from customers has been slow to develop, in part due to the fact that quantum computing is a cutting-edge technology for most potential customers, who are therefore proceeding cautiously with small, exploratory contracts to better understand its applicability to their requirements. Accordingly, the Company has focused on both providing professional services to introduce customers to quantum-based solutions for their operating needs and on customer education to build customer awareness as a means to generate sales. The Company continues to transition towards commercialization, having developed and released multiple products that we are now in the process of marketing. We expect revenues to increase meaningfully in the coming years as we continue to emphasize our hardware capability.

Cost of Revenues

Cost of revenues, which consists of labor consumed to fulfill our obligations under contractual service agreements as well as the component parts of finished goods sold, was $196 thousand for the year ended December 31, 2023 compared to $61 thousand for the prior year, an increase of $135 thousand, or 221%. Cost of revenues for each of the years ended December 31, 2023 and 2022 consists primarily of salary expense. The increase for 2023 was predominantly driven by the execution of new government service contracts. Cost of revenue for these services was contractually structured and limited to the direct salaries and actual hours worked to fulfill the work orders. Rates for these services remained materially unchanged year over year, with contract volume being the driver of growth.

Gross Margin

Gross margin for the year ended December 31, 2023 was $162 thousand compared to $75 thousand for the prior year, an increase of $87 thousand, or 116%. On a percentage basis, gross margin was 45%, a decrease of 10% year-over-year. The change was nearly entirely the result of the shift to contractual service revenue where the cost of goods sold was defined under the terms of our general professional services obligation. Our lack of a scaled and distributed base of revenue generation by product and sales channel can result in large swings in gross margin between reporting periods.

Operating Expenses

Information about our operating expenses for the years ended December 31, 2023 and 2022 is set forth in the below tables (in thousands, except percentages). Operating expenses for the year ended December 31, 2023 decreased primarily as a result of a decrease in general and administrative expenses, partially offset by an increase in research and development expenses.

Research and development expenses consist primarily of employee compensation for employees that primarily engage in research and development efforts and fees for the development of hardware products and supporting software. We focus the bulk of our research and development activities on the continued development of existing products and the development of new offerings for emerging market opportunities.

Research and development expenses in 2023 increased compared with 2022 primarily due to higher headcount and related payroll costs and higher stock-based compensation to incentivize and retain key technologists, as well as higher recurring lab equipment and consumables costs.

Selling and marketing expenses, which consist primarily of employee compensation as well as customer lead generation activities, tradeshow participation, advertising and other marketing and selling costs, also contributed to the decrease in selling and administrative expenses.

Selling and marketing expenses in 2023 decreased compared with 2022 primarily due to lower outsourced professional services costs and gains for forfeited stock-based compensation, offset partially for higher trade show and travel-related costs in 2023.

General and administrative expenses consist primarily of compensation expenses for employees performing administrative functions, and professional fees incurred for legal, auditing and other consulting services.

General and administrative expenses in 2023 decreased compared with 2022 primarily due to expenses related to the merger with QPhoton in 2022 (the “QPhoton Merger”), including an $8.4 million decrease in stock-based compensation and a $700 thousand decrease in legal fees, offset primarily by increases of $1.3 million for additional months of intangibles amortization, and $1.5 million in salaries and benefits driven by higher headcount, related payroll costs, and severance.

Non-operating Income (Expense)

The following table summarizes our non-operating income (expense) for the years ended December 31, 2023 and 2022 (in thousands, except percentages).

The increase in other expense for 2023 compared to 2022 is primarily the result of an increase in interest expense, net, and a decrease in the change in value of the warrant liability during 2023 compared to 2022.

Interest expense, net consists of interest on financial liabilities and amortization of debt issuance costs. The increase in interest expense in 2023 compared to 2022 was attributable to borrowings outstanding under our $8.25 million unsecured promissory note that we issued to Streeterville Capital, LLC in September 2022 (the “Streeterville Unsecured Note”). See Note 8, Financial Liabilities, in the accompanying notes to our consolidated financial statements for additional information.

Gain on change in value of warrant liability is primarily comprised of mark-to-market adjustments for the QPhoton Warrants, as defined below, which have no carrying value as of December 31, 2023. Future mark-to-market adjustments may result in losses if the Company’s stock price increases above the exercise price of the Underlying Options, as defined below. See Note 12, Stock-based Compensation, for additional information on the QPhoton Warrants.

Liquidity and Capital Resources

We have incurred net losses and experienced negative cash flows from operations since inception. Through December 31, 2023, the Company has raised $57.4 million through private placements of equity and $12.6 million through private placements of convertible promissory notes and other debt for a total of $70.0 million. The Company has no lines of credit, and $2.1 million in short-term debt obligations outstanding when excluding the remaining debt issuance costs. We expect to incur additional losses and higher operating expenses for the foreseeable future as we continue to invest in research and development and go-to-market programs. We have determined that additional financing will be required to fund our operations for the next 12 months and our ability to continue as a going concern is dependent upon obtaining additional capital and financing. As of December 31, 2023, the Company had cash and cash equivalents of $2.1 million.

Our primary uses of cash are to fund our operations as we continue to grow our business. We will require a significant amount of cash for expenditures to fund business operations and continue to invest in ongoing research and development for our non-linear quantum optical products and photonics chips. Until such time as we can generate significant revenue from sales or subscriptions of our hardware offerings, we expect to finance our cash needs through public and/or private equity and/or debt financings or other capital sources, including but not limited to U.S. government grant and loan programs. However, we may be unable to raise sufficient funds or enter into such other arrangements, when needed, on favorable terms, or at all. In particular, uncertain and unfavorable conditions in the United States and global macroeconomic environment, including inflationary pressures, rising interest rates, banking collapses, and financial and credit market fluctuations, could reduce our ability to access capital on favorable terms, or at all. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be, or could be, diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. Debt financing and equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, or substantially reduce our product development and go-to-market efforts. It is management’s opinion that these conditions raise substantial doubt about the Company’s ability to continue as a going concern for a period of 12 months from the date of the issuance of the accompanying consolidated financial statements. There can be no assurances that the Company will be able to secure additional equity investments or achieve an adequate sales level.

The following table summarizes total consolidated current assets, liabilities and working capital at December 31, 2023, compared to December 31, 2022 (in thousands).

At December 31, 2023, we had a working capital deficit of $2.2 million as compared to working capital of $0.9 million at December 31, 2022, a decrease of $3.0 million. The decrease in working capital is primarily attributable to the use of cash to pay for operating expenses and capital investments in property and equipment, satisfaction of accrued expense liabilities and the Streeterville Unsecured Note becoming a current portion of long-term debt payable.

Our independent registered public accounting firm included an explanatory paragraph in its report on our consolidated financial statements as of and for the year ended December 31, 2023, noting the existence of substantial doubt about our ability to continue as a going concern. This uncertainty arose from management’s review of our results of operations and financial condition and its conclusion that, based on our operating plans, we did not have sufficient existing working capital to sustain operations for a period of 12 months from the date of the issuance of the accompanying consolidated financial statements.

Cash Flows

The following table summarizes our cash flow for the years ended December 31, 2023 and 2022 (in thousands).

Net cash used in operating activities for the years ended December 31, 2023 and 2022 was $18.3 million and $15.4 million, respectively, in each case primarily as a result of our net loss in each year offset by noncash adjustments for stock-based compensation, depreciation of property and equipment, amortization of intangibles, provision for credit losses, and change in fair value of our QPhoton Warrant liability, as defined below.

Net cash used in investing activities for the years ended December 31, 2023 and 2022 was $2.6 million and $2.2 million, respectively. Cash used in investing activities during the year ended December 31, 2023 was attributable to acquisition of laboratory equipment for $2.1 million and our $500 thousand loan to millionways, Inc. (“millionways”) in June 2023. On June 6, 2023, the Company entered into a Note Purchase Agreement with millionways pursuant to which the Company agreed to purchase from millionways up to three unsecured promissory notes in an aggregate principal amount of up to $2.0 million, subject to the terms and conditions thereof. On June 6, 2023, the Company purchased the notes from millionways and loaned it an aggregate principal amount of $500 thousand. This followed the Company’s entry into a Summary of Proposed Terms with millionways on May 16, 2023, to provide bridge loans to millionways and enter into due diligence to acquire up to 100% of the AI firm. The Company opted not to purchase further promissory notes from millionways. Cash used in investing activities during the year ended December 31, 2022 was attributable to acquisition of laboratory equipment for $870 thousand and our $2.5 million loan to QPhoton, consisting of two unsecured promissory notes, each in the principal amount of $1.25 million, per a Note Purchase Agreement with QPhoton on February 18, 2022 (the “QPhoton Loan”). Upon closing of the QPhoton Merger on June 16, 2022, the Company recouped approximately $1.1 million of the QPhoton Loan in cash, resulting in approximately $1.4 million net total cash used for the QPhoton Merger in our consolidated financial statements.

Net cash provided by financing activities for the year ended December 31, 2023, was $17.7 million compared to $6.2 million during the year ended December 31, 2022. Cash provided by financing activities during the year ended December 31, 2023 was attributable to net $24.7 million received from the sale of shares of our common stock through our At-The-Market (“ATM”) facility, partially offset by repayments of $6.2 million on the Streeterville Unsecured Note. During the year ended December 31, 2022, cash provided by financing activities was primarily attributable to the funds we received from the issuance of the Streeterville Unsecured Note.

On a long-term basis, our liquidity is dependent on continuation and expansion of operations and receipt of revenues. Demand for our products and services will be dependent on, among other things, market acceptance of our products and services, the technology market in general, and general economic conditions, which are cyclical in nature. As most of our revenues will be from the sales of our products and services, our business operations may be adversely affected by the actions of our competitors and prolonged recession periods.

Critical Accounting Estimates

Certain of our accounting policies require the application of significant judgment by our management, and such judgments are reflected in the amounts reported in our condensed consolidated financial statements. In applying these policies, our management uses judgment to determine the appropriate assumptions to be used in the determination of estimates. Those estimates are based on our historical experience, terms of existing contracts, our observance of market trends, information provided by our strategic partners and information available from other outside sources, as appropriate. Actual results may differ significantly from the estimates contained in our condensed consolidated financial statements.

Fair Value of Stock-based Compensation and Derivatives

We recognize stock-based compensation expense for all share-based payment awards in accordance with Accounting Standards Codification (“ASC”) 718, Compensation – Stock Compensation. Stock-based compensation expense for expected-to-vest awards is valued under the single-option approach and amortized on a straight-line basis, accounting for actual forfeitures as they occur. We utilize the Black Scholes pricing model in order to determine the fair value of stock-based option awards. The Black Scholes pricing model requires various highly subjective assumptions including volatility, expected option life, and risk-free interest rate. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates. These estimates involve inherent uncertainties and the application of management judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future.

Another area of critical accounting estimates involves determining the fair market value of the QPhoton Warrants, as defined below. The Company determines which underlying options and warrants are in-the-money or out-of-the-money at period end by comparing to the bid price of the Company’s common stock, then accounts for changes period-over-period by realizing a mark-to-market gain or loss for the period.

Fair Market Value and Useful Life of Intangible Assets

Determining the fair market value and useful life of the intangible assets acquired by the Company through the merger with QPhoton is another critical accounting estimate. In the absence of market pricing for the intangible assets, the Company relied on independent third-party appraisal experts and comparison with similar transactions to arrive at estimates of value as well as useful life. The Company will perform periodic assessments of the intangible assets for impairment, but if any of the initial estimates are incorrect, that could result in a calculation of amortization expense that is too high or too low.

Valuation Allowances for Deferred Taxes

Our income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect management’s assessment of estimated current and future income taxes to be paid. We are subject to income taxes in the United States. Significant judgments and estimates are required in determining the consolidated income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits.

Deferred tax assets and liabilities arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements, which are expected to result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, for all material jurisdictions, we consider all available positive and negative evidence, including scheduled reversals of deferred tax balances, projected future taxable income, tax-planning strategies and results of recent operations. In projecting future taxable income, we begin with historical results and incorporate assumptions about the amount of future state, federal and foreign pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates we use to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating results.

As of December 31, 2023, we had federal and state net operating loss (“NOL”) carryforwards of $49 million, or $13 million on a tax-effected basis at an assumed tax rate of 25%. We believe that it is more likely than not that the benefit from these NOL carryforwards will not be realized. Accordingly, we have provided a full valuation allowance on any potential deferred tax assets relating to these NOL carryforwards. If our assumptions change and we determine we will be able to realize these NOLs, the tax benefits relating to any reversal of the valuation allowance on deferred tax assets as of December 31, 2023, will be accounted for as a reduction of income tax expense.

The calculation of our tax liabilities involves evaluating uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. ASC 740, Income Taxes, states that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including the resolution of any related appeals or litigation processes, on the basis of the technical merits.

We record unrecognized tax benefits as liabilities in accordance with ASC 740 and adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a tax payment that is materially different from our current estimate of the unrecognized tax benefit liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information is made available.

We believe that none of the unrecognized tax benefits may be recognized by the end of 2023.

Legal and Other Contingencies

The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.