Quantum Computing Inc.: Form 10-Q for the period ended Mar 31, 2024

This quarterly report on Form 10-Q and other reports filed Quantum Computing, Inc. (the “Company,” “QCi,” “we,” “our,” and “us”) from time to time with the U.S. Securities and Exchange Commission (the “SEC”) contain or may contain forward-looking statements and information that are based upon beliefs of, and information currently available to, the Company’s management as well as estimates and assumptions made by Company’s management. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. When used in the filings, the words “anticipate,” “believe,” “estimate,” “expect,” “future,” “intend,” “plan,” or the negative of these terms and similar expressions as they relate to the Company or the Company’s management identify forward-looking statements. Such statements reflect the current view of the Company with respect to future events and are subject to risks, uncertainties, assumptions, and other factors, including the risks contained in the “Risk Factors” section of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023, relating to the Company’s industry, the Company’s operations and results of operations, and any businesses that the Company may acquire. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended, or planned.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements. Except as required by applicable law, including the securities laws of the United States, the Company does not intend to update any of the forward-looking statements to conform these statements to actual results.

Our unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the unaudited condensed consolidated financial statements as well as the reported amounts of revenues and expenses during the periods presented. Our financial statements would be affected to the extent there are material differences between these estimates and actual results. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. The following discussion should be read in conjunction with our financial statements and notes thereto appearing elsewhere in this report.

As discussed in Note 15, Restatement of Previously Issued Financial Statements, in the accompanying notes to our unaudited condensed consolidated financial statements, we have restated our previously-issued consolidated financial statements as of and for the year ended December 31, 2023; accordingly, the following has been prepared giving effect to such restatement.

Overview

QCi is a development stage company. Our strategy is to create a range of accessible and affordable quantum machines and photonics chips for use by commercial and government markets. We have developed and continue to primarily develop quantum and photonics products for high-performance computing applications based on patented and proprietary technology. Our technology is central to our strategy because we believe that it enables us to leverage the advantages of size, weight, power and cost (over competing cryogenic products) to drive market adoption and volume of sales. Specifically, our products are designed to operate at room temperature and at very low power levels at an affordable cost.

QCi’s core technology is Entropy Quantum Computing (“EQC”). EQC is a patent pending methodology that utilizes the environment to drive controlled energy loss in a photonic architecture. The Company believes the EQC’s small rack-mountable size and low-energy consumption provides a substantial competitive edge as compared to superconducting, cryogenic quantum systems offered by competitors that are also designed to solve optimization problems. In addition to our photonic computing platform, we have leveraged QCi’s core technology to demonstrate powerful quantum sensing use cases in LIDAR (Light Detection and Ranging), reservoir computing (a form of neural network that can be used in machine learning applications) and quantum cyber authentication (a method for highly secure communication within a network). Several of these important technologies are already in early stages of commercialization.

Our longer-term product development plan is to migrate product designs based on discrete components to a set of optical integrated circuits built on wafers using a crystalline material called lithium niobate (“Thin Film Lithium Niobate” or “TFLN”). The Company believes that TFLN is an excellent material for design and implementation of optical integrated circuits (“TFLN Chips”) suitable for our quantum computing and sensing products because it is crystal based and hence can have optical waveguides directly etched into the material. QCi possesses strong domain experience and intellectual property in TFLN design and chip fabrication and has completed initial production of several specialty devices such as electro-optical modulators (“EOM’s”). TFLN EOM’s have the advantages of large bandwidth, low power consumption, and small size. The Company has begun buildout of a state-of-the-art TFLN chip manufacturing facility in a leased space within Arizona State University’s Research Park in Tempe, Arizona. The Company’s understanding is that this could be the nation’s first dedicated optical integrated circuit manufacturing foundry using TFLN wafers to achieve quantum effects and superior optical interconnects for data centers. Our plan for the facility is to produce a range of custom lithium niobate chips for use in our own product lines as well as chips for sale in the commercial market. The Company has plans to support this initiative by applying for funding for distinct uses under both the Title 17 Clean Energy Financing Program managed by the US Department of Energy’s Loan Programs Office and also the Creating Helpful Incentives to Produce Semiconductors Act of 2022 (the “CHIPS Act”), which specifically includes $39 billion in manufacturing incentives and $13 billion to support new research and development.

We believe that the practical benefits to the customer of QCi’s core offerings are:

• Powerful performance in speed and quality of solution for large complex optimization problems
• Plug and play compatibility with existing IT infrastructure
• Low power consumption – normal operation under 80 watts
• Scalability with potential for migration to nanophotonic system-on-a-chip designs

The Company has limited operations, has generated limited revenue based on sales of products and related services to date, and is expanding our sales and marketing efforts to support our current portfolio of commercially-available products and planned TFLN Chips.

Market Opportunity

Despite enormous growth in the capabilities of conventional computers and silicon microprocessors, some of the world’s most important computational problems are still considered impractical to solve in a reasonable period of time. Quantum computing represents a potential alternative approach to solving those problems because quantum computers apply the properties of quantum physics to operate in a fundamentally different way. Conventional computer chips use binary bits (ones and zeros) to represent information. Quantum computers utilize qubits (quantum bits), which leverage some of the properties of quantum physics, namely superposition and entanglement, to process computations that would be intractably difficult using conventional computers. Quantum machines are intrinsically able to search very large solution spaces using these quantum effects and are thereby able to perform optimization calculations in polynomial time vs. exponential time.

While quantum-based computers will not replace conventional computers in most applications, they are ideally suited to run optimization algorithms, as well as to calculate certain sensing, imaging, and cybersecurity problems that are beyond the reach of general silicon-based computing today. The Company believes that quantum solutions have the potential to bring order of magnitude advances in the fields of medicine, engineering, autonomous vehicles, and cybersecurity and that the demand for quantum computing in these market sectors will likely outpace and outperform the general-purpose computing market in the near- to mid-term and into the foreseeable future.

Our core technology offers practical, cost-effective solutions that materially advance the adoption of quantum machines across several market segments including:

1. Quantum Computing

2. Quantum Intelligence (Artificial Intelligence and Machine Learning)

3. Remote Sensing

4. Imaging

5. Cybersecurity

Economic Conditions, Challenges, and Risks

The markets for high-performance conventional and quantum computing and cloud-based services are dynamic and highly competitive. Our competitors are developing new computing devices, while also enhancing competing cloud-based services for businesses. Aggregate demand for our solutions, services, and devices is also correlated to global macroeconomic and geopolitical factors, which remain dynamic. We must continue to evolve and adapt over an extended time in pace with this changing environment.

The investments we are making in Quantum Optical Chips and devices will continue to increase our operating costs and may decrease our operating margins. Components for our devices are primarily manufactured by third parties. Some of our products contain certain components for which there are very few qualified suppliers. Extended disruptions at these suppliers could impact our ability to manufacture devices on time to meet consumer demand.

Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent. We compete for talented individuals by offering an exceptional working environment, an ability to work on new, ground-breaking quantum technology, the ability to grow one’s career across many different products and businesses, and competitive compensation and benefits.

Results of Operations

Our results of operations for the three months ended March 31, 2024 and 2023 is as follows (in thousands, except percentages):

25

Revenues

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

Revenues for the three months ended March 31, 2024 were $27 thousand compared to $121 thousand for the comparable prior year period, a decrease of $94 thousand or 78%. The decrease in revenues is primarily due to changes in the number of, size of and level of effort performed on active customer proof-of-concept and research and development contracts during the three months ended March 31, 2024. Revenue in the current reporting period is derived from professional services provided to multiple government and commercial customers under multi-month contracts.

Cost of Revenues

Cost of revenues, which consists of direct labor expenses, primarily salary expense for engineering and solutions staff delivering services, was $16 thousand for the three months ended March 31, 2024 compared to $56 thousand for the comparable prior year period, a decrease of $40 thousand or 71%. The decrease is primarily due to the decrease in direct labor expense required to perform on the contracts in the current quarter compared to the prior year period.

Gross Margin

Gross margin for the three months ended March 31, 2024 was $11 thousand and 41%, respectively, compared to $65 thousand and 54%, respectively, for the comparable prior year period, a decrease of $54 thousand and 83%, respectively. The change was nearly entirely the result of a reduction in 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 significant differences in gross margin between reporting periods.

Operating Expenses

Information about our operating expenses for the three months ended March 31, 2024 and 2023 is set forth in the below tables (in thousands, except percentages).

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 for the three months ended March 31, 2024 did not significantly change with increases in stock-based compensation offset by decreases in bonus as the Company sought to create long-term incentives to retain key technical employees. See Note 12, Stock-based Compensation, in the accompanying notes to our unaudited condensed consolidated financial statements for additional information.

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 for the three months ended March 31, 2024 did not significantly change.

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 for the three months ended March 31, 2024 did not significantly change, with changes primarily attributable to increases in severance expense and stock-based compensation expense for the Separation Agreement Shares, offset by pre-vesting forfeitures for certain consultants that separated during the three months ended March 31, 2024.

Non-operating Income (Expense)

The following table summarizes our non-operating income (expense) for the three months ended March 31, 2024 and 2023 (in thousands, except percentages).

The increase in other expense for the three months ended March 31, 2024 compared to the comparable prior year period is primarily the result of no gain in value of the warrant liability recognized during the three months ended March 31, 2024, offset by decreased interest expense, net.

Interest expense, net consists of interest on financial liabilities and amortization of debt issuance costs. The decrease in interest expense in 2024 compared to 2023 was attributable to borrowings outstanding under the Streeterville Unsecured Note which was paid-in-full as of March 1, 2024. See Note 8, Financial Liabilities, in the accompanying notes to our unaudited condensed consolidated financial statements for additional information.

The gain on change in value of warrant liability is primarily comprised of mark-to-market adjustments for the QPhoton Warrants, which have had no carrying value as of March 31, 2024 and 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 11, Capital Stock - Warrants, in the accompanying notes to our unaudited condensed consolidated financial statements 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 March 31, 2024, the Company has raised $65.8 million through private and public placements of equity and $12.6 million through private placements of convertible promissory notes and other debt for a total of $78.4 million. The Company has no lines of credit or 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 March 31, 2024, the Company had cash and cash equivalents of $6.1 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 unaudited condensed 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 March 31, 2024, compared to December 31, 2023 (in thousands):

At March 31, 2024, we had working capital of $3.7 million as compared to a working capital deficit of $2.2 million at December 31, 2023, an increase of $5.9 million. The increase in working capital is primarily attributable to an increase in cash proceeds from issuance of the common stock using the Company’s ATM facility, offset by the use of cash to pay for operating expenses and capital investments in property and equipment.

Cash Flows

The following table summarizes our cash flow for the three months ended March 31, 2024 and 2023 (in thousands).

Net cash used in operating activities for the three months ended March 31, 2024 and 2023 was $3.8 million and $4.3 million, respectively, in each case primarily as a result of our net loss in each period offset by noncash adjustments for stock-based compensation and depreciation and amortization; the prior year comparable period also included adjustments for a mark-to-market gain on the QPhoton Warrant liability.

Net cash used in investing activities for the three months ended March 31, 2024 and 2023 was $1.6 million and approximately $400 thousand, respectively, and was attributable to our purchase of computer hardware, laboratory and TFLN Chip manufacturing equipment. The increase in investment in the current period is primarily due to the purchase of additional equipment in establishing the Company’s TFLN Chip manufacturing facility in a leased space within Arizona State University’s Research Park in Tempe, Arizona.

Net cash provided by financing activities was $9.5 million and $6.1 million for the three months ended March 31, 2024 and 2023, respectively. Cash flows provided by financing activities during the three months ended March 31, 2024 were attributable to use of the ATM facility to sell shares of our common stock, offset by repayments on the Streeterville Unsecured Note and redemptions of Series A Preferred shares. Cash flows provided by financing activities during the period ended March 31, 2023 were attributable to the use of the ATM facility to sell shares of our common stock.

On a long-term basis, our liquidity is dependent on the continuation and expansion of operations and receipt of revenues. Demand for the 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 unaudited 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 unaudited 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 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 March 31, 2024, we had federal and state net operating loss (“NOL”) carryforwards of approximately $55 million, or $14.3 million on a tax-effected basis. 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 March 31, 2024, 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 2024.

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 unaudited condensed consolidated financial statements.

There has been no default in the payment of principal, interest, sinking or purchase fund installment, or any other material default, with respect to any indebtedness of the Company.

(a) Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In designing and evaluating our disclosure controls and procedures, our management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, of the effectiveness of our disclosure controls and procedures. Based on such evaluation, our principal executive officer and principal financial officer concluded that as of March 31, 2024, our disclosure controls and procedures were not effective to provide reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (b) such information is accumulated and communicated to our management, including our Chief Executive Officer and President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Specifically, the Company does not have sufficient accounting staff to enable proper segregation of duties.

(b) Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act) during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We believe there are no changes that constitute material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023, filed with the SEC on April 1, 2024.