| Business Combinations | Note 3 – Business Combinations Merger with QPhoton, Inc. On May 19, 2022, the Company, QPhoton, and Yuping
Huang, the principal stockholder of QPhoton (“Mr. Huang”), entered into an Agreement and Plan of Merger (the “Merger
Agreement”), pursuant to which the Company agreed to acquire QPhoton through a series of merger transactions (collectively with
the other transactions contemplated by the Merger Agreement, the “Transactions”). On June 16, 2022, all conditions precedent
having been met or waived by the parties, the Company closed the Transactions with QPhoton. The merger with QPhoton adds to the Company’s
portfolio of quantum computing products and enables the Company to offer a wider range of quantum information services. The Company accounted
for the Transactions using the acquisition method in accordance with ASC 805, Business Combinations, with the purchase price being allocated
to tangible and identifiable intangible assets acquired and liabilities assumed based on their respective estimated fair values on the
acquisition date. Fair values were initially determined using management estimates at the time of the merger, then updated in June 2023
for the values attributable to intangible assets based on new information the Company received from a third party valuation. The results
of QPhoton are included within the consolidated financial statements commencing on the acquisition date. Pursuant to the Merger Agreement, immediately
following the closing of the Transactions contemplated by the Merger Agreement (the “Closing”), Merger Sub I (a wholly owned
subsidiary of the Company) merged with and into QPhoton, with QPhoton surviving the merger as a wholly-owned subsidiary of the Company,
immediately after which the surviving corporation merged with and into Merger Sub II (also a wholly owned subsidiary of the Company),
with Merger Sub II surviving the merger as a wholly-owned subsidiary of the Company (the “Surviving Company”). The merger
consideration to be paid to the stockholders of QPhoton (the “Merger Consideration”) consisted of (i) 5,802,206 shares of
common stock, par value $0.0001 per share, (ii) 2,377,028 shares of a new series of the Company’s preferred stock, par value $0.0001
per share, to be designated Series B convertible preferred stock (“Series B Preferred Stock”), and (iii) warrants to purchase
up to 7,028,337 shares of common stock (the “Warrants”). Each share of Series B Preferred Stock converts into ten (10) shares
of common stock. The Merger Consideration for stockholders Yuping Huang and Stevens Institute of Technology was issued in 2022. The other
stockholder may have forfeited his rights to the Merger Consideration when he filed a claim asserting Appraisal rights under Delaware
law, and pursuant to the terms of the Merger Agreement, all claims to the Merger Consideration had to be submitted to the Company within
twelve (12) months of the Closing. However, the Company is in settlement negotiations with the remaining QPhoton stockholder and has decided
not to post any adjustment to the purchase price of the Transaction until those negotiations are concluded or abandoned. The purchase price was approximately $83.1 million,
consisting of Company Common Stock, Series B Preferred Stock and Warrants. The purchase agreement did not include any contingent consideration.
Since the Transactions were structured as an exchange of equity securities, the purchase price was calculated based on the fair market
value (in this case the NASDAQ closing price) of the total shares of the Company securities paid to the shareholders of the acquired company,
QPhoton. The closing Price of Company Common Stock on June 16, 2022 was $2.27. The total shares of Company Common Stock offered for QPhoton
was 36,600,823 – which assumes all of the 2,377,028 Series B Convertible Preferred shares are converted to Common Stock at the 10:1
ratio, and that all 7,028,337 warrants to purchase Common Stock are eventually exercised. The warrants were valued using a Black Scholes
formula assuming a maturity of five years, a risk-free interest rate of 2.8%, a volatility of 3.54 and an exercise price of $0.00001.
That results in a total value for the Transactions of $83,083,868. This amount will be used as the purchase price. Under ASC 805 transaction
costs are required to be expensed so legal and accounting fees incurred for the Transactions were not included in the purchase price. The fair value of the prepaid expenses and security
deposits was set at book value, and the fair value of the fixed assets was written up to the purchase cost to reflect the recent purchase
dates of the equipment relative to the closing date of the merger. To estimate the fair value of the identifiable intangible assets, the
Company recorded an estimate at the time of merger. The Company subsequently engaged a third-party valuation expert (the “Third
Party Valuation Expert”), Scalar, LLC, to conduct an independent analysis in line with purchase price accounting standards. The
Third Party Valuation Expert concluded: ● that there was no fair value attributable to management’s initial estimate of $10,000,000 for customer relationships based on the lack of current customer contracts; ● a fair value of $2,722,000 attributable to the non-compete agreement with the founder using the with-and-without method, based on a variation of the income approach, an increase of $2,222,000 in intangibles compared with management’s initial estimate of $500,000. The with-and-without methodology employed uses two scenarios to value the non-compete asset: (1) the “with scenario” captures the estimated cash flows from the business if all of the existing assets were in place including the non-compete asset, and (2) the “without scenario” captures the estimated cash flows from the business if all of the existing assets were in place except the non-compete asset. The difference between the two scenarios is attributed to the presumed loss of cash flows without the non-compete asset in place and represents the value of the non-compete agreement; ● a fair value of $969,000 attributable to the QPhoton trade name and trademark using the relief from royalty methodology, a decrease of $31,000 in intangibles compared with management’s initial estimate of $1,000,000. In the application of the relief from royalty method, the Third Party Valuation Expert estimated the value of the trade names/trademarks by capitalizing the royalties saved by virtue of the Company owning the trade names/trademarks. In other words, the Company realizes a benefit from owning the intangible asset rather than paying a rent or royalty for the use of the asset; ● a fair value of $12,200,000 attributable to the technology and licensed patents using the relief from royalty methodology, an increase of $477,780 in intangibles compared with management’s initial estimate of $11,722,220. In calculating the fair value of the technology and licensed patents, the Third Party Valuation Expert followed the same approach as the trade name/trademark analysis; and ● that there was no identifiable intangible value attributable to management’s initial estimate of $2,250,000 for employee agreements, rather calculated a fair value of $1,912,000 included in goodwill attributable to the assembled workforce using the replacement cost method. The replacement cost method approximates the cost it would take to reconstruct an asset of similar utility (to create a substitute asset). Specifically, this approach considers all of the costs the Company would have incurred to replace the QPhoton workforce with a brand new (but comparable) workforce. The assembled workforce value is added to goodwill per ASC 805-20-55-6, Assembled Workforce and Other Items that Are not Identifiable, and not tracked separately as an amortizing intangible asset. The Company accepted the Third Party Valuation
Expert’s valuation without adjustment. The following table summarizes the adjusted acquisition
date fair values of assets acquired and liabilities assumed by the Company, including the final results of the analysis performed by the
Third Party Valuation Expert for the intangibles:
Purchase price, net of cash acquired $ 81,939,939
Less
Prepaid expenses 16,109
Fixed assets at cost 116,315
Security deposits 97,768
Non-compete agreement with founder 2,722,000
Website domain, trade name and trademark 969,000
Technology and licensed patents 12,200,000
Accounts payable and other current liabilities (2,888,246 )
Goodwill $ 68,706,993 The purchase price and purchase price allocation for QPhoton was initially
considered finalized as of September 30, 2022, then was subsequently revised after the Company received new information from the Third
Party Valuation Expert’s valuation of intangibles. The following table summarizes the changes of intangibles, which resulted in
an increase to goodwill of $9,581,220 compared to initial purchase price allocation estimates reported in the Company’s Form 10-Q:
Quarterly report for quarter ending June 30, 2022.
Initial Final Increase
Intangible Assets Estimate Valuation (Decrease)
Customer relationships $ 10,000,000 $ - $ (10,000,000 )
Non-compete agreement with founder 500,000 2,722,000 2,222,000
Website domain, trade name and trademark 1,000,000 969,000 (31,000 )
Employment agreements 2,250,000 - (2,250,000 )
Technology and licensed patents 11,722,220 12,200,000 477,780
Total $ 25,472,220 $ 15,891,000 (9,581,220 ) Based on the adjusted purchase price allocation,
the goodwill recognized was $68.7 million, which is not expected to be deductible for income tax purposes. The amount allocated to
goodwill and intangible assets reflected the benefits the Company expected to realize from the growth of the acquisition’s operations. Note Purchase Agreement – the Company
and QPhoton On February 18, 2022, the Company entered into
a Note Purchase Agreement (the “Note Purchase Agreement”) with QPhoton, pursuant to which the Company agreed to loan money
to QPhoton using two unsecured promissory notes (each, a “Note”), each in the principal amount of $1,250,000, subject to the
terms and conditions of the Note Purchase Agreement. Also on February 18, 2022, pursuant to the terms of the Note Purchase Agreement,
the Company loaned the principal amount of $1,250,000 to QPhoton. On April 1, 2022, pursuant to the terms of the Note Purchase Agreement,
the Company loaned the principal amount of $1,250,000 to QPhoton, for a total loan under the two Notes of $2,500,000. The Note Purchase Agreement contains customary
representations and warranties by QPhoton and the Company, as well as a “most favored nations” provision for the benefit of
the Company. The Notes issued under the Note Purchase Agreement, including the Notes issued on February 18, 2022 and April 1, 2022, provide
that the indebtedness evidenced by the applicable Note bears simple interest at the rate of 6% per annum (or 15% per annum during the
occurrence of an event of default, as defined in the Notes), and becomes due and payable in full on the earlier of (i) March 1, 2023,
subject to extension by one year at the option of QPhoton, (ii) a change of control (as defined in the Notes) of QPhoton or (iii) an event
of default. As a result of the merger, the Notes and accrued interest are eliminated through consolidation. However, the two Notes have
not been forgiven or converted to equity. |
