# IonQ, Inc. (IONQ) FY 2021 MD&A Verbatim Item 7 Management's Discussion and Analysis from IonQ, Inc.'s 10-K for fiscal year 2021. SEC filing source: https://www.sec.gov/Archives/edgar/data/1824920/000119312522086738/d257705d10k.htm Accession: 0001193125-22-086738 Filing date: 2022-03-28 Report date: 2021-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Confidence: high Company profile: /company/IONQ/ All MD&A years: /company/IONQ/mda/ Next year: /company/IONQ/mda/fy2022/ (FY 2022) Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. This Annual Report contains statements that may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. All statements contained in this Annual Report other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believes,” “expects,” “intends,” “estimates,” “projects,” “anticipates,” “will,” “plan,” “may,” “should,” or similar language are intended to identify forward-looking statements. It is routine for our internal projections and expectations to change throughout the year, and any forward-looking statements based upon these projections or expectations may change prior to the end of the next quarter or year. Readers of this Annual Report are cautioned not to place undue reliance on any such forward-looking statements. As a result of a number of known and unknown risks and uncertainties, our actual results or performance may be materially different from those expressed or implied by these forward-looking statements. Risks and uncertainties are identified under “Risk Factors” in Item 1A herein and in our other filings with the Securities and exchange Commission (the “SEC”). All forward-looking statements included herein are made only as of the date hereof. Unless otherwise required by law, we do not undertake, and specifically disclaim, any obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise after the date of such statement. You should read the following discussion and analysis of our financial condition and results of operations together with our audited consolidated financial statements and related notes included elsewhere in this Annual Report. Unless the context otherwise requires, the terms “IonQ,” “Legacy IonQ” “we,” “us,” “our” and similar terms refer to IonQ Quantum, Inc. prior to the consummation of the business combination and IonQ, Inc. and its wholly owned subsidiary, IonQ Quantum, Inc., after the consummation of the business combination. References to “dMY” refer to the predecessor company prior to the consummation of the business combination. Overview We are developing quantum computers designed to solve the world’s most complex problems, and transform business, society, and the planet for the better. We believe that our proprietary technology, our architecture, and the technology exclusively available to us through license agreements will offer us advantages both in terms of research and development, as well as the commercial value of our intended product offerings. We sell access to a quantum computer with 20 qubits, and we are in the process of researching and developing technologies for quantum computers with increasing computational capabilities. We currently make access to our quantum computers available via three major cloud platforms, Amazon Web Services’ (“AWS”) Amazon Braket, Microsoft’s Azure Quantum, and Google’s Cloud Marketplace, and to select customers via our own cloud service. We are still in the early stages of generating revenue with our 20-qubit quantum computer. We have incurred significant operating losses since our inception. Our net losses were $106.2 million for the year ended December 31, 2021. As of December 31, 2021, we had an accumulated deficit of $145.8 million. We expect to continue to incur losses for the foreseeable future as we prioritize reaching the technical milestones necessary to achieve increasingly higher number of stable qubits and higher levels of fidelity than that which presently exists—prerequisites for quantum computing to reach broad quantum advantage. The Merger Agreement and Public Company Costs On March 7, 2021, Legacy IonQ, dMY and Ion Trap Acquisition Inc. (the “Merger Sub”) entered into an Agreement and Plan of Merger (the “Merger Agreement”). Pursuant to the Merger Agreement, at the closing, the 52 Table of Contents Merger Sub was merged with and into Legacy IonQ, with Legacy IonQ continuing as the surviving corporation following the merger, being a wholly owned subsidiary of dMY and the separate corporate existence of the Merger Sub ceased. Commensurate with the business combination, dMY changed its name to IonQ, Inc. and Legacy IonQ changed its name to IonQ Quantum, Inc. IonQ became the successor registrant with the SEC, meaning that Legacy IonQ’s financial statements for previous periods will be disclosed in the registrant’s future periodic reports filed with the SEC. While the legal acquirer in the Merger Agreement is dMY, for financial accounting and reporting purposes under accounting principles generally accepted in the United States of America (“U.S. GAAP”), Legacy IonQ is the accounting acquirer and the merger is accounted for as a “reverse recapitalization” (i.e., a capital transaction involving the issuance of stock by dMY for the stock of Legacy IonQ). A reverse recapitalization does not result in a new basis of accounting, and the financial statements of the Company represent the continuation of the financial statements of Legacy IonQ in many respects. Under this method of accounting, dMY is treated as the “acquired” company for financial reporting purposes. Upon the closing of the merger and the concurrent private placement of 34,500,000 shares of common stock (the “PIPE”), the most significant change in our financial position and results of operations was an increase in cash (as compared to our balance sheet as of December 31, 2020) of approximately $363 million, which included $345 million in gross proceeds from the PIPE. Total direct and incremental transaction costs of dMY and Legacy IonQ were approximately $52 million, substantially all of which were offset to additional-paid-in-capital as costs related to the reverse recapitalization. As a result of the merger, Legacy IonQ is the successor to an SEC registrant and is listed on the New York Stock Exchange (“NYSE”), which will require IonQ to hire additional personnel and implement procedures and processes to address public company regulatory requirements and customary practices. As a public company, we have incurred and expect to continue to incur, expenses for, among other things, directors’ and officers’ liability insurance, director fees and additional internal and external accounting, legal and administrative resources, including increased audit and legal fees. Impact of COVID-19 on Our Business In March 2020, the COVID-19 outbreak was declared a pandemic by the World Health Organization. There are many uncertainties regarding the ongoing pandemic, and we are closely monitoring its impact on all aspects of our business, including how it impacts our employees, suppliers, vendors, and business partners. The pandemic has resulted in government authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, stay-at-home or shelter-in-place orders, and business shutdowns. These measures may adversely impact our employees and operations and the operations of suppliers and business partners. In addition, various aspects of our business cannot be conducted remotely. These measures by government authorities may continue to remain in place for a significant period of time and could adversely affect our development plans, sales and marketing activities, and business operations. The evolution of the virus is unpredictable at this point and any resurgence may slow down our ability to develop our quantum computing program. The ongoing COVID-19 pandemic could limit the ability of suppliers and business partners to perform, including third-party suppliers’ ability to provide components and materials. We may also experience an increase in the cost of raw materials. The full impact of the COVID-19 pandemic continues to evolve. As such, the full magnitude of the pandemic’s effect on our financial condition, liquidity and future results of operations is uncertain. Management continues to actively monitor our financial condition, liquidity, operations, suppliers, industry, and workforce. Key Components of Results of Operations Revenue We have generated limited revenues since our inception. We derive revenue from providing access to quantum computing as a service (“QCaaS”) and professional services related to co-developing algorithms on our 53 Table of Contents quantum computing systems. In arrangements with the cloud service providers, the cloud service provider is considered the customer and we do not have any contractual relationships with the cloud service providers’ end users. We have determined that our QCaaS contracts represent a combined, stand-ready performance obligation to provide access to our quantum computing systems together with related maintenance and support. The transaction price for our contracts generally includes a variable fee based on usage of our quantum computing systems and may include a fixed fee for a minimum volume of usage to be made available over a defined period of access. Fixed fee arrangements may also include a variable component whereby customers pay an amount for usage over contractual minimums contained in the contracts. For contracts with a fixed transaction price, the fixed fee is recognized as QCaaS subscription-based revenues on a straight-line basis over the access period. For contracts without fixed fees, variable usage fees are billed and recognized during the period of such usage. We are currently focused on marketing our QCaaS and have entered into, and are continuing to enter into new contracts with customers. Operating Costs and Expenses Cost of revenue Cost of revenue primarily consists of expenses related to delivering our services, including personnel-related expenses, allocated facility and other costs for customer facing functions, and costs associated with maintaining the cloud on which the QCaaS resides beginning in the period that QCaaS revenue generating activities began. Personnel-related expenses include salaries, benefits, and stock-based compensation. Cost of revenue excludes depreciation and amortization related to our quantum computing systems and related software. Research and development Research and development expenses consist of personnel-related expenses, including salaries, benefits and stock-based compensation, and allocated facility and other costs for our research and development functions. Unlike a standard computer, design and development efforts continue throughout the useful life of our quantum computing systems to ensure proper calibration and optimal functionality. Research and development expenses also include purchased hardware and software costs related to quantum computing systems constructed for research purposes that are not probable of providing future economic benefit and have no alternate future use as well as costs associated with third-party research and development arrangements. Sales and marketing Sales and marketing and marketing expenses consist of personnel-related expenses, including salaries, benefits and stock-based compensation, costs for direct advertising, marketing and promotional expenditures and allocated facility and other costs for our sales and marketing functions. We expect to continue to make the necessary sales and marketing investments to enable us to increase our market penetration and expand our customer base. General and administrative General and administrative expenses consist of personnel-related expenses, including salaries, benefits and stock-based compensation, and allocated facility and other costs for our corporate, executive, finance, and other administrative functions. General and administrative expenses also include expenses for outside professional services, including legal, auditing and accounting services, recruitment expenses, information technology, travel expenses and certain non-income taxes, insurance, and other administrative expenses. We expect our general and administrative expenses to increase for the foreseeable future as we scale headcount with the growth of our business, and as a result of operating as a public company, including 54 Table of Contents compliance with the rules and regulations of the SEC, NYSE, legal, audit, additional insurance expenses, investor relations activities, and other administrative and professional services. As a result, we expect that our general and administrative expenses will increase in absolute dollars but may fluctuate as a percentage of total revenue over time. Depreciation and amortization Depreciation and amortization expense results from depreciation and amortization of our property and equipment and intangible assets that is recognized over their estimated lives. Nonoperating Costs and Expenses Change in fair value of warrant liabilities The change in fair value of warrant liabilities consists of mark-to-market fair value adjustments recorded associated with the public and private placement warrants assumed as part of the business combination. Offering costs associated with warrants Offering costs associated with warrants consist of transaction costs that have been allocated to the public and private warrants and were expensed upon consummation of the business combination on September 30, 2021 based on the relative fair value of the equity issued and the liability-classified warrants. Other income (expense), net Other income (expense), net consists of income earned on our money market funds and other available for sale investments offset by certain other expenses. Results of Operations The following table sets forth our statements of operations for the periods indicated: [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["","","2021","","","2020"],["","","(in thousands)"],["Revenue","","$","2,099","","","$","\u2014"],["Costs and expenses:"],["Cost of revenue (excluding depreciation and amortization)(1)","","","1,040","","","","143"],["Research and development(1)","","","20,228","","","","10,157"],["Sales and marketing(1)","","","3,233","","","","486"],["General and administrative(1)","","","13,737","","","","3,547"],["Depreciation and amortization","","","2,548","","","","1,400"],["Total operating costs and expenses","","","40,786","","","","15,733"],["Loss from operations","","","(38,687",")","","","(15,733",")"],["Change in fair value of warrant liabilities","","","(63,332",")","","","\u2014"],["Offering costs associated with warrants","","","(4,259",")","","","\u2014"],["Other income (expense), net","","","92","","","","309"],["Loss before benefit for income taxes","","","(106,186",")","","","(15,424",")"],["Benefit for income taxes","","","\u2014","","","","\u2014"],["Net loss","","$","(106,186",")","","$","(15,424",")"]] [[/GREPCENT_TABLE]] 55 Table of Contents [[GREPCENT_TABLE]] [["(1)","Cost of revenue, research and development, sales and marketing, and general and administrative expenses for the periods include stock- based compensation expense as follows:"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["","","2021","","","2020"],["","","(in thousands)"],["Cost of revenue","","$","62","","","$","\u2014"],["Research and development","","","2,841","","","","716"],["Sales and marketing","","","67","","","","\u2014"],["General and administrative","","","4,778","","","","508"]] [[/GREPCENT_TABLE]] Comparison of the Year Ended December 31, 2021 and 2020 Revenue [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","$ Change","","","% Change"],["","","2021","","","2020"],["","","(in thousands)"],["Revenue","","$","2,099","","","$","\u2014","","","$","2,099","","","","100","%"]] [[/GREPCENT_TABLE]] Revenue increased by $2.1 million, or 100%, to $2.1 million for the year ended December 31, 2021 from zero for the year ended December 31, 2020. The increase was primarily driven by four revenue contracts under which we provided services during the year ended December 31, 2021. While we generated revenue in 2020, we executed an arrangement with a customer for the issuance of a warrant to purchase shares of Legacy IonQ Series B-1 convertible redeemable preferred stock. The warrant was evaluated and considered to represent consideration provided to a customer and as such, the recognition of the warrant expense is recorded as a reduction in revenue as revenue is earned under the contract. The increase in revenue in 2021 was also partially due to the contract asset related to the warrant being fully amortized during the year. See Note 11—Warrant Transaction Agreement to our consolidated financial statements for additional information. Cost of revenue [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","$ Change","","","% Change"],["","","2021","","","2020"],["","","(in thousands)"],["Cost of revenue (excluding depreciation and amortization)","","$","1,040","","","$","143","","","$","897","","","","627","%"]] [[/GREPCENT_TABLE]] Cost of revenue increased by $0.9 million, or 627%, to $1.0 million for the year ended December 31, 2021 from $0.1 million for the year ended December 31, 2020. The increase was driven by the increase in costs to service active contracts for the year ended December 31, 2021. Research and development [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","$ Change","","","% Change"],["","","2021","","","2020"],["","","(in thousands)"],["Research and development","","$","20,228","","","$","10,157","","","$","10,071","","","","99","%"]] [[/GREPCENT_TABLE]] Research and development expense increased by $10.1 million, or 99%, to $20.2 million for the year ended December 31, 2021 from $10.2 million for the year ended December 31, 2020. The increase was primarily driven 56 Table of Contents by a $4.9 million increase in payroll-related expenses, including stock-based compensation of $2.1 million, as a result of increased headcount, a $1.3 million increase due to amortization of the Duke and UMD research and development arrangements, a $1.3 million increase in materials, supplies and equipment costs, and a $2.6 million increase in miscellaneous other research and development expenses. Sales and marketing [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","$ Change","","","% Change"],["","","2021","","","2020"],["","","(in thousands)"],["Sales and marketing","","$","3,233","","","$","486","","","$","2,747","","","","565","%"]] [[/GREPCENT_TABLE]] Sales and marketing expense increased by $2.7 million, or 565%, to $3.2 million for the year ended December 31, 2021 from $0.5 million for the year ended December 31, 2020. The increase was primarily due to increased costs to promote service offerings and other marketing initiatives of approximately $2.0 million and an increase of $0.8 million of payroll-related expenses as a result of increased headcount. General and administrative [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","$ Change","","","% Change"],["","","2021","","","2020"],["","","(in thousands)"],["General and administrative","","$","13,737","","","$","3,547","","","$","10,190","","","","287","%"]] [[/GREPCENT_TABLE]] General and administrative expenses increased by $10.2 million, or 287%, to $13.7 million for the year ended December 31, 2021 from $3.5 million for the year ended December 31, 2020. The increase was primarily driven by an increase of $6.3 million in payroll-related expenses, including an increase in stock-based compensation of $4.3 million, due to increased headcount to support the growth of our business, an increase of $1.2 million in legal fees, an increase of $1.1 million in directors and officers insurance costs as a result of becoming a public company, an increase of $0.8 million in auditing and accounting fees, and an increase of $0.7 million in rent and utilities costs due to expansion of headquarters office space in the fourth quarter of 2020. Depreciation and amortization [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","$ Change","","","% Change"],["","","2021","","","2020"],["","","(in thousands)"],["Depreciation and amortization","","$","2,548","","","$","1,400","","","$","1,148","","","","82","%"]] [[/GREPCENT_TABLE]] Depreciation and amortization expenses increased by $1.1 million, or 82%, to $2.5 million for the year ended December 31, 2021 from $1.4 million for the year ended December 31, 2020. The increase was primarily driven by an increase of $0.5 million due to amortization of capitalized internally developed software, an increase of $0.6 million in depreciation expense associated with capitalized quantum computing system costs and capitalized research and development equipment. 57 Table of Contents Change in fair value of warrant liabilities [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","$ Change","","","% Change"],["","","2021","","","2020"],["","","(in thousands)"],["Change in fair value of warrant liabilities","","$","63,332","","","$","\u2014","","","$","63,332","","","","100","%"]] [[/GREPCENT_TABLE]] The change in fair value of warrant liabilities increased $63.3 million as a result of mark-to-market expense adjustments recorded for the public and private placement warrants assumed as part of the business combination. Offering costs associated with warrants [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","$ Change","","","% Change"],["","","2021","","","2020"],["","","(in thousands)"],["Offering costs associated with warrants","","$","4,259","","","$","\u2014","","","$","4,259","","","","100","%"]] [[/GREPCENT_TABLE]] In connection with the business combination, $4.3 million of transaction costs were allocated and expensed related to the liability-classified public and private warrants. Other income (expense), net [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","$ Change","","","% Change"],["","","2021","","","2020"],["","","(in thousands)"],["Other income (expense), net","","$","92","","","$","309","","","$","(217",")","","","(70",")%"]] [[/GREPCENT_TABLE]] Other income (expense), net decreased by $0.2 million, or 70%, for the year ended December 31, 2021, from $0.3 million for the year ended December 31, 2020. The decrease was due to a $0.2 million decrease in short-term dividend income. Liquidity and Capital Resources As of December 31, 2021, we had cash and cash equivalents of $399 million and available-for-sale securities of $203.5 million, with $123.4 million classified as short-term investments and $80.1 million classified as long-term investments. We believe that our cash, cash equivalents and investments as of December 31, 2021 will be sufficient to meet our working capital and capital expenditure needs for the next 12 months. We believe we will meet longer term expected future cash requirements and obligations through a combination of cash flows from operating activities and available funds from our cash, cash equivalents and investment balances. However, this determination is based upon internal projections and is subject to changes in market and business conditions. We have incurred losses since our inception and as of December 31, 2021, we had an accumulated deficit of $145.8 million. During the year ended December 31, 2021, we incurred net losses of $106.2 million. We expect to incur additional losses and higher operating expenses for the foreseeable future. Future Funding Requirements We expect our principal sources of liquidity will continue to be our cash and investments and any additional capital we may obtain through additional equity or debt financings. Our future capital requirements will depend on many factors, including investments in growth and technology. We may in the future enter into arrangements to acquire or invest in complementary businesses, services, and technologies which may require us to seek additional equity or debt financing. 58 Table of Contents Upon the closing of the business combination, we received approximately $636.0 million of gross proceeds. The proceeds are invested in money market funds, commercial paper, corporate and municipal notes and bonds, and other U.S. government and agency securities as disclosed in Note 3—Cash Equivalents and Investments in our consolidated financial statements. The investments will be used to fund the strategic operations of the Company. Our primary uses of cash are to fund our operations as we continue to grow our business. We require a significant amount of cash for expenditures as we invest in ongoing research and development, and commercialization of our products. Until such time as we can generate significant revenue from sales of our QCaaS, if ever, we expect to finance our cash needs through our cash, cash equivalents and investments as well as equity or debt financings or other capital sources, including potential collaborations and other similar arrangements. However, we may be unable to raise additional funds or enter into such other arrangements when needed 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 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 raise funds through collaborations, or other similar arrangements with third parties, we may have to relinquish valuable rights to our quantum computing technology on terms that may not be favorable to us and/or may reduce the value of our common stock. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our quantum computing development efforts. Our future capital requirements and the adequacy of available funds will depend on many factors, including those set forth in the section titled “ Risk Factors .” Other than operating expenses, including our continued investment in our quantum computers, cash requirements for fiscal 2022 are expected to consist primarily of capital expenditures for corporate facilities. The following table summarizes current and long-term material cash requirements as of December 31, 2021, which we expect to fund primarily with cash and cash equivalents ( in millions ): [[GREPCENT_TABLE]] [["","","Material Cash Requirements"],["","","Total","","","Less than 1 Year","","","1 - 3 Years","","","3 - 5 Years","","","More than 5 Years"],["Operating lease obligations(1)","","$","6,984","","","$","644","","","$","1,421","","","$","1,568","","","$","3,351"],["Total","","$","6,984","","","$","644","","","$","1,421","","","$","1,568","","","$","3,351"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(1)","Amounts include direct lease obligations, excluding any taxes, insurance and other related expenses."]] [[/GREPCENT_TABLE]] Cash flows The following table summarizes our cash flows for the period indicated: [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["","","2021","","","2020"],["","","","(in thousands)"],["Net cash used in operating activities","","$","(26,537",")","","$","(12,007",")"],["Net cash used in investing activities","","","(213,785",")","","","(11,676",")"],["Net cash provided by financing activities","","","603,227","","","","276"]] [[/GREPCENT_TABLE]] Cash flows from operating activities Our cash flows from operating activities are significantly affected by the growth of our business primarily related to research and development, sales and marketing, and general and administrative activities. Our 59 Table of Contents operating cash flows are also affected by our working capital needs to support growth in personnel-related expenditures and fluctuations in accounts payable and other current assets and liabilities. Net cash used in operating activities during year ended December 31, 2021 was $26.5 million, resulting primarily from a net loss of $106.2 million, adjusted for non-cash charges of $63.3 million in mark-to-market fair value adjustments associated with our warrant liabilities, $7.7 million in stock-based compensation, $4.3 million in offering costs associated with warrants, $2.5 million in depreciation and amortization, and $1.3 million in costs associated with research and development arrangements. The increase in net cash used in operations from the prior year was primarily related to noncash expenses as well as our increased research and development activities and hiring of personnel to support the growth of our business and being a public company. Net cash used in operating activities during the year ended December 31, 2020 was $12.0 million, resulting primarily from a net loss of $15.4 million, adjusted for non-cash charges of $1.4 million in depreciation and amortization and $1.2 million in stock-based compensation. The increase in net cash used in operations from the prior year was primarily related to our increased research and development activities and hiring of personnel. Cash flows from investing activities Net cash used in investing activities during the year ended December 31, 2021 was $213.8 million primarily resulting from purchases of available-for-sale securities of $203.8 million, additions of $7.8 million to property and equipment primarily related to the development of our quantum computing systems, $1.6 million of capitalized internal software development costs, and $0.6 million of intangible asset acquisition costs. Net cash used in investing activities during the year ended December 31, 2020 was $11.7 million primarily resulting from additions of $10.0 million to property and equipment primarily related to the development of our quantum computing systems, $1.1 million of capitalized internal software development costs, and $0.5 million of intangible assets acquisition costs. Cash flows from financing activities Net cash provided by financing activities during the year ended December 31, 2021 was $603.2 million primarily reflecting proceeds received from the business combination, including the PIPE investment, as well as cash received from the exercise of warrants and exercise of stock options. Net cash provided by financing activities during the year ended December 31, 2020 was $0.3 million primarily reflecting proceeds from stock options exercised. Critical Accounting Estimates This discussion and analysis of financial condition and results of operations is based upon the Company’s consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities. We also make estimates and assumptions on revenue generated and reported expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Our critical accounting policies are described in greater detail in Note 2 to our audited consolidated financial statements included in this Annual Report. Critical accounting estimates are defined as those reflective of significant judgments, estimates and uncertainties, which may result in materially different results under different assumptions and conditions. We have listed below our critical accounting estimates that we believe to have the greatest potential impact on our 60 Table of Contents consolidated financial statements. Historically, our assumptions, judgments and estimates relative to our critical accounting estimates have not differed materially from actual results. Revenue recognition We derive revenue from our QCaaS arrangements as well as from professional services related to co-developing and running algorithms on our quantum computing systems. We have applied judgement in determining that our QCaaS contracts represent a combined, stand-ready performance obligation to provide access to our quantum computing systems together with related maintenance and support. For arrangements with multiple performance obligations, judgement is used to determine whether multiple services in the contract should be accounted for separately or as a group. Judgement is also applied when determining the relative standalone selling price of each performance obligation as this is used to allocate the transaction price to each performance obligation within the contract. In addition, we apply judgment in evaluating any consideration payable to the customer and whether it is in exchange for distinct goods or services or should be reflected as a reduction of revenue. For arrangements where we enter into multiple contracts with a single counterparty at or near the same time, we use judgement in determining whether the contracts should be combined and whether we should account for them as a single contract. We account for them as a single contract when one or more of the following criteria are met: (i) the contracts are negotiated as a package with a single commercial objective; (ii) consideration to be paid in one contract depends on the price or performance of the other contract; and (iii) goods or services promised are a single performance obligation. Contracts with customers are evaluated at the time of execution and may vary in terms. The amount of revenue recognized in a period may vary with respect to the allocation of arrangement consideration to performance obligations with different revenue recognition patterns and changes to existing contract terms. Quantum computing systems Quantum computing systems are included within property and equipment, net on the consolidated balance sheet. Prior to 2019, we built certain quantum computing systems solely for research and development purposes and these quantum computing systems were deemed to have no alternative future use. In 2019, we began to commercialize our quantum computing systems via the offering of QCaaS and quantum computing systems built thereafter were determined to provide a probable future economic benefit. As a result, hardware and labor costs associated with the building of such quantum computing systems were capitalized in the period the costs were incurred. Costs to maintain quantum computing systems are expensed as incurred. Judgement is used to determine when hardware and labor costs incurred for our quantum computing systems should be capitalized as a result of our assessment of whether the system will provide a probable future economic benefit and whether or not the costs represent activities necessary to build the systems, maintain the systems or to perform certain research and development functions. Judgement is also used to determine when the systems are placed into service and the estimated useful life of the associated systems. Changes in these estimates can have a significant impact on the assessment of capitalized costs which could result in material changes to reported property and equipment, net. The amount of depreciation expense associated with the quantum computing systems may also vary based on the estimated useful life. Capitalized internally developed software Capitalized internally developed software, which is included in intangible assets, net, on the consolidated balance sheet, consists of costs to purchase and develop internal-use software, which we use to provide services to our customers. 61 Table of Contents Judgement is used to determine when costs to develop internal-use software for a specific project should be capitalized and whether or not the costs represent activities necessary to enhance the functionality of the software or maintain the performance of the software, and whether it is considered probable that the software will be used to perform the function intended. Judgement is also used to determine when the software is available for use as well as the estimated useful life of the software. The assumptions used to capitalize internally developed software costs consider when the preliminary project stage is completed, whether the software will perform the function intended, and whether the development activities enhance the functionality of the software or maintain the performance of the software. Changes in these estimates can have a significant impact on the assessment of capitalized costs which could result in material changes to reported intangible assets, net. The amortization of capitalized internally developed software may also be impacted by the estimated useful life associated with these intangible assets. Impairment of long-lived assets Long-lived assets, such as our quantum computing systems and capitalized internally developed software are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As of December 31, 2021, we did not have an impairment of any long-lived assets. In determining whether a potential impairment exists, judgement is used in determining the level at which the assessment is made. We have determined that the company consists of one entity-wide asset group for purposes of assessing whether a triggering event has occurred that would indicate the long-lived asset group’s carrying value is not recoverable. Impairment calculations, if necessary, contain uncertainties because they require management to make assumptions and to apply judgment to estimate future cash flows and asset fair values. Key assumptions used in estimating future cash flows and asset fair values include projected revenue growth and operating expenses, as well as forecasting asset useful lives and selecting an appropriate discount rate with respect to any terminal value cash flows. Triggering events occur when there are indicators that the carrying value of a long-lived asset may not be recoverable. These indicators may include internal and external economic factors, including significant decrease in market price of our capital stock, adverse market conditions, and an adverse change in the manner of which the asset is used. The assumptions used to assess impairment consider historical trends, macroeconomic conditions, and projections consistent with our operating strategy including the pace of technological change or specific technological challenges in building our quantum computing systems. Changes in these estimates can have a significant impact on the assessment of fair value which could result in material impairment losses. Warrant liabilities Our private placement warrant liabilities are financial instruments that were initially recorded at fair value on the issuance date and were re-valued upon exercise or at each reporting date. All private placement warrants were exercised as of December 31, 2021. Estimates were used to determine the fair value of the private placement warrants, specifically, when assumed as part of the business combination and then again upon exercise during the year. The fair value of the private placement warrants was determined using the Black-Scholes valuation model. Inherent in the valuation were assumptions related to expected stock-price volatility, expected term, risk- free interest rate and dividend yield. We estimated the volatility of the private placement warrants based on implied volatility from our publicly traded warrants and from historical volatility of select peer company’s common stock that matches the expected remaining life of the private placement warrants. The risk-free interest rate was based on the U.S. Treasury zero-coupon yield curve on the measurement date for a maturity similar to the expected remaining life of the private placement warrants. The expected life of the private placement warrants was assumed to be equivalent to their remaining contractual term. The dividend rate was based on the historical rate, which we anticipated remaining at zero. 62 Table of Contents The assumed expected stock-price volatility, expected term, risk-free interest rate, and dividend yield have a significant impact on the amounts recorded as mark-to-market adjustments for the private placement warrants. We believe the estimates applied were based on reasonable assumptions, but which were inherently uncertain. As a result, actual results may differ from the assumptions and judgments used to determine the fair value of the private placement warrants. Equity valuations and Stock-based compensation Prior to the business combination, the fair value of our equity instruments and the associated stock-based compensation charges for stock options granted was determined based upon information available at the time of grant. Given the absence of a public trading market for our capital stock at the time of grant for awards granted prior to the business combination, and in accordance with the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately Held Company Equity Securities Issued as Compensation , our management exercised reasonable judgment and considered numerous objective and subjective factors to determine the best estimate of the fair value of our equity instruments at each grant date. As there was no public market for Legacy IonQ’s equity prior to the business combination, valuations of equity instruments required the application of significant estimates, assumptions, and judgments. These valuations impact various amounts reported in our consolidated financial statements, including the amounts recorded for stock-based compensation. The following factors impact the significant estimates, assumptions and judgments that drive the determination of the fair values of the Legacy IonQ preferred and common stock that comprised Legacy IonQ’s capital structure prior to the business combination: [[GREPCENT_TABLE]] [["","\u2022","","contemporaneous valuations performed at periodic intervals by independent, third-party specialists;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","","our actual operating and financial performance;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","","our current business conditions and projections;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","","our progress on research and development efforts;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","","our stage of development;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","","the prices, preferences, and privileges of shares of Legacy IonQ convertible preferred stock relative to shares of common stock;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","","likelihood of achieving a liquidity event for the underlying equity instruments, such as a business combination, given prevailing market conditions;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","","lack of marketability of Legacy IonQ common stock; and"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","","macroeconomic conditions."]] [[/GREPCENT_TABLE]] We use the Black-Scholes option-pricing model to determine the estimated fair value for stock options. No stock options have been granted subsequent to the business combination. The Black-Scholes option-pricing model requires the use of subjective assumptions, which determine the fair value of our stock options, including the fair value of our common stock, the option’s expected term, the price volatility of the underlying common stock, risk-free interest rates, and the expected dividend yield of the common stock. The assumptions used to determine the fair value of the stock options represent management’s best estimates. These estimates involve inherent uncertainties and the application of management’s judgment. If any assumptions used in the Black-Scholes option-pricing model change significantly, stock option compensation expense for future awards may differ materially compared with the expense for awards granted previously. We believe the estimates applied to be based on reasonable assumptions, but which are inherently uncertain. 63 Table of Contents Emerging Growth Company Status and Smaller Reporting Company Status Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can choose not to take advantage of the extended transition period and comply with the requirements that apply to non-emerging growth companies, and any such election to not take advantage of the extended transition period is irrevocable. During the extended transition period, it may be difficult or impossible to compare our financial results with the financial results of another public company that complies with public company effective dates for accounting standard updates because of the potential differences in accounting standards used. We will remain an emerging growth company under the JOBS Act until the earliest of (a) December 31, 2025, (b) the last date of our fiscal year in which we have total annual gross revenue of at least $1.07 billion, (c) the date on which we are deemed to be a “large accelerated filer” under the rules of the SEC with at least $700.0 million of outstanding securities held by non-affiliates or (d) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the previous three years. We are also a smaller reporting company as defined in the Exchange Act. We may continue to be a smaller reporting company even after we are no longer an emerging growth company. We may take advantage of certain of the scaled disclosures available to smaller reporting companies and will be able to take advantage of these scaled disclosures for so long as (i) our voting and non-voting common stock held by nonaffiliates is less than $250.0 million measured on the last business day of our second fiscal quarter or (ii) our annual revenue is less than $100.0 million during the most recently completed fiscal year and our voting and non-voting common stock held by non-affiliates is less than $700.0 million measured on the last business day of our second fiscal quarter.