Executive Summary / Key Takeaways

• QS Energy's investment thesis hinges on its Applied Oil Technology (AOT), designed to reduce crude oil viscosity and improve pipeline flow efficiency, potentially offering significant cost and environmental benefits over traditional methods like diluents.
• Despite promising lab results and historical field tests showing viscosity reduction, the AOT technology has faced persistent technical challenges during commercial-scale deployment attempts, including unresolved electrical issues under pressure, preventing commercial acceptance to date.
• Financially, the company is in a precarious state, reporting a \$9.67 million net loss in Q1 2025, a substantial increase from \$449,000 in Q1 2024, driven largely by non-cash stock compensation expenses but also increased cash burn.
• As of March 31, 2025, QS Energy had only \$526,000 in cash, with management estimating a cash runway only through approximately June 2025, while facing \$1.21 million in past-due convertible notes and \$2.49 million in past-due license agreement payables.
• The company's ability to continue operations and pursue commercialization is entirely dependent on raising substantial additional capital, which, coupled with unresolved technical hurdles and the lack of definitive commercial contracts despite partnership efforts, raises substantial doubt about its ability to continue as a going concern.

The Promise of AOT in a Challenging Market

QS Energy, Inc. (QSEP) operates within the energy efficiency sector, specifically targeting the upstream and midstream oil and gas industry with its proprietary Applied Oil Technology (AOT). At its core, AOT is a solid-state system designed to enhance the flow assurance of crude oil pipelines by applying a high-intensity electrical field to the oil in transit. The fundamental goal is to reduce crude oil viscosity, thereby decreasing pipeline pressure loss, increasing flow rate and capacity, and potentially reducing the need for costly diluents or drag reducing agents. This concept, which the company refers to as "electronic diluent" or "eDiluent," represents a potentially significant technological differentiator in a market dominated by traditional mechanical and chemical solutions.

The company's journey began with its incorporation in 1998 and evolved significantly following exclusive licensing agreements with Temple University in 2011, which provided the intellectual property foundation for AOT. Early efforts involved prototype testing, transitioning to the design and production of full-scale commercial prototype units by 2013. Initial field testing agreements with major pipeline operators like TransCanada (TRP) and Kinder Morgan (KMI), while demonstrating some promising results (ATS RheoSystems tests showed viscosity reductions of 8% to 23%), ultimately did not lead to commercial adoption due to various operational and technical challenges encountered during deployment.

The competitive landscape for flow assurance and energy efficiency in oil transport includes large, diversified oilfield service giants like Schlumberger (SLB) and Halliburton (HAL), as well as specialized equipment providers like Flowserve Corporation (FLS). These competitors offer a range of solutions, from chemical additives and mechanical pumps to advanced digital optimization tools. QSEP's AOT aims to carve out a niche by offering a non-chemical, solid-state approach that targets the fundamental property of viscosity through electrical means. While major players offer integrated services and have vast scale and R&D budgets, QSEP's potential competitive advantage lies in the specific performance characteristics and potential cost/environmental benefits of AOT, assuming technical viability at scale can be definitively proven. The company's strategy relies on third-party manufacturing to avoid significant capital expenditures, contrasting with the integrated manufacturing capabilities of larger rivals.

The Technical Gauntlet: Persistent Challenges and Recent Progress

The path to commercializing AOT has been marked by significant technical hurdles. Following the early tests, a major demonstration project initiated in December 2018 with a U.S.-based pipeline operator faced repeated setbacks. Despite multiple design modifications and troubleshooting efforts through 2019 and early 2020, the system experienced primary power supply failures and persistent electrical short circuits, particularly when subjected to normal pipeline operating pressure. As of early 2020, the specific cause of the pressure-related short circuit remained undiagnosed, leading to the suspension of testing in July 2020 due to a lack of capital.

Limited funding in 2021 allowed for renewed testing and troubleshooting. This led to a critical discovery: the insulating material within the AOT internals swelled when exposed to crude oil, a factor not accounted for in the original design and a likely contributor to the arcing issues. This prompted a redesign of internal components, including the grid pack, spacer rings, and screens. By August 2022, component testing indicated that the new design concept could reduce arcing and allow for the application of full voltage. Subsequent assembly and testing of a full AOT stack in a vessel successfully achieved a voltage of 40.1kV in the lab. Based on these results, the company believed the AOT would be ready for customer oil testing and field deployment.

However, despite this progress, no such testing or deployment has occurred since the successful lab test. The company continues to seek agreement with a suitable development partner to test pipeline oil as a prelude to another field test. The history of technical challenges underscores the significant operational risk associated with the technology's readiness for widespread commercial deployment under varied real-world conditions.

Commercial Ambitions Meet Financial Headwinds

Against the backdrop of ongoing technical development, QS Energy is actively pursuing commercial opportunities. The company has engaged with potential partners and customers, aiming for commercial acceptance and adoption. Recent strategic initiatives include a Collaboration Agreement signed in August 2024 with VIPS Petroleum, LLC, intended to facilitate the deployment of AOT technology to VIPS customers. Additionally, a Memorandum of Understanding (MOU) with the Australia Asia India Business Organization (AAIBO) in December 2024 signaled progress towards a potential contract in Southeast Asia.

While these partnerships represent potential pathways to market, the company explicitly stated in its May 14, 2025 filing that, as of that date, it had not entered into any definitive contracts with any VIPS customers or other stakeholders for the deployment and use of its AOT products and technology. This highlights the significant uncertainty surrounding the timing and realization of future revenues.

The company's financial position reflects the prolonged development phase and lack of commercial revenue. For the three months ended March 31, 2025, QS Energy reported a net loss of \$9.67 million, a dramatic increase from the \$449,000 net loss in the same period of 2024. This surge in losses was primarily driven by a significant increase in operating expenses, which rose from \$326,000 in Q1 2024 to \$9.51 million in Q1 2025. The increase was largely attributable to non-cash expenses, specifically \$8.15 million related to stock compensation expense from vested options and warrants, options issued for director compensation, and common stock issued for services. However, cash operating expenses also increased by \$1.04 million, driven by higher salaries and benefits (\$650,000 increase), consulting fees (\$261,000 increase), and other corporate and administrative costs. Research and development expenses remained relatively flat at \$47,000 in both periods.

This financial performance underscores a critical liquidity challenge. As of March 31, 2025, the company had only \$526,000 in cash on hand. Management estimates that these funds are sufficient to continue operations only through approximately June 2025. The company has incurred negative cash flow from operations for years, including \$1.16 million used in operating activities during Q1 2025. Funding has historically come from the issuance of convertible debt and equity.

Adding to the financial strain are substantial past-due liabilities. As of March 31, 2025, the company had \$1.21 million in convertible notes payable and accrued interest that had reached maturity and were past due. Furthermore, \$2.49 million in license agreement payables to Temple University were also past due (excluding a deferred portion). The company also has ongoing contractual commitments, including obligations to a former officer.

Outlook and Significant Risks

QS Energy's outlook is inextricably linked to its ability to secure additional funding and achieve commercial breakthroughs. The company explicitly states its dependence on raising substantial additional capital through the issuance of debt and equity to fund operations, including R&D, sales and marketing, manufacturing readiness, and ongoing public company costs. There is no assurance that future financing will be available or on terms satisfactory to the company.

The combination of recurring net losses, negative operating cash flow, a stockholders deficit of \$4.35 million as of March 31, 2025, and significant past-due liabilities raises substantial doubt about the company's ability to continue as a going concern. This assessment is also shared by the company's independent registered public accounting firm.

Key risks for investors include:

• Going Concern Risk: The severe liquidity constraints and dependence on future financing pose an existential threat.
• Technical Risk: Despite recent lab progress, the AOT technology has not been proven reliable under commercial pipeline operating conditions. Unresolved technical issues could prevent commercial adoption.
• Commercialization Risk: The company has not yet secured definitive customer contracts for AOT deployment, and there is no assurance that current partnership efforts will result in revenue-generating agreements.
• Funding Risk: Inability to raise sufficient capital will halt operations and commercialization efforts.
• Dilution Risk: Future financing, if available, is likely to be highly dilutive to existing shareholders given the company's financial state.
• Intellectual Property Risk: While the Temple University licenses are foundational, maintaining and protecting this IP requires ongoing investment and successful commercialization to generate royalties.
• Competitive Risk: Larger, better-funded competitors could develop alternative or superior technologies or leverage their scale and integrated offerings to dominate the market, even if AOT proves technically viable.

Conclusion

QS Energy represents a high-stakes investment proposition centered on the potential of its Applied Oil Technology to disrupt crude oil pipeline transport efficiency. The AOT's promise of viscosity reduction through a non-chemical, electrical process offers a compelling vision for cost savings and environmental benefits in an industry seeking optimization. However, this technological promise is currently overshadowed by significant financial distress and unresolved technical challenges that have plagued the technology's path to commercial readiness for years.

The company's current financial state, marked by rapidly increasing losses (driven by significant non-cash expenses but also rising cash burn), minimal cash reserves, and substantial past-due obligations, presents a dire picture. The ability to continue operations is entirely contingent on securing additional, highly uncertain financing. While strategic partnerships offer a glimmer of hope for future commercial contracts, the lack of definitive agreements and the unresolved technical hurdles remain critical barriers. For investors, QSEP is a speculative opportunity where the potential upside of AOT's eventual commercial success must be weighed against the immediate and substantial risks to the company's very survival as a going concern. The coming months, and the company's ability to raise capital and demonstrate technical and commercial viability, will be critical in determining its fate.