XTI Aerospace, Inc.: Form 10-Q for the period ended Sep 30, 2020

You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the related notes included elsewhere in this Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the SEC. In addition to our historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Form 10-Q, particularly in Part II, Item 1A, “Risk Factors.”

Except where indicated, all share and per share data in this section, as well as the condensed consolidated financial statements, reflect the 1-for-45 reverse split of our common stock effective on January 7, 2020.

Overview of Our Business

We are an indoor intelligence company. Our business and government customers use our solutions to secure, digitize and optimize their indoor spaces with our positioning, mapping and analytics products. Our indoor intelligence platform uses sensor technology to detect accessible cellular, Wi-Fi, Bluetooth, ultra-wide band (“UWB”) and radio frequency identification (“RFID”) signals emitted from devices within a venue providing positional information similar to what global positioning system (“GPS”) satellite systems provide for the outdoors. Combining this positional data with our dynamic and interactive mapping solution and a high-performance analytics engine, yields near real time insights to our customers providing them with visibility, security and business intelligence within their indoor spaces. Our highly configurable platform can also ingest data from our customers’ and other third party sensors, Wi-Fi access points, Bluetooth beacons, video cameras, and big data sources, among others to maximize indoor intelligence. We also offer digital tear-sheets with optional invoice integration, digital ad delivery, and an e-edition designed for reader engagement for the media, publishing and entertainment industry. Our Indoor Intelligence products secure, digitize and optimize the interior of any premises with indoor positioning and data analytics that provide rich positional information, similar to a global positioning system, and browser-like intelligence for the indoors.

Our Indoor Intelligence product line has long sales cycles, which result from customer-related issues such as budget and procurement processes but also because of the early stages of indoor-positioning technology and the learning curve required for customers to implement such solutions. Customers also often engage in a pilot program first which prolongs sales cycles and is typical of most emerging technology adoption curves. Indoor Intelligence sales can be licensed-based with government customers but commercial customers may prefer a SaaS or subscription model. Our other digital solutions are also delivered on a SaaS model and allow us to generate industry analytics that complement our indoor-positioning solutions.

We experienced a net loss of approximately $7.5 million and $6.6 million for the three months ended September 30, 2020 and 2019, respectively, and a net loss of $20.9 million and $17.0 million for the nine months ended September 30, 2020 and 2019, respectively. We cannot assure you that we will ever earn revenues sufficient to support our operations, or that we will ever be profitable. In order to continue our operations, we have supplemented the revenues we earned with proceeds from the sale of our equity and debt securities and proceeds from loans and bank credit lines. During the first quarter of 2020, we raised $5 million in gross proceeds in connection with a debt financing and during the nine months ended September 30, 2020, we raised net proceeds of approximately $44.0 million, in connection with sales under our at-the-market equity facility (the “ATM”). In addition, we may raise additional capital under the ATM facility up to a maximum gross proceeds of $150 million, however, general economic or other conditions resulting from COVID-19 or other events materially may impact the liquidity of our common stock or our ability to continue to access capital from the ATM to support our growth plans. Given our cash balances and budgeted cash flow requirements, we believe we have sufficient funds to support ongoing operations for the next twelve months.

Effects of COVID-19

The impact of the COVID-19 pandemic on our business and results of operations continues to remain uncertain at this time. While we have been able to continue operations remotely, we have experienced supply chain constraints and delays in the receipt of certain components of our products impacting delivery times for our products. We have also seen some impact in the demand of certain products and delays in certain projects and customer orders either because they require onsite services which could not be performed while shelter in place orders have been in effect or because of the uncertainty of the customer’s financial position and ability to invest in our technology. Despite these challenges, we were able to realize growth in revenue during the first and third quarters of 2020 and for the nine months of 2020 when compared to the same periods of 2019 as a result of an increase in sales associated with our indoor intelligence platform, including our sensors, in addition to additional revenue from the sale of Systat software licenses. The impact that COVID-19 will have on general economic conditions is continuously evolving and the ultimate impact the pandemic will have on our results of operations continues to remain uncertain and there are no assurances that we will be able to continue to experience the same growth or not be materially adversely effected. A further discussion of the impact of the COVID-19 pandemic on our business is set forth below in Part II, Item 1A. Risk Factors.

A further discussion of the impact of the COVID-19 pandemic on our business is set forth below in Part II, Item 1A. Risk Factors.

Corporate Strategy Update

Management continues to pursue a corporate strategy that is focused on building and developing our business as a provider of end-to-end solutions ranging from the collection of data to delivering insights from that data to our customers with a focus on securing, digitizing and optimizing premises with our indoor positioning, mapping and analytics solutions for businesses and governments. In connection with such strategy and to facilitate our long-term growth, we continue to evaluate various strategic transactions including acquisitions of companies with technologies and intellectual property (“IP”) that complement those goals by adding technology, differentiation, customers and/or revenue. Some of these opportunities may offer us the ability to enhance our technology and product offerings, expand our verticals and/or our international presence and global footprint. We believe these complementary technologies will add value to the Company and allow us to provide a comprehensive indoor intelligence platform, offering a one-stop shop to our customers. In addition, we may seek to expand our capabilities around security, artificial intelligence, augmented reality and virtual reality or other high growth sectors. Candidates with proven technologies that complement our overall strategy may come from anywhere in the world, as long as there are strategic and financial reasons to make the acquisition. In addition, we are also exploring opportunities that will supplement our revenue growth. We are primarily looking for accretive acquisitions that have business value and operational synergies, but will be opportunistic for other strategic and/or attractive transactions that we believe may increase overall shareholder value, which may include, but not be limited to other alternative investment opportunities, such as minority investments. joint ventures or special purpose acquisition companies. If we make any acquisitions in the future, we expect that we may pay for such acquisitions with cash, equity securities and/or debt in combinations appropriate for each acquisition. In addition, we may consider an assignment of our remaining note receivable from Sysorex Inc. (“Sysorex”). In furtherance of this strategy, over the last year, we enhanced our product offerings and expanded our intellectual property portfolio by completing several strategic transactions, including, the acquisition of (1) Locality Systems, Inc. (“Locality”), a technology company based near Vancouver, Canada, specializing in wireless device positioning and radio frequency (“RF”) augmentation of video surveillance systems, (2) Jibestream Inc. (“Jibestream”), a provider of a highly configurable intelligent indoor mapping platform to expand our suite of products, (3) certain GPS products, software, technologies, and intellectual property from GTX Corp (“GTX”), a U.S. based company specializing in GPS technologies, (4) an exclusive, worldwide license to market, distribute and develop the SYSTAT and SigmaPlot software suite of products from Systat Software, Inc., (5) a suite of on-device “blue dot” indoor location and motion technologies, including patents, trademarks, software and related intellectual property (IP), from Ten Degrees, Inc., Ten Degrees International and certain other affiliated parties and (6) Nanotron Technologies GmbH, a global location awareness technology company to strengthen and expand our product portfolio and capabilities for UWB, RTLS, and 2.4 GHz CSS.

Recent Events

“Blue Dot” Technology Acquisition

On August 19, 2020, in accordance with the terms and conditions of that certain Asset Purchase Agreement, by and among us, Ten Degrees Inc., a Delaware corporation (“TDI”), Ten Degrees International Limited, a Cayman Islands exempted company limited by shares and the sole shareholder of 100% of the outstanding capital stock of TDI (“TDIL”), mCube International Limited, a Cayman Island company (“MCI”), and the holder of a majority of the outstanding capital of TDIL and mCube, Inc., a Delaware corporation, and the sole shareholder of 100% of the outstanding capital stock of MCI (“mCube”, together with TDI, TDIL, and MCI collectively, the “Transferors”), dated August 19, 2020 (the “APA”), we acquired a suite of on-device “blue-dot” indoor location and motion technologies, including patents, trademarks, software and related intellectual property from the Transferors (collectively, the “Assets”).

The Assets were acquired for consideration consisting of (i) $1.5 million in cash and (ii) 480,000 shares of our common stock.

In accordance with the terms of the APA, commencing as of the date of the APA, the Transferors, and their affiliates, have agreed to not compete with our business associated with the Assets for a period of five years from the closing date. In addition, each party agreed to not solicit any employees from the other party for a period of one year from the closing date, subject to certain exceptions.

All of Transferors’ right, title and interest in and to the Assets were sold, conveyed, transferred, assigned, and delivered to us in accordance with a Bill of Sale and Assignment executed by the Transferors, dated as of the closing date.

Nanotron Acquisition

On October 6, 2020, we acquired, through our wholly-owned subsidiary Inpixon GmbH, a limited liability company incorporated under the laws of Germany (the “Purchaser), all of the outstanding capital stock (the “Nanotron Shares”) of Nanotron Technologies GmbH, a limited liability company incorporated under the laws of Germany (“Nanotron”), pursuant to the terms and conditions of that certain Share Sale and Purchase Agreement, dated as of October 5, 2020 (the “Purchase Agreement”), among the Purchaser, Nanotron and Sensera Limited, a stock corporation incorporated under the laws of Australia and the sole shareholder of Nanotron (the “Seller”).

As a result of the acquisition, we now own 100% of Nanotron. Nanotron’s business consists of developing and manufacturing location-aware IoT systems and solutions.

At the closing, the Purchaser paid to the Seller an aggregate purchase price of $8,700,000 (less the Holdback Funds (as defined below) and certain other closing adjustments) for the Nanotron Shares (“Purchase Price”). The Purchase Price may be subject to certain post-Closing adjustments based on actual working capital as of the closing as described in the Purchase Agreement. The Purchaser retained $750,000 (the “Holdback Funds”) from the Purchase Price to secure the Seller’s obligations under the Purchase Agreement, with any unused portion of the Holdback Funds to be released to the Seller on the date that is 18 months after the closing date. The Purchaser paid the Purchase Price from funds received in connection with a capital contribution from us, and a portion of the Purchase Price was used by the Seller to satisfy outstanding loans payable by the Seller to obtain the release of certain existing security interests on Nanotron’s assets.

Subscription of Units of Cardinal Venture Holdings

On September 30, 2020, we entered into a Subscription Agreement (the “Subscription Agreement”) with Cardinal Venture Holdings LLC, a Delaware limited liability company (“CVH”), pursuant to which we agreed to (i) contribute up to $1,800,000 (the “Contribution”) to CVH and (ii) purchase up to 599,999 Class A Units of CVH (the “Class A Units”) and up to 1,800,000 Class B Units of CVH (the “Class B Units,” and, together with the Class A Units, the “Units”). The $1,800,000 purchase price was paid on October 12, 2020 and therefore that is the date the purchase of the Units was closed.

CVH owns certain interests in the sponsor entity (the “Sponsor”) to a special purpose acquisition company formed for the purpose of pursuing an initial public offering of its securities followed by effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination with one or more businesses (the “SPAC”). It is anticipated that the Contribution will be used by CVH to fund the Sponsor’s purchase of securities in the SPAC.

Nadir Ali, our Chief Executive Officer, beneficially owns membership interests in CVH through 3AM LLC, a Delaware limited liability company and a founding member of CVH (“3AM”).

Concurrently with our entry into the Subscription Agreement, we entered into the Amended and Restated Limited Liability Company Agreement of CVH (the “LLC Agreement”), dated as of September 30, 2020. Under the terms of the LLC Agreement, in the event the Managing Member (as defined in the LLC Agreement) can no longer manage CVH’s affairs due to his death, disability or incapacity, 3AM will serve as CVH’s replacement Managing Member. Except as may be required by law, the Company, as a non-managing member under the LLC Agreement, does not have any voting rights and generally cannot take part in the management or control of CVH’s business and affairs.

The LLC Agreement provides that each Class A Unit and each Class B Unit represents the right of the Company to receive any distributions made by the Sponsor on account of the Class A Interests and Class B Interests, respectively, of the Sponsor.

We are not required to make additional capital contributions to CVH, unless any such capital contribution is approved by all of CVH’s members. In addition, the LLC Agreement contains terms and conditions that provide for limitations on liability, restrictions on rights to distributions and certain indemnification rights for CVH’s members.

Equity Distribution Agreement

We entered into an Equity Distribution Agreement, dated March 3, 2020,with Maxim Group LLC (“Maxim”) under which we may offer and sell shares of our common stock in connection with an at-the-market equity facility (“ATM”) from time to time through Maxim, acting exclusively as our sales agent. The ATM had an initial aggregate offering amount of up to $50.0 million, which we increased to $150.0 million pursuant to Amendment No. 1 to Equity Distribution, dated as of June 19, 2020 (the “Amendment”). The Amendment also provided that Maxim will receive a reduced commission of 3.25%, down from 4.0%, from any sales in excess of the initial $50.0 million offering amount. We intend to use the net proceeds of the ATM primarily for working capital and general corporate purposes. We may also use a portion of the net proceeds to invest in or acquire businesses or technologies that we believe are complementary to our own.

We issued and sold 31,574,358 shares of common stock during the nine months ended September 30, 2020, in connection with the ATM at per share prices between $1.13 and $2.11, resulting in net proceeds to the Company of approximately $44 million, after subtracting sales commissions and other offering expenses.

Subsequent to the quarter ended September 30, 2020, the Company issued 213,474 shares of common stock in connection with the ATM, at per share prices between $1.1206 and $1.1209, resulting in net proceeds to the Company of approximately $230,000 after subtracting sales commissions and other offering expenses.

Such sales were made pursuant to the Company’s effective shelf registration statement on Form S-3 (File No. 333-223960), which was filed with the Securities and Exchange Commission (the “SEC”) on March 27, 2018, as amended on May 15, 2018, and declared effective on June 5, 2018 (the “Registration Statement”), and a base prospectus dated as of June 5, 2018 included in the Registration Statement and the prospectus supplements relating to the ATM filed with the SEC on March 3, 2020 and June 22, 2020.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). In connection with the preparation of our consolidated financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

Our significant accounting policies are discussed in Note 3 of the condensed consolidated financial statements. We believe that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require our most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. There have been no changes to estimates during the periods presented in the filing. Historically changes in management estimates have not been material.

Revenue Recognition

The Company records revenue according to “Revenue from Contracts with Customers (Topic 606)”, or ASU 2016-12, which requires revenue to be recognized either at a “point in time” or “over time”, depending on the facts and circumstances of the arrangement, and is evaluated using a five-step model.

Software As A Service Revenue Recognition

With respect to sales of our maintenance, consulting and other service agreements including our digital tear-sheets, customers pay fixed monthly fees in exchange for the Company’s service. The Company’s performance obligation is satisfied over time as the digital tear-sheets are provided continuously throughout the service period. The Company recognizes revenue evenly over the service period using a time-based measure because the Company is providing continuous access to its service.

Mapping Services Revenue Recognition

Mapping services revenue is accounted for using the percentage of completion method. As soon as the outcome of a contract can be estimated reliably, contract revenue is recognized in the consolidated statement of operations in proportion to the stage of completion of the contract. Contract costs are expensed as incurred. Contract costs include all amounts that relate directly to the specific contract, are attributable to contract activity, and are specifically chargeable to the customer under the terms of the contract

Professional Services Revenue Recognition

The Company’s professional services include fixed fee and time and materials contracts. Fixed fees are paid monthly, in phases, or upon acceptance of deliverables. The Company’s time and materials contracts are paid weekly or monthly based on hours worked. Revenue on time and materials contracts is recognized based on a fixed hourly rate as direct labor hours are expended. Materials, or other specified direct costs, are reimbursed as actual costs and may include markup. The Company has elected the practical expedient to recognize revenue for the right to invoice because the Company’s right to consideration corresponds directly with the value to the customer of the performance completed to date. For fixed fee contracts including maintenance service provided by in house personnel, the Company recognizes revenue evenly over the service period using a time-based measure because the Company is providing continuous service. Because the Company’s contracts have an expected duration of one year or less, the Company has elected the practical expedient in ASC 606-10-50-14(a) to not disclose information about its remaining performance obligations. Anticipated losses are recognized as soon as they become known. For the three and nine months ended September 30, 2020 and 2019, the Company did not incur any such losses. These amounts are based on known and estimated factors.

Contract Balances

The timing of our revenue recognition may differ from the timing of payment by our customers. The Company records a receivable when revenue is recognized prior to payment and the Company has an unconditional right to payment. Alternatively, when payment precedes the provision of the related services, the Company records deferred revenue until the performance obligations are satisfied. As of September 30, 2020, the Company had deferred revenue of approximately $1,761,000 related to software license agreements and approximately $81,000 related to cash received in advance for product maintenance services provided by the Company’s technical staff. The Company expects to satisfy its remaining performance obligations for these maintenance services and recognize the deferred revenue and related contract costs over the next twelve months.

Long-lived Assets

We account for our long-lived assets in accordance with Accounting Standards Codification (“ASC”) 360, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“ASC 360”), which requires that long-lived assets be evaluated whenever events or changes in circumstances indicate that the carrying amount may not be recoverable or the useful life has changed. Some of the events or changes in circumstances that would trigger an impairment test include, but are not limited to:

• significant under-performance relative to expected and/or historical results (negative comparable sales growth or operating cash flows for two consecutive years);
• significant negative industry or economic trends;
• knowledge of transactions involving the sale of similar property at amounts below our carrying value; or
• our expectation to dispose of long-lived assets before the end of their estimated useful lives, even though the assets do not meet the criteria to be classified as “held for sale.”

Long-lived assets are grouped for recognition and measurement of impairment at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets. The impairment test for long-lived assets requires us to assess the recoverability of our long-lived assets by comparing their net carrying value to the sum of undiscounted estimated future cash flows directly associated with and arising from our use and eventual disposition of the assets. If the net carrying value of a group of long-lived assets exceeds the sum of related undiscounted estimated future cash flows, we would be required to record an impairment charge equal to the excess, if any, of net carrying value over fair value.

When assessing the recoverability of our long-lived assets, which include property and equipment and finite-lived intangible assets, we make assumptions regarding estimated future cash flows and other factors. Some of these assumptions involve a high degree of judgment and also bear a significant impact on the assessment conclusions. Included among these assumptions are estimating undiscounted future cash flows, including the projection of comparable sales, operating expenses, capital requirements for maintaining property and equipment and residual value of asset groups. We formulate estimates from historical experience and assumptions of future performance, based on business plans and forecasts, recent economic and business trends, and competitive conditions. In the event that our estimates or related assumptions change in the future, we may be required to record an impairment charge. Based on our evaluation we did not record a charge for impairment for the three and nine months ended September 30, 2020 and 2019.

The benefits to be derived from our acquired intangibles, will take additional financial resources to continue the development of our technology. Management believes our technology has significant long-term profit potential, and to date, management continues to allocate existing resources to the develop products and services to seek returns on its investment. We continue to seek additional resources, through both capital raising efforts and meeting with industry experts, as part of our continued efforts. Although there can be no assurance that these efforts will be successful, we intend to allocate financial and personnel resources when deemed possible and/or necessary. If we choose to abandon these efforts, or if we determine that such funding is not available, the related development of our technology (resulting in our lack of ability to expand our business), may be subject to significant impairment.

As described previously, we continue to experience weakness in market conditions, a depressed stock price, and challenges in executing our business plans. The Company will continue to monitor these uncertainties in future periods, to determine the impact.

We evaluate the remaining useful lives of long-lived assets and identifiable intangible assets whenever events or circumstances indicate that a revision to the remaining period of amortization is warranted. Such events or circumstances may include (but are not limited to): the effects of obsolescence, demand, competition, and/or other economic factors including the stability of the industry in which we operate, known technological advances, legislative actions, or changes in the regulatory environment. If the estimated remaining useful lives change, the remaining carrying amount of the long-lived assets and identifiable intangible assets would be amortized prospectively over that revised remaining useful life. We have determined that there were no events or circumstances during the three and nine months ended September 30, 2020 and 2019, which would indicate a revision to the remaining amortization period related to any of our long-lived assets. Accordingly, we believe that the current estimated useful lives of long-lived assets reflect the period over which they are expected to contribute to future cash flows and are therefore deemed appropriate.

Acquired In-Process Research and Development (“IPR&D”)

In accordance with authoritative guidance, we recognize IPR&D at fair value as of the acquisition date, and subsequently account for it as an indefinite-lived intangible asset until completion or abandonment of the associated research and development efforts. Once an IPR&D project has been completed, the useful life of the IPR&D asset is determined and amortized accordingly. If the IPR&D asset is abandoned, the remaining carrying value is written off. During fiscal year 2014, we acquired IPR&D through the acquisition of AirPatrol, in 2015 through the acquisition of the assets of LightMiner, in 2019 through the acquisitions of Locality, Jibestream and certain assets of GTX and in 2020 through the SYSTAT licensing agreement and the acquisition of assets of Ten Degrees. Our IPR&D is comprised of AirPatrol, LightMiner, Locality, Jibestream, GTX, SYSTAT and Ten Degrees technology, which was valued on the date of the acquisition. It will take additional financial resources to continue development of these technologies.

We continue to seek additional resources, through both capital raising efforts and meeting with industry experts, for further development of the AirPatrol, Locality, Jibestream, GTX, SYSTAT and Ten Degrees technologies. Through September 30, 2020, we have made some progress with raising capital since these acquisitions, building our pipeline and getting industry acknowledgment. We have been recognized by leading industry analysts in a report on leading indoor positioning companies and were also awarded the IoT Security Excellence award by TMC. Management remains focused on growing revenue from these products and continues to pursue efforts to recognize the value of the AirPatrol, Locality, Jibestream, GTX, SYSTAT and Ten Degrees technologies. Although there can be no assurance that these efforts will be successful, we intend to allocate financial and personnel resources when deemed possible and/or necessary. If we choose to abandon these efforts, or if we determine that such funding is not available, the related IPR&D will be subject to significant impairment.

Impairment of Long-Lived Assets Subject to Amortization

We amortize intangible assets with finite lives over their estimated useful lives and review them for impairment whenever an impairment indicator exists. We continually monitor events and changes in circumstances that could indicate carrying amounts of our long-lived assets, including our intangible assets, may not be recoverable. When such events or changes in circumstances occur, we assess recoverability by determining whether the carrying value of such assets will be recovered through the undiscounted expected future cash flows. If the future undiscounted cash flows are less than the carrying amount of these assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. We did not recognize any intangible asset impairment charges for the three and nine months ended September 30, 2020 and 2019. See “Acquired In-Process Research and Development (“IPR&D”)” for further information.

Software Development Costs

The Company develops and utilizes internal software for the processing of data provided by its customers. Costs incurred in this effort are accounted for under the provisions of FASB ASC 350-40, Internal Use Software and ASC 985-20, Software – Cost of Software to be Sold, Leased or Marketed, whereby direct costs related to development and enhancement of internal use software is capitalized, and costs related to maintenance are expensed as incurred. The Company capitalizes its direct internal costs of labor and associated employee benefits that qualify as development or enhancement. These software development costs are amortized over the estimated useful life which management has determined ranges from one to four years.

Allowance for Doubtful Accounts

We maintain our reserves for credit losses at a level believed by management to be adequate to absorb potential losses inherent in the respective balances. We assign an internal credit quality rating to all new customers and update these ratings regularly, but no less than annually. Management’s determination of the adequacy of the reserve for credit losses for our accounts and notes receivable is based on the age of the receivable balance, the customer’s credit quality rating, an evaluation of historical credit losses, current economic conditions, and other relevant factors.

As of September 30, 2020 and December 31, 2019, reserves for credit losses included a reserve for doubtful accounts of approximately $ 467,000 and $646,000, respectively, due to the aging of the items greater than 120 days outstanding and other potential non-collections.

Business Combinations

We account for business combinations using the acquisition method of accounting, and accordingly, the assets and liabilities of the acquired business are recorded at their fair values at the date of acquisition. The excess of the purchase price over the estimated fair value is recorded as goodwill. Any changes in the estimated fair values of the net assets recorded for acquisitions prior to the finalization of more detailed analysis, but not to exceed one year from the date of acquisition, will change the amount of the purchase price allocable to goodwill. Any subsequent changes to any purchase price allocations that are material to our consolidated financial results will be adjusted. All acquisition costs are expensed as incurred and in-process research and development costs are recorded at fair value as an indefinite-lived intangible asset and assessed for impairment thereafter until completion, at which point the asset is amortized over its expected useful life. Separately recognized transactions associated with business combinations are generally expensed subsequent to the acquisition date. The application of business combination and impairment accounting requires the use of significant estimates and assumptions.

Upon acquisition, the accounts and results of operations are consolidated as of and subsequent to the acquisition date and are included in our Consolidated Financial Statements from the acquisition date.

Stock-Based Compensation

We account for equity instruments issued to non-employees in accordance with accounting guidance, which requires that such equity instruments are recorded at their fair value on the measurement date, which is typically the date the services are performed.

We account for equity instruments issued to employees in accordance with accounting guidance that requires that awards are recorded at their fair value on the date of grant and are amortized over the vesting period of the award. We recognize compensation costs over the requisite service period of the award, which is generally the vesting term of the equity instrument issued.

The Black-Scholes option valuation model is used to estimate the fair value of the options or the equivalent security granted. The model includes subjective input assumptions that can materially affect the fair value estimates. The model was developed for use in estimating the fair value of traded options or warrants. The expected volatility is estimated based on the average of historical volatilities for industry peers.

The Company incurred stock-based compensation charges of $256,000 and $871,000 for the three months ended September 30, 2020 and 2019, respectively, and $941,000 and $2,618,000 for the nine months ended September 30, 2020 and 2019 respectively, which are included in general and administrative expenses. Key weighted-average assumptions used to apply this pricing model during the nine months ended September 30, 2020 were as follows:

Results of Operations

Three months ended September 30, 2020 compared to three months ended September 30, 2019

(in thousands, except percentages)

* Amounts used to calculate dollar and percentage changes are based on numbers in the thousands. Accordingly, calculations in this item, which may be rounded to the nearest hundred thousand, may not produce the same results.

Revenues

Revenues for the three months ended September 30, 2020 were $2,554,000 compared to $1,534,000 for the comparable period in the prior year for an increase of $1,020,000, or approximately 66%. Revenues increased in the third quarter of 2020 over the prior period in 2019 primarily attributable to an increase in sales in our Aware and Mapping product lines and the addition of sales from the new Systat licensing product line.

Cost of Revenues

Cost of revenues for the three months ended September 30, 2020 were $645,000 compared to $382,000 for the comparable period in the prior year. This increase of $263,000, or approximately 69%, was primarily attributable the increased sales during the quarter.

Gross Profit

The gross profit margin for the three months ended September 30, 2020 and 2019 was 75%.

Operating Expenses

Operating expenses for the three months ended September 30, 2020 were $8.2 million and $6.8 million for the comparable period in the prior year. This increase of approximately $1.4 million is primarily attributable to the increased operating expenses of the Systat licensing product line, increased professional fees and marketing expenses offset by a decrease in travel expenses, stock based compensation and amortization of intangibles.

Loss From Operations

Loss from operations for the three months ended September 30, 2020 was $6.2 million as compared to $5.7 million for the comparable period in the prior year. This increase in loss of approximately $0.5 million was primarily attributable to higher operating expenses offset by the increase in revenue for the quarter ended September 30, 2020.

Other Income/Expense

Other income/expense for the three months ended September 30, 2020 was a loss of $1,205,000 compared to a loss of $928,000 for the comparable period in the prior year. This increase in loss of $277,000 is primarily attributable to a $648,000 valuation allowance adjustment on held for sale loan offset by a reduction in interest expense due to the pay down of notes payable.

Provision for Income Taxes

There was no provision for corporate income taxes for the three months ended September 30, 2020 and 2019 as the Company was in a net taxable loss position. Deferred tax assets resulting from such losses are fully reserved as of September 30, 2020 and 2019 since, at present, the Company has no history of taxable income and it is more likely than not that such assets will not be realized.

Net Income Attributable to Non-Controlling Interest

Net income attributable to non-controlling interest for the three months ended September 30, 2020 was $16,000 compared to net income of $5,000 for the comparable period in the prior year. This increase in income of $11,000 was attributable to the gain from Inpixon India and is immaterial.

Net Loss Attributable To Stockholders of Inpixon

Net loss attributable to stockholders of Inpixon for the three months ended September 30, 2020 was $7.5 million compared to $6.6 million for the comparable period in the prior year. The higher loss of approximately $0.9 million was primarily attributable the higher operating expenses offset by the increased revenue during the three months ended September 30, 2020.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019

(in thousands, except percentages)

* Amounts used to calculate dollar and percentage changes are based on numbers in the thousands. Accordingly, calculations in this item, which may be rounded to the nearest hundred thousand, may not produce the same results.

Revenues

Revenues for the nine months ended September 30, 2020 were $5,434,000 compared to $4,387,000 for the comparable period in the prior year for an increase of $1,047,000, or approximately 24%, which was primarily attributable to additional mapping revenues due to a full nine months of sales during 2020, the addition of sales from the new Systat licensing product line offset by a decline in Aware product line sales (in the second quarter) during the 2020 period.

Cost of Revenues

Cost of revenues for the nine months ended September 30, 2020 were $1,459,000 compared to $1,109,000 for the comparable period in the prior year. This increase of $350,000, or approximately 32%, was primarily attributable to the increased sales during the quarter.

Gross Profit

The gross profit margin for the nine months ended September 30, 2020 was 73% compared to 75% for the nine months ended September 30, 2019. This decrease in margin is primarily due to the addition of the Systat licensing product line sales at a lower margin.

Operating Expenses

Operating expenses for the nine months ended September 30, 2020 were $20.9 million and $18.6 million for the comparable period ended September 30, 2019. This increase of approximately $2.3 million is primarily attributable to increased operating expenses of the Systat licensing product line, increased operating expenses of the Jibestream division as it was included for a full nine months during 2020, increased professional fees and marketing expenses offset by a decrease in travel expenses, stock based compensation and amortization of intangibles.

Loss From Operations

Loss from operations for the nine months ended September 30, 2020 was $16.9 million as compared to $15.3 million for the comparable period in the prior year. This increase in loss of approximately $1.6 million was primarily attributable to higher operating expenses offset by the increase in revenue for the nine months ended September 30, 2020.

Other Income/Expense

Other income/expense for the nine months ended September 30, 2020 was a loss of $4,068,000 compared to a loss of $1,723,000 for the comparable period in the prior year. This increase in loss of approximately $2,345,000 is primarily attributable to the additional expense of the $1,514,000 valuation allowance adjustment due to the uncertainty of being repaid in connection with note receivable from Sysorex and a $648,000 valuation allowance for related party receivable from a settlement agreement in the nine months ended September 30, 2020.

Provision for Income Taxes

There was no provision for corporate income taxes for the nine months ended September 30, 2020 and 2019 as the Company was in a net taxable loss position. Deferred tax assets resulting from such losses are fully reserved as of September 30, 2020 and 2019 since, at present, the Company has no history of taxable income and it is more likely than not that such assets will not be realized. The Company recorded an income tax benefit of approximately $87,000 during the nine months ended September 30, 2020 for the reduction of the deferred tax liability related to the amortization of the Locality and Jibestream intangibles.

Net Income Attributable To Non-Controlling Interest

Net income attributable to non-controlling interest for the nine months ended September 30, 2020 was $25,000 compared to net income of $9,000 for the comparable period in the prior year. This increase in income of $16,000 was attributable to the gain from Inpixon India and is immaterial.

Net Loss Attributable To Stockholders of Inpixon

Net loss attributable to stockholders of Inpixon for the nine months ended September 30, 2020 was $20.9 million compared to $17.0 million for the comparable period in the prior year. The higher loss of approximately $3.9 million was primarily attributable to the higher operating expenses to include the expenses of the new Systat division and a full nine months of the Jibestream division, the $1,514,000 valuation allowance adjustment on held for sale loan and the $648,000 valuation allowance on related party receivable offset by the increased revenue during the nine ended September 30, 2020.

Non-GAAP Financial information

EBITDA

EBITDA is defined as net income (loss) before interest, provision for (benefit from) income taxes, and depreciation and amortization. Adjusted EBITDA is used by our management as the matrix in which it manages the business. It is defined as EBITDA plus adjustments for other income or expense items, non-recurring items and non-cash stock-based compensation.

Adjusted EBITDA for the three months ended September 30, 2020 was a loss of $4.6 million compared to a loss of $2.4 million for the prior period in 2019. Adjusted EBITDA for the nine months ended September 30, 2020 was a loss of $12.4 million compared to a loss of $7.0 million for the prior period in 2019.

The following table presents a reconciliation of net income/loss attributable to stockholders of Inpixon, which is our GAAP operating performance measure, to Adjusted EBITDA for the three and nine months ended September 30, 2020 and 2019 (in thousands):

40

We rely on Adjusted EBITDA, which is a non-GAAP financial measure for the following:

• to review and assess the operating performance of our Company as permitted by Accounting Standards Codification Topic 280, Segment Reporting;
• to compare our current operating results with corresponding periods and with the operating results of other companies in our industry;
• as a basis for allocating resources to various projects;
• as a measure to evaluate potential economic outcomes of acquisitions, operational alternatives and strategic decisions; and
• to evaluate internally the performance of our personnel.

We have presented Adjusted EBITDA above because we believe it conveys useful information to investors regarding our operating results. We believe it provides an additional way for investors to view our operations, when considered with both our GAAP results and the reconciliation to net income (loss). By including this information, we can provide investors with a more complete understanding of our business. Specifically, we present Adjusted EBITDA as supplemental disclosure because of the following:

• we believe Adjusted EBITDA is a useful tool for investors to assess the operating performance of our business without the effect of interest, income taxes, depreciation and amortization and other non-cash items including stock based compensation, amortization of intangibles, change in the fair value of shares to be issued, change in the fair value of derivative liability, impairment of goodwill and one time charges including gain/loss on the settlement of obligations, severance costs, provision for doubtful accounts, acquisition costs and the costs associated with public offerings;
• we believe that it is useful to provide to investors with a standard operating metric used by management to evaluate our operating performance; and
• we believe that the use of Adjusted EBITDA is helpful to compare our results to other companies.

Even though we believe Adjusted EBITDA is useful for investors, it does have limitations as an analytical tool. Thus, we strongly urge investors not to consider this metric in isolation or as a substitute for net income (loss) and the other condensed consolidated statement of operations data prepared in accordance with GAAP. Some of these limitations include the fact that:

• Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;
• Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
• Adjusted EBITDA does not reflect the significant interest expense or the cash requirements necessary to service interest or principal payments on our debt;
• Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;
• Adjusted EBITDA does not reflect income or other taxes or the cash requirements to make any tax payments; and
• other companies in our industry may calculate Adjusted EBITDA differently than we do, thereby potentially limiting its usefulness as a comparative measure.

Because of these limitations, Adjusted EBITDA should not be considered a measure of discretionary cash available to us to invest in the growth of our business or as a measure of performance in compliance with GAAP. We compensate for these limitations by relying primarily on our GAAP results and providing Adjusted EBITDA only as supplemental information.

Proforma Non-GAAP Net Loss per Share

Basic and diluted net loss per share for the three months ended September 30, 2020 was ($0.18) compared to ($12.68) for the prior period in 2019. Basic and diluted net loss per share for the nine months ended September 30, 2020 was ($0.90) compared to ($65.89) for the prior period in 2019.

Proforma non-GAAP net income (loss) per share is used by our Company’s management as an evaluation tool as it manages the business and is defined as net income (loss) per basic and diluted share adjusted for non-cash items including stock based compensation, amortization of intangibles and one time charges including gain on the settlement of obligations, severance costs, provision for doubtful accounts, acquisition costs and the costs associated with public offerings.

Proforma non-GAAP net loss per basic and diluted common share for the three months ended September 30, 2020 was ($0.13) compared to a loss of ($7.44) per share for the prior period in 2019. Proforma non-GAAP net loss per basic and diluted common share for the nine months ended September 30, 2020 was ($0.64) compared to a loss of ($35.45) per share for the prior period in 2019.

The following table presents a reconciliation of net loss per basic and diluted share, which is our GAAP operating performance measure, to proforma non-GAAP net loss per share for the periods reflected (in thousands, except per share data):

We rely on proforma non-GAAP net loss per share, which is a non-GAAP financial measure:

• to review and assess the operating performance of our Company as permitted by Accounting Standards Codification Topic 280, Segment Reporting;
• to compare our current operating results with corresponding periods and with the operating results of other companies in our industry;
• as a measure to evaluate potential economic outcomes of acquisitions, operational alternatives and strategic decisions; and
• to evaluate internally the performance of our personnel.

We have presented proforma non-GAAP net loss per share above because we believe it conveys useful information to investors regarding our operating results. We believe it provides an additional way for investors to view our operations, when considered with both our GAAP results and the reconciliation to net income (loss), and that by including this information we can provide investors with a more complete understanding of our business. Specifically, we present proforma non-GAAP net loss per share as supplemental disclosure because:

• we believe proforma non-GAAP net loss per share is a useful tool for investors to assess the operating performance of our business without the effect of non-cash items including stock based compensation, amortization of intangibles and one time charges including gain on the settlement of obligations, severance costs, provision for doubtful accounts, change in the fair value of shares to be issued, acquisition costs and the costs associated with public offerings;
• we believe that it is useful to provide to investors a standard operating metric used by management to evaluate our operating performance; and
• we believe that the use of proforma non-GAAP net loss per share is helpful to compare our results to other companies.

Liquidity and Capital Resources as of September 30, 2020

Our current capital resources and operating results as of and through September 30, 2020, consist of:

1) an overall working capital of $23.2 million;

2) cash of approximately $31.4 million;

3) ATM equity facility in an aggregate offering amount of up to $150 million of which we have raised approximately $44.0 million of net proceeds after subtracting sales commissions and other offering costs as of September 30, 2020; and

4) net cash used by operating activities for the period of $15.6 million.

The breakdown of our overall working capital deficit is as follows (in thousands):

Net cash used in operating activities during the nine months ended September 30, 2020 of $15.6 million consists of net loss of $20.9 million offset by non-cash adjustments of $8.3 million less net cash changes in operating assets and liabilities of approximately $2.9 million.

During the first quarter of 2020, we raised $5 million in gross proceeds in connection with a debt financing and during the nine months ended September 30, 2020 we raised net proceeds of approximately $44 million in connection with sales under the ATM. Given our current cash balances and budgeted cash flow requirements, the Company believes such funds are sufficient to support ongoing operations for the next 12 months from the issuance date of the financial statements. In addition, we may continue to raise up to an aggregate of $150 million in gross proceeds under the ATM, however, general economic or other conditions resulting from COVID 19 or other events materially may impact the liquidity of our common stock or our ability to continue to access capital from the ATM to support our growth plans. In addition, the impact of the COVID-19 pandemic on our business and results of operations continues to remain uncertain at this time. While we have been able to continue operations remotely we have experienced supply chain constraints and delays in the receipt of certain components of our products impacting delivery times for our products, we have also seen some impact in the demand of certain products including our SaaS or subscription based services and products, delays in certain projects and customer requests either because they require onsite services which could not be performed while shelter in place orders have been in effect or because of the uncertainty of the customer’s financial position and ability to invest in our technology. If we are successful in growing our revenues as we did in the first and third quarters of 2020 we may be able to offset any revenue loss that may be experienced due to any constraints that may result from the pandemic or other general economic conditions, however, there are no assurances that we will be successful or that we will be able to offset any losses, if realized. The Company is also pursuing possible strategic transactions and may raise such additional capital as needed, using our equity securities, an assignment of the remaining note receivable from Sysorex and/or cash and debt financings in combinations appropriate for each acquisition.

Liquidity and Capital Resources as of September 30, 2020 Compared to September 30, 2019

The Company’s net cash flows used in operating, investing and financing activities for the nine months ended September 30, 2020 and 2019 and certain balances as of the end of those periods are as follows (in thousands):

Operating Activities for the nine months ended September 30, 2020

Net cash used in operating activities during the nine months ended September 30, 2020 was $15.6 million. The cash flows related to the nine months ended September 30, 2020 consisted of the following (in thousands):

The non-cash income and expense of $8.3 million consisted primarily of the following (in thousands):

The net use of cash in the change in operating assets and liabilities aggregated a decrease of approximately $2.9 million and consisted primarily of the following (in thousands):

Operating Activities for the nine months ended September 30, 2019

Net cash used in operating activities during the nine months ended September 30, 2019 was $9.1 million. The cash flows related to the nine months ended September 30, 2019 consisted of the following (in thousands):

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The non-cash income and expense of $8.4 million consisted primarily of the following (in thousands):

The net use of cash in the change in operating assets and liabilities aggregated a decrease of approximately $537,000 and consisted primarily of the following (in thousands):

Cash Flows from Investing Activities as of September 30, 2020 and 2019

Net cash flows used in investing activities during the nine months ended September 30, 2020 was approximately $4.9 million compared to net cash flows used in investing activities during the nine months ended September 30, 2019 of approximately $4.9 million. Cash flows related to investing activities during the nine months ended September 30, 2020 include $2.2 million payment for the Systat Licensing Agreement, $1.5 million payment for the Ten Degrees acquisition, $688,000 investment in capitalized software and $546,000 for the purchase of property and equipment. Cash flows related to investing activities during the nine months ended September 30, 2019 include $3.7 million payment for the Jibestream acquisition, $658,000 investment in capitalized software, $250,000 investment in GTX, $204,000 investment in Locality, and $58,000 for the purchase of property and equipment.

Cash Flows from Financing Activities as of September 30, 2020 and 2019

Net cash flows provided by financing activities during the nine months ended September 30, 2020 was approximately $47.1 million. During the nine months ended September 30, 2020, the Company received incoming cash flows of $44 million from the issuance of common stock, $5.0 million of proceeds from promissory notes, and $292,000 of repayments from related parties, offset by $1.8 million of loans to related party, $250,000 of acquisition liability repayments, $150,000 of net repayments to bank facility and $74,000 of notes payable repayments. Net cash flows provided by financing activities during the nine months ended September 30, 2019 was $13.3 million. During the nine months ended September 30, 2019, the Company received incoming cash flows of $14.8 million from the issuance of common stock, preferred stock and warrants, $6.8 million of net proceeds from promissory notes, $1.7 million of repayments from a related party, and $237,000 net proceeds from bank facility offset by $9.9 million of loans to related parties, $141,000 loan to Jibestream, $71,000 notes payable repayment, $50,000 loan to GTX, and $15,000 advances to related party.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet guarantees, interest rate swap transactions or foreign currency contracts. We do not engage in trading activities involving non-exchange traded contracts.

Recently Issued Accounting Standards

For a discussion of recently issued accounting pronouncements, please see Note 3 to our financial statements, which are included in this Form 10-Q in Item 1.

Disclosure Controls and Procedures

Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the Principal Executive Officer and Principal Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Internal controls are procedures which are designed with the objective of providing reasonable assurance that (1) our transactions are properly authorized, recorded and reported; and (2) our assets are safeguarded against unauthorized or improper use, to permit the preparation of our condensed consolidated financial statements in conformity with GAAP.

In connection with the preparation of this Form 10-Q, management, with the participation of our Principal Executive Officer and Principal Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)). Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this Form 10-Q, our disclosure controls and procedures were effective.

Changes in Internal Controls

There have been no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or 15d-15 under the Exchange Act that occurred during the quarter ended September 30, 2020 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. The Company’s management determined that there were no material changes needed to internal controls as a result of the COVID-19 pandemic.

Limitations of the Effectiveness of Control

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations of any control system, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected.

We face a number of significant risks and uncertainties in connection with our operations. Our business, results of operations and financial condition could be materially adversely affected by these risks. In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors disclosed in Part I, Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2019 and in the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2020, filed with the SEC on August 14, 2020, and the Current Report on Form 8-K, filed with the SEC on October 5, 2020, which reports are incorporated by reference herein, all of which could materially affect our business, financial condition and future results. For example, these risks now include risks related to recent transactions, the COVID-19 pandemic and related economic developments.