The consolidated financial information contained in this quarterly report on Form 10-Q represents interim condensed financial data and, therefore, does not include all footnote disclosures required to be included in financial statements prepared in conformity with accounting principles generally accepted in the United States (“GAAP”). Such footnote information was included in the Company's Annual Report on Form 10-K for the year ended October 31, 2018,2019, filed with the Securities and Exchange Commission (“SEC”); the consolidated financial data included herein should be read in conjunction with that report. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (which include only normal recurring adjustments) necessary to present fairly the Company’s consolidated financial position as of April 30, 2019,2020, and its consolidated results of operations for the three and six months ended April 30, 2019,2020, and 2018.

Certain financial information in the footnotes has been rounded to the nearest thousand for presentation purposes.

The consolidated financial statements include the accounts of PASSUR and its wholly-owned subsidiary. All significant inter-company transactions and balances have been eliminated in consolidation.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include those related to revenue recognition, stock-based compensation, software development costs, the PASSUR Network and income taxes. Actual results could differ from those estimates.

The Company derives revenue primarily from subscription-based, real-time decision and solution information and professional services. Revenues are recognized when control of these services is transferred to the customer, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those services.

The Company determines revenue recognition through the following steps:

Subscription services revenue is comprised of cloud-based subscription fees that provide the customer the right to access the Company’s software and receive support and updates, if any, for a period of time. The Company has determined such access represents a stand-ready service provided continually throughout the contract term. As such, control and satisfaction of this stand-ready performance obligation is deemed to occur over time. The Company’s subscription contracts include a fixed amount of consideration that is recognized ratably over the non-cancellable contract term, beginning on the date that access is made available to the customer. The passage of time is deemed to be the most faithful depiction of the transfer of control of the services as the customer simultaneously receives and consumes the benefit provided by the Company’s performance. Subscription contracts are generally one to three years in length, billed either monthly, quarterly or annually, typically in advance, which coincides with the terms of the agreement. The Company’s subscription contracts do not have a significant financing component and customer invoices are typically due within 30 days. There is no significant variable consideration related to these arrangements. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether transfer of control to customers has occurred.

Professional services primarily consist of value assessments and customer training services. Payment for professional services is generally a fixed fee or a fee based on time and materials. The obligation to provide professional services is generally satisfied over time, with the customer simultaneously receiving and consuming the benefits as the Company satisfies its performance obligations. For professional services, revenue is recognized by measuring progress toward the complete satisfaction of the Company’s obligation. Progress for services that are contracted for a fixed price is generally measured based on hours incurred as a portion of total estimated hours, and as a practical expedient, progress for services that are contracted for time and materials is generally based on the amount the Company has the right to invoice. Professional services contracts are generally one year or less in length, billed either in advance, upon pre-defined milestones or as services are rendered, which coincidesin accordance with the terms of the agreement. The Company’s professional service contracts do not have a significant financing component and customer invoices are typically due within 30 days.

Contracts with customers may include material rights which are also performance obligations. Material rights primarily arise when the contract gives the customer the right to renew subscription services at a discounted price in the future. This may occur from time to time when the Company’s contracts provide an implicit discount as the customer pays a nonrefundable up-front fee in connection with the initial services contract that it does not have to pay again in order to renew the service. These non-refundable up-front fees are not related to any promised service that the customer benefits from other than providing access to the subscription service.  Revenue allocated to material rights is recognized when the customer exercises the right over the estimated renewal period of five years or when the right expires. If exercised by the customer, the amount previously deferred for the material right is included in the transaction price of the renewal contract and allocated to the services included in that contract. If expired, revenue is recognized as subscription services revenue in the period the right expired. If the up-front fees do not provide the customer with a material right, then the amount is included in the transaction price of the initial services contract and allocated to the performance obligations in that contract.

Some of the Company’s contracts with customers contain multiple distinct performance obligations. For these contracts, the transaction price is allocated to the separate performance obligations on a relative standalone selling price basis.  The standalone selling price reflects the price the Company would charge for a specific service if it was sold separately in similar circumstances and to similar customers. The Company maximizes the use of directly observable transactions to determine the standalone selling prices for its performance obligations. For subscription services, the Company separately determines the standalone selling prices by type of solution and customer demographics. For professional services, the Company separately determines standalone selling price by type of services.

The commissions that the Company pays for obtaining a contract with a customer are conditional on future service provided by the employee. Therefore, since these costs are not incremental solely based on obtaining a contract, the Company does not defer any commission costs.

The disaggregation of revenue by customer and type of performance obligation is as follows:

The following table discloses the aggregate amount of the transaction price allocated to the remaining performance obligations as of the end of the reporting period, and when the Company expects to recognize the revenue.

*Approximately 97%94% of these amounts are expected to be recognized between 12 and 36 months.

The table above includes amounts billed and not yet recognized as revenue, as well as, unrecognized future committed billings in customer contracts and excludes future billing amounts for which the customer has a termination for convenience right in their agreement.

Costs associated with subscription and maintenance revenues consistconsisted primarily of direct labor, depreciation of PASSUR and Surface Multilateration (“SMLAT”) Network Systems (both collectively, the “PASSUR Network”), amortization of capitalized software development costs, communication costs, data feeds, travel and entertainment, and consulting fees. Also, included in cost of revenues arewere costs associated with upgrades to PASSUR and SMLAT Systems necessary to make such systems compatible with new software applications, as well as the ordinary repair and maintenance of existing PASSUR and SMLAT Systems. Additionally, cost of revenues in each reporting period ishas been impacted by: (1) the number of PASSUR and SMLAT Systems added to the PASSUR Network, which includesincluded the cost of production, shipment, and installation of these assets, which arewere capitalized to the PASSUR Network; and (2) new capitalized costs associated with software development projects. Both of these are referred to as “Capitalized Assets” and arewere depreciated and/or amortized over their respective useful lives and charged to cost of revenues.

On December 22, 2017March 27, 2020, the U.S. governmentCoronavirus Aid, Relief and Economic Security Act (the “CARES Act”) was enacted comprehensive tax reform commonly referredin response to as the Tax Cuts and Jobs Act (“TCJA”).COVID-19 pandemic.  Under FASB Accounting Standards Codification (“ASC”) Topic 740,Income Taxes, the effects of changes in tax rates and tax laws are recognized in the period in which the new legislation is enacted.  The TCJACARES Act made broadvarious tax law changes, including among others: (i) modified the limitation on business interest expenses under IRC Section 163(j) for the 2019 and complex changes2020 tax years to permit additional expensing of interest, (ii) enacted a technical correction so that qualified improvement property can be immediately expensed under IRC Section 168(k); and (iii) made modifications to the U.S. tax code, including, but not limited to: (1) reduced the U.S. federal corporate tax rate from 35% to 21% effective January 1, 2018; (2) changed the rules related to uses and limitations of net operating loss carryforwards createdrules, including to permit federal net operating losses incurred in tax2018, 2019, or 2020 to be carried back to the five preceding taxable years beginning after December 31, 2017; (3) accelerated expensing on certain qualified property; (4) createdin order to generate a new limitation on deductible interest expense to 30%refund for previously paid income taxes; and (iv)  enhanced the recoverability of tax adjusted EBITDA through 2021 and then 30% of tax adjusted EBIT thereafter; (5) eliminated the corporate alternative minimum tax; and (6) imposed further limitations ontax (AMT) credits.  Given the deductibility of executive compensation under IRC §162(m) for tax years beginning after December 31, 2017.

The Company’s provision for income taxes consists of federal, state and stateforeign taxes, as applicable, in amounts necessary to align the Company’s year-to-date tax provision with the effective rate that it expects to achieve for the full year. Each quarter the Company updates its estimate of the annual effective tax rate and records cumulative adjustments as necessary.  

For both the three and six months ended April 30, 2019 and 2018,2020, the Company recorded an income tax provision of $31,560, which was attributable to foreign withholding tax.  The effective tax rate for the six months ended April 30, 2020 was (0.3)% as compared to the U.S. federal corporate tax rate of 21% due to foreign withholding taxes.  The Company did not record an income tax benefit on its pre-tax losses as the Company maintains a full valuation allowance against its net deferred tax assets and the net deferred tax assets were not realizable on a more-likely-than-not basis.

For the six months ended April 30, 2019, the Company recorded an income tax provision (benefit). of $0.  The Company is projectingprojected that its annual effective tax rate for the six months ended April 30, 2019 to bewas 0% as itsthe Company’s net deferred tax assets arewere not realizable on a more-likely-than-not basis.

The Company records accounts receivablesreceivable for agreements where amounts due from customers are contractually required and are non-refundable. The carrying amount of accounts receivablesreceivable is reduced by a valuation allowance that reflects the Company’s best estimate of the amounts that will not be collected. Net accounts receivable is comprised of the monthly, quarterly, or annual committed amounts due from customers pursuant to the terms of each respective customer’s agreement.  AccountAccounts receivable balances include amounts attributable to deferred revenues. The Company’s accounts receivable balances included $3,000$108,000 of unbilled receivables associated with contractually committed services provided to existing customers as of the six months ended April 30, 2019,2020, which will be invoiced subsequent to April 30, 2019.2020. At October 31, 2018,2019, the Company’s accounts receivable balance included $12,000$100,000 of unbilled receivables associated with contractually committed services provided to existing customers during the twelve months ended October 31, 2018.

The provision for doubtful accounts was $159,000$509,000 and $165,000 as of April 30, 20192020 and October 31, 2018,2019, respectively. During the quarter ended April 30, 2020, the Company increased its provision for doubtful accounts in response to the financial and economic uncertainty facing the air transportation industry and several of the Company’s customers as a result of the COVID-19 pandemic.  The Company is in discussions with several customers regarding extended terms and temporary suspension of services.  In addition to reviewing delinquent accounts receivable, the Company considers many factors in estimating its reserve, including historical data, experience, customer types, credit worthiness, and economic trends. The Company monitors its outstanding accounts receivable balances and believes the provision is adequate.

The PASSUR Network is comprised of PASSUR and SMLAT Systems whichand includes the direct production, shipping, and installation costs incurred for each PASSUR and SMLAT System,systems, which are recorded at cost, net of accumulated depreciation. As described in “Cost of Revenues” above, in light of the FAA's mandate for ADS-B equipage on aircrafts operating in most U.S. airspace effective January 2020, and parallel adoption of ADS-B requirements in much of the world, we determined that services that traditionally had relied on our proprietary network of sensors for aircraft surveillance can now be powered by a combination of FAA data plus commercial ADS-B aggregator feeds and other data feds available to the Company. This provides a more cost-effective solution and will allow us to focus more on value-added analytics, and less on sensor technology.  In this regard, the Company reviewed and decommissioned approximately half of the PASSUR Network system assets.  It is the Company’s intention to decommission all remaining PASSUR Network system assets throughout the remainder of this fiscal year.  As a result, the Company wrote off net assets applicable to the PASSUR Network systems of approximately $3,565,000, which amount is included as an impairment charge for the three and six months ended April 30, 2020.  The write-off amount includes PASSUR System and SMLAT System assets as well as inventory of finished and spare parts.

The Company did not capitalize any costs related to the PASSUR Network for both the three and six months ended April 30, 2020. Additionally, the Company did not purchase any parts for the PASSUR Network and used $0 and $9,300 of PASSUR Network parts for repairs during the three and six months ended April 30, 2020, respectively.

Depreciation expenses related to the Company-owned PASSUR Network was $148,000 and $374,000 for the three and six months ended April 30, 2020, respectively. Depreciation is charged to cost of revenues and is recorded using the straight-line method over the estimated useful life of the asset, which was estimated at five years for SMLAT Systems and seven years for PASSUR Systems.

As a result of the FAA mandate, and the corresponding review conducted by the Company, which resulted in the commencement of the decommissioning of the PASSUR Network, the Company anticipates that the costs of maintaining and operating these systems, including depreciation, will decrease materially in the balance of the fiscal year.  

The Company capitalized $61,000 of PASSUR Network costs for both the three and six months ended April 30, 2019. Additionally, the Company used $13,000 and $22,000 of PASSUR Network parts for repairs during the three and six months ended April 30, 2019, respectively, and did not make any material purchases of parts during the same period.

Depreciation expenses related to the Company-owned PASSUR Network was $210,000 and $416,000 for the three and six months ended April 30, 2019, respectively. Depreciation is charged to cost of revenues and is recorded using the straight-line method over the estimated useful life of the asset, which is estimated at five years for SMLAT Systems and seven years for PASSUR Systems.

The net carrying balance of the PASSUR Network assets, after the effect of the write off described above as of April 30, 2019,2020, was $0 and $3,949,000, as of April 30, 2020 and October 31, 2018, was $4,426,000 and $4,801,000,2019, respectively. Included in the net carrying balance as of April 30, 2019 and October 31, 2018,2019, were parts and finished goods for the PASSUR Network totaling $1,857,000 and $1,892,000, respectively,$1,831,000, which havehad not yet been installed. PASSUR Network assets which are not installed are carried at cost and not depreciated until installed.

net carrying value of the related capitalized development cost asset.  Where the revenue amount was less than the net carrying value of the asset, we determined that an impairment had occurred.  As a result of this exercise, the Company wrote-off assets totaling $6,134,000 based on the assumption that the carrying value of the software capitalization is representative of 100% of the committed contract values remaining.

The Company capitalized $0 and $489,000 of software development costs during the three and six months ended April 30, 2020, respectively.  For the three and six months ended April 30, 2019, the Company capitalized $647,000 and $1,342,000, respectively, of software development costs. In addition, the Company did not incur any capitalized software development costs during the quarter ended April 30, 2020.

The Company amortized $520,000 and $1,208,000 of capitalized software development costs during the three and six months ended April 30, 2020, respectively. For the three and six months ended April 30, 2019, the Company amortized $592,000 and $1,112,000 of capitalized software development costs, respectively. The Company previously recorded amortization of the software on a straight-line basis over the estimated useful life of the software, typically over five years within “Cost of Revenues”.

The Company follows the provisions of ASC 350-40, “Internal Use Software” (“ASC 350-40”). ASC 350-40 provides guidance for determining whether computer software is internal-use software, and on accounting for the proceeds of computer software originally developed or obtained for internal use and then subsequently sold to the public.  It also provides guidance on capitalization of the costs incurred for computer software developed or obtained for internal use. The Company expensesexpensed all costs incurred during the preliminary project stage of its development, and capitalizescapitalized the costs incurred during the application development stage. Costs incurred relating to upgrades and enhancements to the software arewere capitalized if it iswas determined that these upgrades or enhancements addadded additional functionality to the software. Costs incurred to improve and support products after they become available arewere charged to expense as incurred.

As a result of the three and six months ended April 30, 2018,industry changes in response to the COVID-19 pandemic (described in “Impact of the COVID-19 Pandemic” below), the corresponding review conducted by the Company capitalized $754,000 and $1,302,000, respectively, of software development costs.

The Company reviews long-lived assets for impairment when circumstances indicate the carrying amount of an asset may not be recoverable. Impairment is recognized to the extent the sum of undiscounted estimated future cash flows expected to result from the use of the asset is less than the carrying value. Assets to be disposed of are carried at the lower of their carrying value or fair value, less costs to sell. The Company evaluates the periods of amortization continually in determining whether later events and circumstances warrant revised estimates of useful lives. If estimates are changed, the unamortized costs will be allocated to the increased or decreased number of remaining periods in the asset’s revised life.

Each reporting period, the Company assesses the realizability of its deferred tax assets to determine if it is more-likely-than-not that some portion, or all, of the deferred tax asset will be realized.  The Company considered all available positive and negative evidence including the reversal of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operating results. The ultimate realization of a deferred tax asset is ultimately dependent on sufficient taxable income within the available carryback and/or carryforward periods to utilize the deductible temporary differences.  Based on the weight of available evidence including recent financial operating results, the Company determined its net deferred tax assets are not realizable on a more-likely-than-not basis and that a valuation allowance is required against its net deferred tax assets.

The recorded amounts of the Company’s cash, receivables, and accounts payables approximate their fair values principally because of the short-term nature of these items. The fair value of related party debt is not practicable to determine due primarily to the fact that the Company’s related party debt is held by its Chairman and significant shareholder, and the Company does not have any third-party debt with which to compare.

Additionally, on a recurring basis, the Company uses fair value measures when analyzing asset impairments. Long-lived assets and certain identifiable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined such indicators are present, and the review indicates that the assets will not be fully recoverable based on the undiscounted estimated future cash flows expected to result from the use of the asset, their carrying values are reduced to estimated fair value.