Pressure BioSciences, Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

3. Summary of Significant Accounting Policies (Policies)

3. Summary of Significant Accounting Policies (Policies)

6 Months Ended

Jun. 30, 2013

The condensed consolidated financial statements include the accounts of Pressure BioSciences, Inc., and its wholly-owned subsidiary PBI BioSeq, Inc. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

To prepare our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, we are required to make significant 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. In addition, significant estimates were made in projecting future cash flows to quantify deferred tax assets, the costs associated with fulfilling our warranty obligations for the instruments that we sell, and the estimates employed in our calculation of fair value of stock options awarded and warrant derivative liability. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from the estimates and assumptions used.

Revenue Recognition

We recognize revenue in accordance with FASB ASC 605, Revenue Recognition. Revenue is recognized when realized or earned when all the following criteria have been met: persuasive evidence of an arrangement exists; delivery has occurred and risk of loss has passed to the customer; the seller’s price to the buyer is fixed or determinable; and collectability is reasonably assured.

Our current instruments, the Barocycler NEP3229 and NEP2320, require a basic level of instrumentation expertise to set-up for initial operation. To support a favorable first experience for our customers, we send a highly trained technical representative to the customer site to install every Barocycler that we sell or lease domestically. The installation process includes uncrating and setting up the instrument, followed by introductory user training. Product revenue related to current Barocycler instrumentation is recognized upon the completion of the installation and introductory training process of the Barocycler NEP3229 and NEP2320 instrumentation at the customer location, for domestic installations. Product revenue related to sales of PCT instrumentation to our foreign distributors and overseas customers, to our domestic distributors, and to our new Barocycler HUB440 instrument is recognized upon shipment through a common carrier unless installation is specifically requested by the customer. We provide for the expected costs of warranty upon the recognition of revenue for the sales of our instrumentation. Our sales arrangements do not provide our customers with a right of return. Product revenue related to the HUB440 and our consumable products such as PULSE Tubes, MicroTubes, and application specific kits is recorded upon shipment through a common carrier. Shipping costs are included in sales and marketing expense. Any shipping costs billed to customers are recognized as revenue.

In accordance with FASB ASC 840, Leases, we account for our lease agreements under the operating method. We record revenue over the life of the lease term and we record depreciation expense on a straight-line basis over the thirty-six month estimated useful life of the Barocycler instrument. The depreciation expense associated with assets under lease agreement is included in the “Cost of PCT products and services” line item in our consolidated statements of operations. Many of our lease and rental agreements allow the lessee to purchase the instrument at any point during the term of the agreement with partial or full credit for payments previously made. We pay all maintenance costs associated with the instrument during the term of the leases.

Revenue from government grants is recorded when expenses are incurred under the grant in accordance with the terms of the grant award.

Our transactions sometimes involve multiple elements (i.e., products and services). Revenue under multiple element arrangements is recognized in accordance with FASB ASC 605-25 Multiple-Element Arrangements (“ASC 605”). When vendor specific objective evidence or third party evidence of selling price for deliverables in an arrangement cannot be determined, the Company develops a best estimate of the selling price to separate deliverables and allocates arrangement consideration using the relative selling price method. Additionally, this guidance eliminates the residual method of allocation. If an arrangement includes undelivered elements that are not essential to the functionality of the delivered elements, we defer the fair value of the undelivered elements based on the estimated selling price of the total arrangement. Fair value is determined based upon the price charged when the element is sold separately. If there is not sufficient evidence of the fair value of the undelivered elements, no revenue is allocated to the delivered elements and the total consideration received is deferred until delivery of those elements for which objective and reliable evidence of the fair value is not available. We provide certain customers with extended service contracts with revenue recognized ratably over the life of the contract.

Cash and Cash Equivalents

Our policy is to invest available cash in short-term, investment-grade, interest-bearing obligations, including money market funds, and bank and corporate debt instruments. Securities purchased with initial maturities of three months or less are valued at cost plus accrued interest, which approximates fair market value, and are classified as cash equivalents.

Research and Development

Research and development costs, which are comprised of costs incurred in performing research and development activities including wages and associated employee benefits, facilities, consumable products and overhead costs that are expensed as incurred. In support of our research and development activities we utilize our Barocycler instruments that are capitalized as fixed assets and depreciated over their expected useful life.

Inventories

Inventories are valued at the lower of cost (average cost) or market (sales price). The cost of Barocycler instruments consists of the cost charged by the contract manufacturer. The cost of manufactured goods includes material, freight-in, direct labor, and applicable overhead. The composition of inventory as of June 30, 2013 and December 31, 2012 is as follows:

	June 30,			December 31,
	2013			2012
Raw materials	$	204,025		$	183,655
Finished goods		712,614			789,707
Inventory reserve		(50,000	)		(50,000	)
Total	$	866,639		$	923,362

Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation. For financial reporting purposes, depreciation is recognized using the straight-line method, allocating the cost of the assets over their estimated useful lives of three years for certain laboratory equipment, from three to five years for management information systems and office equipment, and three years for all PCT finished units classified as fixed assets. Property and equipment includes net book value of $6,038 relating to Barocycler instruments held under lease or collaboration.

Intangible Assets

We have classified as intangible assets, costs associated with the fair value of acquired intellectual property. Intangible assets including patents are amortized on a straight-line basis over sixteen years. The Company’s intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. When impairment is indicated, any excess of carrying value over fair value is recorded as a loss. As of the date of this report’s filing, no event has come to our attention that would cause us to record an impairment of intangible assets.

Long-Lived Assets and Deferred Costs

The Company’s long-lived assets and other assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of an asset to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If such asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. Through the date of this report’s filing, the Company had not experienced impairment losses on its long-lived assets.

Concentrations

Credit Risk

Our financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash, cash equivalents, and trade receivables. We have cash investment policies which, among other things, limit investments to investment-grade securities. We perform ongoing credit evaluations of our customers, and the risk with respect to trade receivables is further mitigated by the fact that many of our customers are government institutions, large pharmaceutical and biotechnology companies, and academic laboratories.

The following table illustrates the level of concentration as a percentage of total revenues during the three months and six months ended June 30, 2013 and 2012:

	For the Three Months Ended
	June 30,
	2013			2012
Top Five Customers		87	%		73	%
Federal Agencies		61	%		49	%

	For the Six Months Ended
	June 30,
	2013			2012
Top Five Customers		69	%		60	%
Federal Agencies		55	%		50	%

The following table illustrates the level of concentration as a percentage of net accounts receivable balance as of June 30, 2013 and December 31, 2012:

	June 30,			December 31,
	2013			2012
Top Five Customers		76	%		34	%
Federal Agencies		35	%		32	%

Product Supply

Source Scientific, LLC has been our sole contract manufacturer for our PCT NEP3229 and NEP2320 instrumentation. Until we develop a network of manufacturers and subcontractors, obtaining alternative sources of supply or manufacturing services could involve significant delays and other costs and challenges, and may not be available to us on reasonable terms, if at all. The failure of a supplier or contract manufacturer to provide sufficient quantities, acceptable quality and timely products at an acceptable price, or an interruption of supplies from such a supplier could harm our business and prospects.

Computation of Loss per Share

Computation of Loss per Share

Basic loss per share is computed by dividing loss available to common shareholders by the weighted average number of common shares outstanding. Diluted loss per share is computed by dividing loss available to common shareholders by the weighted average number of common shares outstanding plus additional common shares that would have been outstanding if dilutive potential common shares had been issued. For purposes of this calculation, convertible preferred stock, common stock dividends, and warrants and options to acquire common stock, are all considered common stock equivalents in periods in which they have a dilutive effect and are excluded from this calculation in periods in which these are anti-dilutive to our net loss.

The following table illustrates our computation of loss per share for the three months and six months ended June 30, 2013 and 2012:

	For the Three Months Ended						For the Six Months Ended
	June 30,						June 30,
	2013			2012			2013			2012
Numerator:
Net loss	$	(1,066,041	)	$	(509,692	)	$	(1,845,410	)	$	(1,572,599	)
Accrued dividend for Preferred Stock		(39,237	)		(394,430	)		(71,410	)		(418,844	)
Deemed dividend on Series J Convertible Preferred Stock		(68,634	)		-			(651,182	)		-
Deemed dividend on warrant modifications		-			(185,544	)		-			(185,544	)
Net loss applicable to common shareholders	$	(1,173,912	)	$	(1,089,666	)	$	(2,568,002	)	$	(2,176,987	)

Denominator for basic and diluted loss per share:
Weighted average common stock shares outstanding		11,521,794			10,197,850			11,883,797			10,352,461

Loss per common share - basic and diluted	$	(0.10	)	$	(0.11	)	$	(0.22	)	$	(0.21	)

The following table presents securities that could potentially dilute basic loss per share in the future. For all periods presented, the potentially dilutive securities were not included in the computation of diluted loss per share because these securities would have been anti-dilutive to our net loss. The Series C Convertible Preferred Stock, Series D Convertible Preferred Stock, Series G Convertible Preferred Stock, Series H Convertible Preferred Stock and Series J Convertible Preferred Stock are presented below as if they were converted into common shares according to the conversion terms in Note 5.

	For the Six Months Ended
	June 30,
	2013		2012
Stock options		1,759,552		1,555,500
Convertible debt		625,000		7,000
Common stock warrants		11,774,599		5,115,533
Preferred stock warrants		-		-
Convertible preferred stock:
Series D Convertible Preferred		750,000		461,539
Series E Convertible Preferred		-		343,137
Series G Convertible Preferred		1,453,200		-
Series H Convertible Preferred		1,000,000		-
Series J Convertible Preferred		5,087,500		-
		22,449,851		7,482,709

Accounting for Income Taxes

Accounting for Income Taxes

We account for income taxes under the asset and liability method, which requires recognition of deferred tax assets, subject to valuation allowances, and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. A valuation allowance is established if it is more likely than not that all or a portion of the net deferred tax assets will not be realized. If substantial changes in the Company’s ownership should occur, as defined in Section 382 of the Internal Revenue Code, there could be sufficient limitations on the amount of net loss carry forwards that could be used to offset future taxable income.

Warrant Derivative Liability

The warrants issued in connection with the registered direct offering of Series D Convertible Preferred Stock (the “Series D Warrants”) are measured at fair value and liability-classified because the Series D Warrants contain “down-round protection” and therefore, do not meet the scope exception under ASC 815, Derivatives and Hedging, (“ASC 815”). Since “down-round protection” is not an input into the calculation of the fair value of the warrants, the warrants cannot be considered indexed to the Company’s own stock which is a requirement for the scope exception as outlined under ASC 815. The estimated fair value of the warrants was determined using the binomial model, resulting in an allocation of the gross proceeds of $283,725 to the warrants issued in the Series D registered direct offering. The fair value will be affected by changes in inputs to that model including our stock price, expected stock price volatility, the contractual term, and the risk-free interest rate. We will continue to classify the fair value of the warrants as a liability until the warrants are exercised, expire or are amended in a way that would no longer require these warrants to be classified as a liability, whichever comes first. The down-round protection for the Series D Warrants survives for the life of the Series D Warrants which ends in May 2017.

Conversion Option Liability

The Company signed three convertible notes and has determined that conversion options are embedded in the notes and it is required to bifurcate the conversion option from the host contract under ASC 815 and account for the derivatives at fair value. The estimated fair value of the conversion options was determined using the binomial model. The fair value of the conversion options will be classified as a liability until the debt is converted by the note holders or paid back by the Company. The fair value will be affected by changes in inputs to that model including our stock price, expected stock price volatility, the contractual term, and the risk-free interest rate. We will continue to classify the fair value of the conversion options as a liability until the conversion options are exercised, expire or are amended in a way that would no longer require these conversion options to be classified as a liability, whichever comes first. The Company has adopted a sequencing policy that reclassifies contracts (from equity to assets or liabilities) with the most recent inception date first. Thus any available shares are allocated first to contracts with the most recent inception dates.

Accounting for Stock-Based Compensation

We maintain equity compensation plans under which incentive stock options and non-qualified stock options are granted to employees, independent members of our Board of Directors and outside consultants. We recognize stock-based compensation expense over the requisite service period using the Black-Scholes formula to estimate the fair value of the stock options on the date of grant.

Determining Fair Value of Stock Option Grants

Valuation and Amortization Method - The fair value of each option award is estimated on the date of grant using the Black-Scholes pricing model based on certain assumptions. The estimated fair value of employee stock options is amortized to expense using the straight-line method over the vesting period, which is over four years for options granted in 2012 and 2013.

Expected Term - The Company uses the simplified calculation of expected life, as the Company does not currently have sufficient historical exercise data on which to base an estimate of expected term. Using this method, the expected term is determined using the average of the vesting period and the contractual life of the stock options granted.

Expected Volatility - Expected volatility is based on the Company’s historical stock volatility data over the expected term of the award.

Risk-Free Interest Rate - The Company bases the risk-free interest rate used in the Black-Scholes valuation method on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term.

Forfeitures - The Company records stock-based compensation expense only for those awards that are expected to vest. The Company estimated a forfeiture rate of 5% for awards granted based on historical experience and future expectations of options vesting. The Company used this historical rate as our assumption in calculating future stock-based compensation expense.

We recognized stock-based compensation expense of $8,977 and $11,222 for the three months ended June 30, 2013 and 2012, respectively. The following table summarizes the effect of this stock-based compensation expense within each of the line items of our costs and expenses within our Condensed Consolidated Statements of Operations:

	For the Three Months Ended June 30,
	2013		2012
Research and development	$	667	$	3,508
Selling and marketing		523		3,669
General and administrative		7,787		4,045
Total stock-based compensation expense	$	8,977	$	11,222

We recognized stock-based compensation expense of $28,017 and $20,090 for the six months ended June 30, 2013 and 2012, respectively. The following table summarizes the effect of this stock-based compensation expense within each of the line items of our costs and expenses within our Condensed Consolidated Statements of Operations:

	For the Six Months Ended June 30,
	2013		2012
Research and development	$	5,503	$	6,125
Selling and marketing		4,192		6,783
General and administrative		18,322		7,182
Total stock-based compensation expense	$	28,017	$	20,090

Fair Value of Financial Instruments

Due to their short maturities, the carrying amounts for cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate their fair value. Long-term liabilities are primarily related to liabilities transferred under contractual arrangements with carrying values that approximate fair value.

Fair Value Measurements

Fair Value Measurements

The Company follows the guidance of FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”) as it related to all financial assets and financial liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis.

The Company generally defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company uses a three-tier fair value hierarchy, which classifies the inputs used in measuring fair values. These tiers include: Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring the Company to develop its own assumptions.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company has determined that it does not have any financial assets measured at fair value and that its financial liabilities are currently all classified within Level 3 in the fair value hierarchy. The development of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s management.

The following tables set forth the Company’s financial liabilities that were accounted for at fair value on a recurring basis as of June 30, 2013.

			Fair value measurements at June 30, 2013 using:
	June 30, 2013		Quoted prices in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Series D Preferred Stock Purchase Warrants	$	284,876		-		-	$	284,876

	January 1, 2013		Change in Fair Value		June 30, 2013
Series D Preferred Stock Purchase Warrants	$	160,812	$	124,064	$	284,876

The assumptions for the binomial pricing model are represented in the table below for the warrants issued in the Series D private placement reflected on a per share common stock equivalent basis.

Assumptions	November 10, 2011			Warrants revalued at December 31, 2012			Warrants revalued at June 30, 2013
Expected life (in months)		60.0			46.0			40.0
Expected volatility		104.5	%		146.4	%		111.5	%
Risk-free interest rate		0.875	%		0.44	%		0.36	%
Exercise price	$	0.81		$	0.40		$	0.40
Fair value per warrant	$	0.54		$	0.15		$	0.23

The following tables set forth the Company’s financial liabilities that were accounted for at fair value on a recurring basis as of June 30, 2013.

			Fair value measurements at June 30, 2013 using:
	June 30, 2013		Quoted prices in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
April 11, 2013 note, conversion option	$	178,942					$	178,942
May 24, 2013 note, conversion option		124,559						124,559
June 6, 2013 note, conversion option		112,061						112,061
June 26, 2013 note, conversion option		81,939						81,939
Embedded conversion options	$	497,501		-		-	$	497,501

	Issuance fair value		Change in fair value			June 30, 2013
April 11, 2013 note, conversion option	$	274,840	$	(95,898	)	$	178,942
May 24, 2013 note, conversion option		122,223		2,336			124,559
June 6, 2013 note, conversion option		158,715		(46,654	)		112,061
June 26, 2013 note, conversion option		84,146		(2,207	)		81,939
Embedded conversion options	$	639,924	$	(142,423	)	$	497,501

The assumptions for the binomial pricing model are represented in the table below for the warrants issued in the Series D private placement reflected on a per share common stock equivalent basis.

Assumptions	April 11, 2013			Conversion options revalued at June 30, 2013
Expected life (in months)		12			9
Expected volatility		206.2	%		142.2	%
Risk-free interest rate		0.10	%		0.15	%
Exercise price	$	0.14		$	0.17
Fair value per conversion option	$	0.29		$	0.22

Assumptions	May 24, 2013			Conversion options revalued at June 30, 2013
Expected life (in months)		24			23
Expected volatility		170.0	%		165.2	%
Risk-free interest rate		0.27	%		0.36	%
Exercise price	$	0.25		$	0.21
Fair value per conversion option	$	0.31		$	0.30

Assumptions	June 6, 2013			Conversion options revalued at June 30, 2013
Expected life (in months)		12			11
Expected volatility		209.7	%		155.5	%
Risk-free interest rate		0.13	%		0.15	%
Exercise price	$	0.40		$	0.40
Fair value per conversion option	$	0.25		$	0.18

Assumptions	June 26, 2013			Conversion options revalued at June 30, 2013
Expected life (in months)		12			12
Expected volatility		189.2	%		179.8	%
Risk-free interest rate		0.13	%		0.15	%
Exercise price	$	0.17		$	0.17
Fair value per conversion option	$	0.26		$	0.25

Advertising

Advertising costs are expensed as incurred. We did not incur significant advertising expenses during the three or six months ended June 30, 2013 or in the same period of the prior year.