Pressure BioSciences, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

2. Summary of Significant Accounting Policies (Policies)

2. Summary of Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2013

The 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 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 impairment of assets, 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

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, lease, or rent through our domestic sales force. 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 instrumentation at the customer location, for domestic installations. Product revenue related to sales of PCT instrumentation to our foreign distributors is recognized upon shipment through a common carrier. 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.

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.

Revenue from service contracts is recorded ratably over the length of the contract.

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. 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 to such time as they are delivered. 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 the Company uses its best estimate of the value of those items and recognizes revenues based on the relative values of the delivered and undelivered items. 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 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 Barocyclers 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 December 31, 2013 and 2012 is as follows:

	December 31,
	2013			2012
Raw materials	$	147,290		$	183,655
Finished goods		639,386			789,707
Inventory reserve		(50,000	)		(50,000	)
Total	$	736,676		$	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.

Intangible Assets

We have classified as intangible assets, costs associated with the fair value of acquired intellectual property. Intangible assets, including patents, are being amortized on a straight-line basis over sixteen years. We perform an annual review of our intangible assets for impairment. When impairment is indicated, any excess of carrying value over fair value is recorded as a loss. An impairment analysis of intangible assets was performed as of December 31, 2013. Based on this analysis, we have concluded that no impairment of intangible assets had occurred.

Long-Lived Assets and Deferred Costs

The Company’s long-lived assets and other assets are reviewed for impairment in accordance with the guidance of the FASB ASC 360-10-05, Property, Plant, and Equipment, 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 December 31, 2013, the Company had not experienced impairment losses on its long-lived assets. While our current and historical operating losses and cash flow are indicators of impairment, we performed an impairment test at December 31, 2013 and determined that such long-lived assets were not impaired.

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 and university labs. Allowances are provided for estimated amounts of accounts receivable which may not be collected. At December 31, 2013 and 2012, we determined that no allowance against accounts receivable was necessary.

The following table illustrates the level of concentration of the below two groups within revenue as a percentage of total revenues during the years ended December 31, 2013 and 2012:

	For the Year Ended
	December 31,
	2013			2012
Top Five Customers		53	%		50	%
Federal Agencies		33	%		41	%

The following table illustrates the level of concentration of the below two groups within accounts receivable as a percentage of total accounts receivable balance as of December 31, 2012 and 2011:

	For the Year Ended
	December 31,
	2013			2012
Top Five Customers		86	%		34	%
Federal Agencies		16	%		32	%

Product Supply

BIT Group USA, formerly Source Scientific, LLC, has been our sole contract manufacturer for all of our PCT instrumentation. Until we develop a broader 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

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, warrants to acquire preferred stock convertible into Common Stock, 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. The following table illustrates our computation of loss per share for the years ended December 31, 2013 and 2012.

	For the Year Ended
	December 31,
	2013			2012
Numerator:
Net loss	$	(4,084,427	)	$	(3,450,205	)
Accrued dividend for Preferred Stock paid in common stock		-			(278,184	)
Deemed dividend on warrant modifications		-			(190,891	)
Issuance of common stock for dividends paid in kind		-			(284,116	)
Beneficial conversion feature for preferred stock		(1,002,602	)		-
Preferred dividends accrued		(100,420	)		-
Preferred dividends paid in cash		(60,000	)		(196,819	)
Net loss applicable to common shareholders	$	(5,247,449	)	$	(4,400,215	)

Denominator for basic and diluted loss per share:
Weighted average common shares outstanding		11,821,870			10,154,175

Loss per common share - basic and diluted	$	(0.44	)	$	(0.43	)

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.

	For the Year Ended
	December 31,
	2013		2012
Stock options		1,771,708		1,605,750
Convertible debt		2,242,024		-
Common stock warrants		15,012,327		6,687,099
Preferred stock warrants		-		-
Convertible preferred stock:
Series A Convertible Preferred		-		-
Series B Convertible Preferred		-		-
Series C Convertible Preferred		-		-
Series D Convertible Preferred		750,000		750,000
Series E Convertible Preferred		-		-
Series G Convertible Preferred		1,453,200		1,453,200
Series H Convertible Preferred		1,000,000		-
Series J Convertible Preferred		5,087,500		-
Series K Convertible Preferred		4,000,000		-
		31,316,759		10,496,049

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. The Company considers many factors when assessing the likelihood of future realization of our deferred tax assets, including recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income or loss, the carry-forward periods available to us for tax reporting purposes, and other relevant factors. 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 significant limitations on the amount of net loss carry forwards that could be used to offset future taxable income.

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 equity 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 generally is over three years.

Expected Term - The Company uses the simplified calculation of expected life, described in the FASB ASC 718, Compensation-Stock Compensation, 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 - As required by FASB ASC 718, Compensation-Stock Compensation, 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. We used this historical rate as our assumption in calculating future stock-based compensation expense.

The following table summarizes the assumptions we utilized for grants of stock options to the three sub-groups of our stock option recipients during the twelve months ended December 31, 2013 and 2012:

Assumptions	Non-Employee Board Members	CEO, other Officers and Employees
Expected life	2.0-5.0 (yrs)	6.0 (yrs)
Expected volatility	55.66%-134.75%	55.66%-124.89%
Risk-free interest rate	1.00%-4.94%	0.50%-4.94%
Forfeiture rate	0.00%-5.00%	2.00%-5.00%
Expected dividend yield	0.0%	0.0%

On August 15, 2012, the Board of Directors approved the immediate re-pricing of certain outstanding stock options (approximately 1,555,500 shares) held by current officers, employees and board members with outstanding stock options to $1.00 per share, a 200% premium to the closing market price on August 15, 2012 of $0.32, for original stock options with an exercise price above $1.00, to $0.60 per share, a 88% premium to the closing market price on August 15, 2012 of $0.32, for original stock options with an exercise price below $1.00 but above $0.60. The compensation value created by the re-pricing, as determined under the Black-Scholes method, was approximately $62,000 and under current accounting rules results in a non-cash expense in current and future periods, not to exceed the vesting periods of the stock options.

Assumptions for re-pricing of the options were:

Assumptions	Awards re-priced during the year ended December 31, 2012
Expected life (in years)		6
Weighted average expected volatility		124.9	%
Risk-free interest rate		0.7	%
Weighted average re-priced Black-Scholes calculated fair value		0.32

We recognized stock-based compensation expense of $136,796 and $133,193 for the years ended December 31, 2013 and 2012, respectively. The following table summarizes the effect of this stock-based compensation expense within each of the line items within our accompanying Consolidated Statements of Operations:

	For the Year Ended December 31,
	2013		2012
Research and development	$	53,509	$	30,034
Selling and marketing		26,551		28,944
General and administrative		56,736		74,215
Total stock-based compensation expense	$	136,796	$	133,193

During the years ended December 31, 2013 and 2012, the total fair value of stock options awarded was $128,642 and $116,816, respectively.

As of December 31, 2013, the total estimated fair value of unvested stock options to be amortized over their remaining vesting period was $65,953. The non-cash, stock based compensation expense associated with the vesting of these options will be $45,598 in 2014, $18,575 in 2015, and $1,780 in 2016.

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. Short-term and long-term liabilities are primarily related to liabilities transferred under contractual arrangements with carrying values that approximate fair value.

Advertising

Advertising costs are expensed as incurred. During 2013 we did not spend anything on advertising. We incurred $500 in advertising expense in 2012.

Fair Value Measurements

The Company follows the guidance of FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”) as of June 30, 2012, 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 an entity 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 following tables set forth the Company’s financial liabilities that were accounted for at fair value on a recurring basis as of December 31, 2013 and December 31, 2012. The assumptions used to determine fair value of the warrants are contained in the table in Note 7 of the accompanying consolidated financial statements. The development of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s management.

			Fair value measurements at December 31, 2013 using:
	December 31, 2013		Quoted prices in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Series D Common Stock Purchase Warrants	$	344,570	$	-	$	-	$	344,570

			Fair value measurements at December 31, 2012 using:
	December 31, 2012		Quoted prices in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Series D Common Stock Purchase Warrants	$	160,812	$	-	$	-	$	160,812

January 1,

2013

Change in Fair Value

December 31,

2013

Series D Common Stock Purchase Warrants

160,812

183,758

344,570

January 1,

2012

Change in Fair Value

December 31,

2012

Series D Common Stock Purchase Warrants

231,200

(70,388

)

160,812

	Fair value measurements at December 31, 2013 using:
	December 31, 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	$	130,734		-		-	$	130,734
June 26, 2013 note, conversion option		55,307		-		-		55,307
December 4, 2013 note, conversion option		98,129		-		-		98,129
December 23, 2013 note, conversion option		72,027		-		-		72,027
Embedded conversion options	$	356,197		-		-	$	356,197

	Issuance date fair value		Change in fair value			Reclassified			December 31, 2013
April 11, 2013 note, conversion option	$	274,840	$	(144,106	)	$	-		$	130,734
May 24, 2013 note, conversion option		122,223		(18,702	)		(103,521	)		-
June 6, 2013 note, conversion option		158,715		(120,535	)		(38,180	)		-
June 26, 2013 note, conversion option		84,146		(28,839	)		-			55,307
December 4, 2013 note, conversion option		77,388		20,741			-			98,129
December 23, 2013 note, conversion option		59,903		12,124			-			72,027
Embedded conversion options	$	777,215	$	(279,317	)	$	(141,701	)	$	356,197

The assumptions for the binomial pricing model are represented in the table below for the conversion options reflected on a per share common stock equivalent basis.

Assumptions	April 11, 2013			Conversion options revalued at December 31, 2013
Expected life (in months)		12			4
Expected volatility		206.2	%		149.9	%
Risk-free interest rate		0.10	%		0.04	%
Exercise price	$	0.14		$	0.14
Fair value per conversion option	$	0.29		$	0.13

Assumptions	May 24, 2013			Conversion options revalued at November 22, 2013
Expected life (in months)		24			18
Expected volatility		170.0	%		181.8	%
Risk-free interest rate		0.27	%		0.35	%
Exercise price	$	0.25		$	0.17
Fair value per conversion option	$	0.31		$	0.17

Assumptions	June 6, 2013			Conversion options revalued at December 26, 2013
Expected life (in months)		12			5
Expected volatility		209.7	%		132.9	%
Risk-free interest rate		0.13	%		0.07	%
Exercise price	$	0.40		$	0.40
Fair value per conversion option	$	0.25		$	0.06

Assumptions	June 26, 2013			Conversion options revalued at December 31, 2013
Expected life (in months)		12			6
Expected volatility		189.2	%		136.5	%
Risk-free interest rate		0.13	%		0.07	%
Exercise price	$	0.17		$	0.14
Fair value per conversion option	$	0.26		$	0.14

Assumptions	December 4, 2013			Conversion options revalued at December 31, 2013
Expected life (in months)		24			23
Expected volatility		170.3	%		170.3	%
Risk-free interest rate		0.30	%		0.38	%
Exercise price	$	0.40		$	0.40
Fair value per conversion option	$	0.16		$	0.18

Assumptions	December 23, 2013			Conversion options revalued at December 31, 2013
Expected life (in months)		36			36
Expected volatility		151.4	%		152.5	%
Risk-free interest rate		0.77	%		0.78	%
Exercise price	$	0.40		$	0.40
Fair value per conversion option	$	0.17		$	0.19