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)

9 Months Ended

Sep. 30, 2012

Principles of Consolidation

The consolidated condensed 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

Use of Estimates

To prepare our consolidated condensed 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 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 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 and overseas customers 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 Barocycler 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. 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

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

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

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 September 30, 2012 and December 31, 2011 is as follows:

	September 30,		December 31,
	2012		2011
Raw materials	$	163,260	$	193,121
Finished goods		742,393		875,892
Total	$	905,653	$	1,069,013

Our finished goods inventory as of September 30, 2012 included 58 Barocycler instruments. Our finished goods inventory as of December 31, 2011 included 68 Barocycler instruments.

Property and Equipment

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 $24,104 relating to Barocycler instruments held under lease or collaboration.

Intangible Assets

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

Long-Lived Assets and Deferred Costs

The Company’s long-lived assets and other assets are reviewed for impairment at least annually or 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

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 nine months ended September 30, 2012 and 2011:

	For the Three Months Ended
	September 30,
	2012		2011
Top Five Customers		76%		58%
Federal Agencies		38%		29%

	For the Nine Months Ended
	September 30,
	2012		2011
Top Five Customers		54%		29%
Federal Agencies		46%		15%

The following table illustrates the level of concentration as a percentage of net accounts receivable balance as of September 30, 2012 and December 31, 2011:

	September 30,		December 31,
	2012		2011
Top Five Customers		76%		89%
Federal Agencies		30%		42%

Product Supply

Source Scientific, LLC has been our sole contract manufacturer for all of our PCT 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 nine months ended September 30, 2012 and 2011:

	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2012			2011			2012			2011
Numerator:
Net loss	$	(796,038	)	$	(561,723	)	$	(2,368,637	)	$	(2,153,269	)
Accrued interest on convertible debt, after tax		—			5,208			—			5,208
Accrued dividend for Preferred Stock		(36,092	)		(71,736	)		(454,936	)		(196,310	)
Beneficial conversion feature for Preferred Stock		—			—			—			(304,823	)
Preferred dividends paid in Common Stock		(88,350	)		—			(249,907	)		(76,017	)
Preferred dividends paid in cash		—			—			—			(42,037	)
Deemed dividend on warrant modifications		(5,347	)		(325,595	)		(190,891	)		(325,595	)
Net loss applicable to common shareholders	$	(925,827	)	$	(953,846	)	$	(3,264,371	)	$	(3,092,843	)
Denominator for basic and diluted loss per share:
Weighted average common stock shares outstanding		10,872,877			6,253,349			9,598,066			6,228,585
Loss per common share - basic and diluted	$	(0.09	)	$	(0.15	)	$	(0.34	)	$	(0.50	)

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 A Convertible Preferred Stock, Series B Convertible Preferred Stock, Series C Convertible Preferred Stock, Series D Convertible Preferred Stock, Series E Convertible Preferred Stock, and Series G Convertible Preferred Stock are presented below as if they were converted into common shares according to the conversion terms in Note 5. All of the outstanding shares of Series A Convertible Preferred Stock and Series B Convertible Preferred Stock were voluntarily converted by the holders in 2011 into shares of common stock. On April 5, 2012, the holders of the Series C Convertible Preferred Stock exchanged all of their Series C Preferred Stock and warrants (“Series C Units”) for units that we offered in our February 2012 private placement consisting of shares of common stock and warrants to purchase shares of common stock (with a warrant to purchase 0.5 shares of common stock for each share of common stock purchased in the February 2012 private placement), resulting in an aggregate of 1,372,247 shares of common stock and warrants to purchase an aggregate of 686,125 shares of common stock being issued to the holders of Series C Units.

	For the Three Months Ended				For the Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
Stock options		1,680,250		1,503,500		1,680,250		1,503,500
Convertible debt		—		412,000		—		412,000
Common stock warrants		6,080,501		4,210,074		6,080,501		4,210,074
Convertible preferred stock:
Series A Convertible Preferred		—		155,710		—		155,710
Series B Convertible Preferred		—		13,480		—		13,480
Series C Convertible Preferred		—		880,980		—		880,980
Series D Convertible Preferred		750,000		—		750,000		—
Series E Convertible Preferred		245,098		—		245,098		—
Series G Convertible Preferred		1,200,950		—		1,200,950		—
		9,956,799		7,175,744		9,956,799		7,175,744

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 significant limitations on the amount of net loss carry forwards that could be used to offset future taxable income.

Warrant Derivative Liability

Warrant Derivative Liability

The warrants issued in connection with the Series C Convertible Preferred Stock private placement (the “Series C Warrants”) and 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 C Warrants are entitled to certain rights in subsequent financings and the Series D Warrants contain “down-round protection” and, therefore, do not meet the scope exception for treatment as a derivative 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 $583,250 to the total warrants issued in the Series C private placement and $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. Effective immediately with the April 5, 2012 exchange of Series C Warrants for the warrants issued in our February 2012 private placement, the down-round protection for Series C Warrants ended. We reclassified the fair value of $132,665 associated with the Series C Warrants valued as of April 5, 2012 to Stockholders’ Equity from the Warrant Derivative Liability.

Accounting for Stock-Based Compensation

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 is over four years for options granted in 2012.

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. We used this historical rate as our assumption in calculating future stock-based compensation expense.

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. Accordingly, the value of the employee stock-based compensation recognized for the three months ended September 30, 2012 amounted to $96,726, including the $62,000 discussed above, compared to $32,520 recognized in the comparable quarter of the prior fiscal year.

Assumptions for re-pricing of options during the three months ended September 30, 2012 were:

Assumptions	Awards re-priced during the three months ended September 30, 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 $96,726 and $32,520 for the three months ended September 30, 2012 and 2011, 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 Consolidated Statements of Operations:

	For the Three Months Ended, September 30,
	2012		2011
Research and development	$	21,633	$	11,609
Selling and marketing		17,877		6,452
General and administrative		57,216		14,459
Total stock-based compensation expense	$	96,726	$	32,520

We recognized stock-based compensation expense of $116,816 and $113,689 for the nine months ended September 30, 2012 and 2011, 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 Consolidated Statements of Operations:

	For the Nine Months Ended, September 30,
	2012		2011
Research and development	$	27,759	$	36,951
Selling and marketing		24,659		40,192
General and administrative		64,398		36,546
Total stock-based compensation expense	$	116,816	$	113,689

Fair Value of Financial Instruments

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. Our promissory notes and short-term loans are primarily related to liabilities transferred under contractual arrangements with carrying values that approximate fair value.

Fair Value Measurements

Fair Value Measurements

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. For fair value measurements categorized within Level 3 of the fair value hierarchy, the Vice President of Finance and Administration determines the Company’s valuation policy and procedures. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Vice President of Finance and Administration and are approved by the Chief Financial Officer.

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 September 30, 2012. The Series C Common Stock Purchase Warrants were exchanged for warrants without a derivative feature and were reclassified as an equity instrument within Stockholders’ Equity as of September 30, 2012.

			Fair value measurements at September 30, 2012 using:
	September 30, 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		267,566		—		—		267,566
	$	267,566	$	—	$	—	$	267,566

	January 1, 2012		Change in Fair Value			Reclassified to Equity			September 30, 2012
Series C Common Stock Purchase Warrants	$	205,353	$	(72,688	)	$	(132,665	)	$	—
Series D Common Stock Purchase Warrants		231,200		36,366			—			267,566
	$	436,553	$	(36,322	)	$	(132,665	)	$	267,566

The following table sets forth the Company’s financial liabilities that were accounted for at fair value on a recurring basis as of December 31, 2011.

	January 1, 2011		Change in Fair Value		December 31, 2011
Series C Common Stock Purchase Warrants	$	—	$	205,353	$	205,353
Series D Common Stock Purchase Warrants		—		231,200		231,200
	$	—	$	436,553	$	436,553

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

					Warrants revalued at April 5, 2012
Assumptions	April 8, 2011		June 20, 2011		April 8, 2011		June 20, 2011
Expected term (in months)		36.0		36.0		24.0		24.0
Expected volatility		118.5%		118.5%		100%		100%
Risk-free interest rate		0.625%		0.625%		0.75%		0.75%
Exercise price	$	2.13	$	2.13	$	2.13	$	2.13
Fair value per warrant	$	0.70	$	0.62	$	0.15	$	0.15

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 September 30, 2012
Expected term (in months)		60.0		50.0
Expected volatility		104.5%		146.4%
Risk-free interest rate		0.875%		0.4375%
Exercise price	$	0.81	$	0.40
Fair value per warrant	$	0.54	$	0.26

Rent Expense

Rent Expense

Rental costs are expensed as incurred. During the nine months ended September 30, 2012 and 2011, we incurred $88,200 and $103,248, respectively, in rent expense for the use of our corporate office and research and development facilities.