General

3 Months Ended

Dec. 30, 2012

Accounting Policies [Abstract]

Note 1 - General

The information contained in the following Notes to Condensed Consolidated Financial Statements is condensed from that which appears in the audited consolidated financial statements for ISC8 Inc. (“ISC8”), and its subsidiaries (together with ISC8, the “Company”), and the accompanying unaudited condensed consolidated financial statements do not include certain financial presentations normally required under accounting principles generally accepted in the United States of America (“GAAP”). Accordingly, the unaudited condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and related notes contained in the Annual Report on Form 10-K of the Company for the fiscal year ended September 30, 2012 (“Fiscal 2012”), including the risk factors contained therein, as updated in our Quarterly Report on Form 10-Q for the quarter ended December 30, 2012. It should be understood that accounting measurements at interim dates inherently involve greater reliance on estimates than at year-end. The results of operations for the interim periods presented are not necessarily indicative of the results expected for the entire year.

The consolidated financial information for the 13-week periods ended December 30, 2012 and January 1, 2012 included herein is unaudited but includes all normal recurring adjustments which, in the opinion of management, are necessary to present fairly the consolidated financial position of the Company at December 30, 2012, and the results of its operations and its cash flows for the 13-week period ended December 30, 2012 as compared to the same period ended January 1, 2012.

The Company sold its thermal imaging business, consisting of the Company’s business of researching, developing, designing, manufacturing, producing, marketing, selling and distributing thermal camera products, including clip-on thermal imagers, thermal handheld and mounted equipment devices, other infrared imaging devices and thermal cameras, and in all cases, related thermal imaging products (the “Thermal Imaging Business”), to Vectronix, Inc. (“Vectronix”) on January 31, 2012 (the “Thermal Imaging Asset Sale”) pursuant to an Asset Purchase Agreement dated October 17, 2011 between the Company and Vectronix (the “Thermal Imaging APA”). The operations of the Thermal Imaging Business are presented as discontinued operations. To provide comparability between the periods, the consolidated financial information for the 13-week period ended January 1, 2012 has been reclassified to reflect the Company’s results of continuing operations excluding the Thermal Imaging Business.

The condensed consolidated financial information as of September 30, 2012 included herein is derived from the Company’s audited consolidated financial statements as of, and for the year ended, September 30, 2012.

Description of Business

The Company is actively engaged in the design, development, manufacture and sale of security products, particularly cyber security solutions for government and commercial applications, utilizing technologies we  pioneered for three-dimensional (“3-D”) stacking of various products including semiconductors, anti-tamper systems, high-speed processor assemblies, and miniaturized vision systems and sensors. The Company also performs customer-funded contract research and development related to these products, mostly for U.S. Government customers or other prime contractors.

Acquisition of Bivio Software

On October 12, 2012, pursuant to the terms of the Foreclosure Sale Agreement between the Company and GF Acquisition Co. 2012, LLC (“GFAC”) dated October 4, 2012 (the “Foreclosure Sale Agreement”), the Company acquired substantially all of the assets of the NetFalcon and the Network Content Control System Business of Bivio Networks, Inc. and certain of its subsidiaries, an international provider of cyber security solutions and products (“Bivio” or “Bivio Software”).  The purchase price was $600,000 payable in cash to GFAC, and the issuance to GFAC of a warrant to purchase 1,000,000 shares of common stock of the Company at the lower of $0.12 or the price of a future equity financing (“Bivio Warrant”). In addition, the Company assumed certain liabilities, including accounts payable, contractual obligations, reclamation obligations and other liabilities related to Bivio Software.

Summary of Significant Accounting Policies

Revenues.  We primarily derive our revenues from three sources, (i) contracts to develop prototypes and provide research, development, design, testing and evaluation of complex detection and control defense systems, (ii) product sales, and (iii) cyber related software revenue.

Research and Development Contracts

This segment relates primarily to our Government contracting business, our cyber products and some of our Secure Memory products which are funded internally and are part of our operating expense. The terms of our government research and development contracts are usually cost reimbursement plus a fixed fee, fixed price with billing entitlements based on the level of effort we expend, or occasionally firm fixed price. Our cost reimbursement plus fixed fee research and development contracts require our good faith performance of a statement of work within overall budgetary constraints, but with latitude as to resources utilized. Our fixed price level of effort research and development contracts require us to deliver a specified number of labor hours in the performance of a statement of work. Our firm fixed price research and development contracts require us to deliver specified items of work independent of resources utilized to achieve the required deliverables. For all types of research and development contracts, we recognize revenues as we incur costs and include applicable fees or profits primarily in the proportion that costs incurred bear to estimated final costs. Costs and estimated earnings in excess of billings under U.S. government research and development contracts are accounted for as unbilled revenues on uncompleted contracts, stated at estimated realizable value and are expected to be realized in cash within one year.

Upon the initiation of each research and development contract, a detailed cost budget is established for direct labor, material, subcontract support and allowable indirect costs based on our proposal and the required scope of the contract as may have been modified by negotiation with the customer, usually a U.S. government agency or prime contractor. A program manager is assigned to secure the needed labor, material and subcontract in the program budget to achieve the stated goals of the contract and to manage the deployment of those resources against the program plan. Our accounting department collects the direct labor, material and subcontract charges for each contract and provides such information to the respective program managers and senior management.

The program managers review and report the performance of their contracts against the respective program plans with our senior management on a monthly basis. These reviews are summarized in the form of estimates of costs to complete the contracts (“ETCs”). If an ETC indicates a potential overrun against budgeted program resources, it is the responsibility of the program manager to revise the program plan in a manner consistent with the customer’s objectives to eliminate such overrun and achieve planned contract profitability, and to seek necessary customer agreement to such revision. To mitigate the financial risk of such re-planning, we attempt to negotiate the deliverable requirements of our research and development contracts to allow as much flexibility as possible in technical outcomes. Given the inherent technical uncertainty involved in research and development contracts, in which new technology is being invented, explored or enhanced, such flexibility in terms is frequently achievable. When re-planning does not appear possible within program budgets, senior management makes a judgment as to whether the program statement of work will require additional resources to be expended to meet contractual obligations or whether it is in our interest to supplement the customer’s budget with our own funds. If either determination is made, we record an accrual for the anticipated contract overrun based on the most recent ETC of the particular contract.

We provide for anticipated losses on contracts by recording a charge to earnings during the period in which a potential for loss is first identified. We adjust the accrual for contract losses quarterly based on the review of outstanding contracts. Upon completion of a contract, we reduce any associated accrual of anticipated loss on such contract as the previously recorded obligations are satisfied.

We consider many factors when applying GAAP related to revenue recognition. These factors generally include, but are not limited to:

• The actual contractual terms, such as payment terms, delivery dates, and pricing terms of the various product and service elements of a contract;

• Time period over which services are to be performed;

• Costs incurred to date;

• Total estimated costs of the project;

• Anticipated losses on contracts; and

• Collectability of the revenues.

We analyze each of the relevant factors to determine its impact, individually and collectively with other factors, on the revenue to be recognized for any particular contract with a customer. Our management is required to make judgments regarding the significance of each factor in applying the revenue recognition standards, as well as whether or not each factor complies with such standards. Any misjudgment or error by our management in evaluation of the factors and the application of the standards could have a material adverse effect on our future operating results.

Product Sales

Our revenues derived from product sales are primarily the result of shipments of our stacked chip products. Production orders for our products are generally priced in accordance with established price lists. We primarily ship stacked chip products to original equipment manufacturers (“OEMs”).

We recognize revenue from product sales upon shipment, provided that the following conditions are met:

• There are no unfulfilled contingencies associated with the sale;

• We have a sales contract or purchase order with the customer; and

• We are reasonably assured that the sales price can be collected.

The absence of any of these conditions, including the lack of shipment, would cause revenue recognition to be deferred. Our terms are freight on board (“FOB”) shipping point.  We record product support expenses incurred and accrue such expenses expected to be incurred in relation to shipped products. We do not offer contractual price protection on any of our products. Accordingly, we do not maintain any reserves for post-shipment price adjustments.  We do not utilize distributors for the sale of our products, but we are engaged with channel partners that act as an extension of our internal sales team. We do not enter into revenue transactions in which the customer has the right to return product. Accordingly, we do not make any provisions for sales returns or adjustments in the recognition of revenue.

Cyber Related Software Revenue

The Company generates revenue from the sale of licensing rights to its software products directly to end-users and through value-added resellers, or VARs. The Company also generates revenue from sales of hardware, installation, and post contract support (maintenance), performed for clients who license its products. A typical system contract contains multiple elements of the above items. Revenue earned on software arrangements involving multiple elements is allocated to each element based on the fair values of those elements. The fair value of an element is based on vendor-specific objective evidence (“VSOE”). The Company limits its assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold separately. VSOE calculations are updated and reviewed quarterly or annually depending on the nature of the product or service. When evidence of fair value exists for the delivered and undelivered elements of a transaction, then discounts for individual elements are aggregated and the total discount is allocated to the individual elements in proportion to the elements' fair value relative to the total contract fair value. When evidence of fair value exists for the undelivered elements only, the residual method is used. Under the residual method, The Company defers revenue related to the undelivered elements based on VSOE of fair value of each of the undelivered elements and allocates the remainder of the contract price net of all discounts to revenue recognized from the delivered elements. If VSOE of fair value of any undelivered element does not exist, all revenue is deferred until VSOE of fair value of the undelivered element is established or the element has been delivered.

For arrangements that include both software and non-software elements, we allocate revenue to the software deliverables and non-software deliverables based on their relative selling prices. In such circumstances, the accounting principles establish a hierarchy to determine the selling price to be used for allocating revenue to deliverables as follows: (i) VSOE, (ii) third-party evidence of selling price ("TPE") and (iii) best estimate of the selling price ("ESP"). When we are unable to establish a selling price using VSOE, or TPE, we use ESP to allocate the arrangement fees to the deliverables.

Provided the fees are fixed or determinable and collection is considered probable, revenue from licensing rights and sales of hardware and third-party software is generally recognized upon physical or electronic shipment and transfer of title. In certain transactions where collection risk is high, the revenue is deferred until collection occurs or becomes probable. If the fee is not fixed or determinable, then the revenue recognized in each period (subject to application of other revenue recognition criteria) will be the lesser of the aggregate of amounts due and payable or the amount of the arrangement fee that would have been recognized on a straight line basis over the contractual period.

Consolidation. The consolidated financial statements include the accounts of ISC8 and its subsidiaries, ISC8 Europe Limited, Novalog, Inc. (“Novalog”), MicroSensors, Inc. (“MSI”), RedHawk Vision Systems, Inc. (“RedHawk”) and iNetWorks Corporation (“iNetWorks”). As of December 30, 2012, of the Company’s subsidiaries only ISC8 Europe Limited had material operations and assets and had separate employees and facilities. All significant intercompany transactions and balances were eliminated in the consolidation.

Fiscal Periods. The Company’s fiscal year ends on the Sunday nearest September 30. Fiscal 2012 ended on September 30, 2012 and consisted of 52 weeks. The fiscal year ending September 29, 2013 (“Fiscal 2013”) will consist of 52 weeks. The Company’s first quarter of Fiscal 2013 consisted of 13 weeks ended December 30, 2012.

Reportable Segments. The Company is presently managing its operations as a single business segment. The Company is continuing to evaluate the current and potential business derived from sales of its products and, in the future, may present its consolidated statement of operations in more than one segment if the Company segregates the management of various product lines in response to business and market conditions.

Goodwill and Other Intangible Assets. The Company acquired goodwill as a result of its purchase of Bivio Software.  As a result, we will test goodwill for impairment annually at the end of the third fiscal quarter, referred to as the annual test date. The Company will also test for impairment between annual test dates if an event occurs or circumstances arise that would indicate the carrying amount may be impaired. Goodwill impairment testing is performed as a single reporting unit.

The first step of the impairment test involves comparing the fair values of the single reporting unit with its carrying value.  If the carrying amount of the single reporting unit exceeds its fair value, we perform the second step of the goodwill impairment test. The second step of the goodwill impairment test involves comparing the implied fair value of the single reporting unit’s goodwill with the carrying value of that goodwill. The amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. As of December 30, 2012, we have not identified any events or circumstances that would require an interim goodwill impairment test.

Intangible assets with definite lives at December 30, 2012 consist principally of software technology, trade names, and customer relationship, which were acquired as a result of the business combination with Bivio Software.  These assets are amortized on a straight-line basis over their estimated useful lives.

Derivatives. A derivative is an instrument whose value is “derived” from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts (“Embedded Derivatives”) and for hedging activities. As a matter of policy, the Company does not invest in separable financial derivatives or engage in hedging transactions. However, the Company has entered into complex financing transactions that involve financial instruments containing certain features that have resulted in the instruments being deemed derivatives or containing Embedded Derivatives. The Company may engage in other similar complex debt transactions in the future, but not with the intention to enter into derivative instruments. Derivatives and Embedded Derivatives, if applicable, are measured at fair value using the Binomial Lattice (“Binomial Lattice”) pricing model and marked to market through earnings. However, such new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant estimates and assumptions, which may impact the level of precision in the financial statements. Furthermore, depending on the terms of a derivative or Embedded Derivative, the valuation of derivatives may be removed from the financial statements upon conversion of the underlying instrument into some other security or the terms of the underlying instrument becoming fixed.

Subsequent Events. Management evaluated events subsequent to December 30, 2012 through the date the accompanying consolidated financial statements were filed with the Securities and Exchange Commission for transactions and other events that may require adjustment of and/or disclosure in such financial statements, and other than described, have determined that there are no subsequent events that require disclosure.