General

6 Months Ended

Mar. 31, 2013

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 March 31, 2013. 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 and 26-week periods ended March 31, 2013 and April 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 March 31, 2013, and the results of its operations and its cash flows for the 13-week and 26-week periods ended March 31, 2013 as compared to the same period ended April 1, 2012.

    The condensed consolidated financial information as of March 31, 2013 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, and sale of security products, particularly cyber security solutions for government and commercial applications. The Company presently offered or will offer products in the following areas:

Cyber Advance Threat Detection. The Company started the development of cyber security products, and during the last two years this technology has evolved into the Cyber adAPT™ product suite focused on detecting advanced persistent threats (“Advanced Persistent Threats”). The Cyber adAPT™ system identifies data exfiltration or modification due to sophisticated attacks by learning the topology and leverage knowledge of advance malware’s actions to identify host that have been compromised.  The Advanced Persistent Threats products have a number of potential U.S. government and commercial applications globally, including network and electronic security.  This product will be available in the future.

Cyber Forensic Investigations. The Company’s Cyber NetFalcon provides long-term tracking of user applications, networks and devices to strengthen cyber security operation.  Users of this product include but are not limited to enterprises, network operators and government agencies. This product allows forensic examination of information once malicious activity has been detected. This product is currently available to the end users.

Web-Filtering for Service Providers. The Company’s Cyber NetControl product allows service providers and enterprises to protect their users from accessing inappropriate content on a network-wide or per-user basis.  This product is currently available to end users. In addition NetFalcon® can also be used to augment packet capture devices to help speed time to access critical data.

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, and other liabilities related to Bivio Software.

Discontinued Operations

   On January 31, 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, to Vectronix, Inc. (“Vectronix”) (the “Thermal Imaging Asset Sale”), pursuant to an Asset Purchase Agreement dated October 17, 2011 between the Company and Vectronix (the “Thermal Imaging APA”).

   In addition, on March 19, 2013, the Company discontinued its government-focused business, including the Secure Memory Systems, Cognitive and Microsystems business units (the “Government Business”), to focus on the Company’s cyber-security business.

   The operations of the Thermal Imaging Business and Government Business are presented as discontinued operations. To provide comparability between the periods, the consolidated financial information for all periods presented has been reclassified to reflect the Company’s results of continuing operations.

Summary of Significant Accounting Policies

   There have been no significant changes to the Company’s significant accounting policies during the 26 weeks ended March 31, 2013. See Note 1 to the Company’s consolidated financial statements included in the Company’s 2012 Annual Report on Form 10-K for a comprehensive description of the Company’s significant accounting policies.

   Revenue – Continuing Operations.  The Company’s cyber security business derives revenue from three principal sources, hardware, software, and maintenance, as follows:.

   The Company generates revenue from the sale of licensing rights to its software products directly to end-users and through value-added resellers (“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, the Company allocates 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 the Company is unable to establish a selling price using VSOE, or TPE, the Company uses 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.

    Revenue – Discontinued Operations.  As a result of the discontinuation of the Company’s Government businesses during March 2013, any contractual obligations related to certain existing contracts at the point of discontinuation were subcontracted to outside parties (“Subcontracted Contracts”), thereby relieving the Company of responsibility of deliverables in business lines which were no longer part of continuing operations.  The remainder of outstanding contracts that were not subcontracted to outside parties have been terminated at the Company’s request, thereby relieving the Company of its contractual obligations.  The Subcontracted Contracts consist of cost reimbursement plus a fixed fee as well as fixed price level of effort research and development contracts.

    The Company will continue to recognize revenue from discontinued operations through the end of the subcontract periods on the Subcontracted Contracts.  The Company anticipates all such subcontracts to be completed no later than September 29, 2013.  The revenue recognized from discontinued operations related to Subcontracted Contracts based on incurred costs plus applicable fees or profits primarily in the proportion that costs incurred bear to estimated final costs.  The Company will maintain on its balance sheet certain unbilled revenue related to contracts related to prior fiscal years which are pending the government’s evaluation and audit of final indirect rates.  The Company will continue to review the estimates of costs to complete contracts on the Subcontracted Contracts on a monthly basis, until the subcontracts are complete.  If a contract overrun is anticipated as a result of that review, the Company will record an accrual for the anticipated overrun and record a charge to earnings in the period in which the anticipated loss is first identified.

Product Sales

    Related to its discontinued Government Business, the Company has a final stacked chip product sale in process as of March 31, 2013.  The Company will recognize revenue from discontinued operations on this sale when the following conditions are met:

• There are no unfulfilled contingencies associated with the sale; and

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

The absence of any of these conditions, including the lack of shipment, will cause revenue recognition to be deferred. The Company’s terms on this sale are freight on board (“FOB”) shipping point.  

    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 and for the period ended March 31, 2013, the only Company subsidiary that had operations and assets as well as separate employees and facilities was ISC8 Europe Limited . As of and for the period ended March 31, 2013, ISC8 Europe Limited’s operations and assets were immaterial to the overall consolidated financial statements. 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 second quarter of Fiscal 2013 consisted of 26 weeks ended March 31, 2013.

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.

Reclassifications. Certain previously reported amounts have been reclassified to conform to the current consolidated financial statement presentation.

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 March 31, 2013, we have not identified any events or circumstances that would require an interim goodwill impairment test.

Intangible assets with definite lives at March 31, 2013 consist principally of software technology, trade names, and customer relationship, which were acquired as a result of the business combination with Bivio Software or developed internally.  These assets are amortized on a straight-line basis over their estimated useful lives. The Company will test for impairment between annual test dates if an event occurs or circumstances arise that would indicate the carrying amount may be impaired. 

Deferred Costs. Financing costs associated with the Company’s debt issuances are capitalized as deferred costs and amortized using straight-line as interest expense over the debt period, which approximates the effective interest method due to the short term of the instrument.

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 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.

Deferred Compensation. The Company has a deferred compensation plan, the Executive Salary Continuation Plan Liability (the “ESCP”), for key employees. Presently, two of the Company’s retired executives are receiving benefits aggregating $184,700 per annum under the ESCP and is considered a current liability. The remaining long term portion is held under the ESCP Liability.

Foreign Currency Translation. Assets and liabilities denominated in foreign currency are translated into U.S. dollars using the exchange rates in effect at the balance sheet date. Statements of operations accounts are translated at the average exchange rates during the year. The impact of exchange rate fluctuations from translation of assets and liabilities is included in accumulated other comprehensive income (loss), a component of stockholders' equity. Realized gains and losses resulting from foreign currency transactions are other income (expense) in the Condensed Consolidated Statements of Operations.

Earnings (Loss) Per Share. Basic earnings (loss) per share is computed by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share are calculated utilizing the treasury stock method.  Under this method the weighted average number of common shares is adjusted for common stock issuable upon exercise of stock options, warrants, and other commitments to issue common stock in periods in which they have a dilutive effect, and when the stock awards exercise price is lower than the Company's average share price for the period.  Since the Company incurred a net loss for the 13 and 26 weeks ended March 31, 2013 basic and diluted loss per share were the same. Inclusion of such awards would be anti-dilutive. See Note 8.

    Subsequent Events. Management evaluated events subsequent to March 31, 2013 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. See Note 15.