10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2014

OR

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from_________ to __________

Commission file number 001-08402

ISC8 INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	33-0280334
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

151 Kalmus Dr., Suite A-203

Costa Mesa, California 92626

(Address of Principal Executive Offices) (Zip Code)

Registrant’s Telephone Number, Including Area Code:

(714) 444-8753

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]   No [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]   No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	[   ]	Accelerated filer	[   ]
Non-accelerated filer	[   ]	Smaller reporting company	[X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [   ]   No [X]

 As of June 4, 2014, there were 256,580,728 shares of common stock outstanding.

ISC8 INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE FISCAL PERIOD ENDED MARCH 31, 2014

TABLE OF CONTENTS

		PAGE
	PART I – FINANCIAL INFORMATION	1
Item 1.	Financial Statements	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25
Item 4.	Controls and Procedures	26
	PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
Item 6.	Exhibits	33
Signatures

Unless otherwise indicated, or unless the context of the discussion requires otherwise, we use the terms “ISC8,” “Irvine Sensors,” the “Company,” “we,” “us,” “our” and similar references to refer to ISC8 Inc. and its subsidiaries. ISC8®, ISC8[secure] ®, Irvine Sensors®, Cyber adAPT™, NetFalcon™, NetControl™, Neo-Chip™, Neo-Stack®, Neo-Layer™, TOWHAWK®, Novalog™, Vault®, Eagle™, and RedHawk™ are among the Company’s trademarks. Any other trademarks or trade names mentioned in this report are the property of their respective owners.

Safe Harbor Regarding Forward Looking Statements

 From time to time, information provided by us or statements made by our employees may contain “forward-looking” information which involves risks and uncertainties. Any statements in this Quarterly Report and accompanying materials that are not statements of historical fact are forward-looking statements (including, but not limited to, statements concerning our projected revenues, expenses, gross profit and income, mix of revenue, demand for our products, the need for additional capital, our ability to repay our outstanding debt, market acceptance of our products and technologies, the competitive nature of our business and markets, the success and timing of new product introductions and commercialization of our technologies, product qualification requirements of our customers, the need to divest assets, our significant accounting policies and estimates). These forward-looking statements are based on a number of assumptions made by us, and involve a number of risks and uncertainties, and accordingly, actual results could differ materially. Factors that may cause such differences include, but are not limited to, those discussed in this Quarterly Report and set forth in Part I, Item 1A of our Form 10-K for the year ended September 30, 2013 available through the website of the Securities and Exchange Commission (“SEC”) at www.sec.gov, our website at www.isc8.com, or upon written request to our Investor Relations Department at 151 Kalmus Drive, Suite A-203, Costa Mesa, California 92626. You should carefully consider these factors in connection with forward-looking statements concerning us.

 Except as required by law, we undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

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PART I

FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

ISC8 INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

	March 31, 2014			September 30, 2013 (1)
Assets
Current assets:
Cash and cash equivalents	$	147,000		$	136,000
Accounts receivable, net		-			119,000
Deposit on PFG credit line		523,000			1,000,000
Prepaid expenses and other current assets		335,000			561,000
Total current assets		1,005,000			1,816,000
Restricted cash		75,000			75,000
Property and equipment, net		553,000			753,000
Goodwill		393,000			393,000
Intangible assets, net		727,000			790,000
Deferred financing costs, net		51,000			715,000
Other assets		32,000			126,000
Non-current assets of discontinued operations		290,000			297,000
Total assets	$	3,126,000		$	4,965,000
Liabilities and Stockholders’ Deficit
Current liabilities:
Accounts payable	$	1,331,000		$	1,024,000
Accrued expenses		1,837,000			3,066,000
Deferred revenue		17,000			221,000
Senior secured revolving credit facility, net of discount		3,054,000			4,908,000
Senior subordinated secured convertible promissory notes, net of discount		1,623,000			15,793,000
Senior subordinated secured convertible bridge notes, net of discount		1,155,000			-
Subordinated secured convertible promissory notes, net of discount		843,000			-
Senior subordinated secured promissory notes		-			5,392,000
Capital lease obligations, current portion		329,000			447,000
Other current liabilities		75,000			-
Current liabilities from discontinued operations		624,000			678,000
Total current liabilities		10,888,000			31,529,000
Subordinated secured convertible promissory notes, net of discount		-			8,570,000
Capital lease obligations, less current portion		67,000			77,000
Derivative liability		797,000			19,245,000
Executive salary continuation plan liability		910,000			957,000
Other liabilities		-			139,000
Total liabilities		12,662,000			60,517,000
Commitments and contingencies (Note 8)
Stockholders’ deficit:
Convertible preferred stock, $0.01 par value, 1,000,000 shares authorized, 900 shares of Series B Convertible Cumulative Preferred Stock issued and outstanding as of March 31, 2014 and September 30, 2013, liquidation preference of $866,000, and 2,800 and 0 shares of Series D Convertible Preferred Stock issued and outstanding, liquidation preference of $27,820,000 and $0, as of March 31, 2014 and September 30, 2013, respectively(2)		-			-
Common stock, $0.01 par value, 2,000,000,000 and 800,000,000 shares authorized; 255,080,000 and 205,581,000 shares issued and outstanding at March 31, 2014 and September 30, 2013, respectively (3)		2,551,000			2,056,000
Additional paid-in capital		231,910,000			181,443,000
Accumulated other comprehensive income (loss)		46,000			(123,000	)
Accumulated deficit		(244,367,000	)		(239,252,000	)
ISC8 stockholders’ deficit		(9,860,000	)		(55,876,000	)
Noncontrolling interest		324,000			324,000
Total stockholders’ deficit		(9,536,000	)		(55,552,000	)
Total liabilities and stockholders’ deficit	$	3,126,000		$	4,965,000

(1)   The condensed consolidated balance sheet as of September 30, 2013 was derived from the audited consolidated financial statement included in the Company’s 2013 Annual Report on Form 10-K, filed with the SEC on December 24, 2013.  

(2)    The number of shares of Convertible Preferred Stock issued and outstanding has been rounded to the nearest one hundred (100).

(3)   The number of shares of common stock issued and outstanding has been rounded to the nearest one thousand (1000).

See Accompanying Notes to Condensed Consolidated Financial Statements

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ISC8 INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

		Three Months Ended March 31,						Six Months Ended March 31,
		2014			2013			2014			2013
Revenues	$	78,000		$	102,000		$	171,000		$	196,000
Cost of revenues		45,000			44,000			93,000			81,000
Gross Profit		33,000			58,000			78,000			115,000
Operating expenses:
General and administrative expense		2,532,000			2,320,000			4,907,000			4,290,000
Research and development expense		1,223,000			1,799,000			3,121,000			3,464,000
Total operating expenses		3,755,000			4,119,000			8,028,000			7,754,000
Operating loss		(3,722,000	)		(4,061,000	)		(7,950,000	)		(7,639,000	)
Interest and other (income) expense
Interest expense		621,000			3,806,000			4,549,000			5,793,000
Change in fair value of derivative liability		261,000			466,000			(7,073,000	)		(4,481,000	)
Gain on extinguishment of debt		-			-			(316,000	)		-
Other (income) expense		(2,000	)		64,000			2,000			63,000
Total interest and other (income) expenses		880,000			4,336,000			(2,838,000	)		1,375,000
Loss from continuing operations before provision for income taxes		(4,602,000	)		(8,397,000	)		(5,112,000	)		(9,014,000	)
Provision for income taxes		-			3,000			3,000			3,000
Loss from continuing operations		(4,602,000	)		(8,400,000	)		(5,115,000	)		(9,017,000	)
Loss from discontinued operations		-			(1,191,000	)		-			(2,738,000	)
Net loss	$	(4,602,000	)	$	(9,591,000	)	$	(5,115,000	)	$	(11,755,000	)
Basic and diluted net loss per common share
Loss from continuing operations	$	(0.02	)	$	(0.05	)	$	(0.02	)	$	(0.06	)
Loss from discontinued operations	$	-		$	(0.01	)	$	-		$	(0.02	)
Net loss per share, basic and diluted	$	(0.02	)	$	(0.06	)	$	(0.02	)	$	(0.08	)
Basic and diluted weighted average number of common shares outstanding		245,122,000			153,688,000			234,858,000			147,541,000

See Accompanying Notes to Condensed Consolidated Financial Statements

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ISC8 INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(unaudited)

		Three Months Ended March 31,					Six Months Ended March 31,
		2014			2013		2014			2013
Net loss	$	(4,602,000	)	$	(9,591,000	)	$	(5,115,000	)	$	(11,755,000	)
Other comprehensive income before tax from continuing operations:
Foreign currency translation adjustments		23,000			-			169,000			-
Comprehensive loss	$	(4,579,000	)	$	(9,591,000	)	$	(4,946,000	)	$	(11,755,000	)

See Accompanying Notes to Condensed Consolidated Financial Statements

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ISC8 INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Six Months Ended March 31,
	2014			2013
Cash flows from operating activities:
Net loss	$	(5,115,000	)	$	(11,755,000	)
(Income) loss from discontinued operations		-			2,738,000
Loss from continuing operations		(5,115,000	)		(9,017,000	)
Adjustments to reconcile loss from continuing operations to net cash used in operating activities:
Depreciation and amortization		339,000			95,000
Provision for bad debt		174,000			-
Non-cash interest expense		3,790,000			5,255,000
Gain on extinguishment of debt		(316,000	)		-
Change in fair value of derivative liability		(7,073,000	)		(4,481,000	)
Non-cash stock-based compensation		2,539,000			300,000
Loss on disposal of property and equipment		4,000			-
Changes in assets and liabilities:
Accounts receivable		(55,000	)		(127,000	)
Prepaid expenses and other current assets		194,000			(60,000	)
Other assets		262,000			-
Accounts payable and accrued expenses		1,029,000			643,000
Other current liabilities		75,000			-
Deferred revenue		(204,000	)		67,000
Executive Salary Continuation Plan liability		(47,000	)		(7,000	)
Net cash used in operating activities		(4,404,000	)		(7,332,000	)
Cash flows from investing activities:
Property and equipment expenditures		-			(45,000	)
Proceeds from sale of Thermal assets		-			1,200,000
Net cash paid related to acquisition of Bivio		-			(569,000	)
Net cash provided by investing activities		-			586,000
Cash flows from financing activities:
Proceeds from unsecured convertible promissory notes		1,738,000			7,380,000
Proceeds from Series D Convertible Preferred Stock		4,533,000			-
Proceeds from options and warrants exercised		16,000			103,000
Net change in deposit on PFG credit line		477,000			-
Principal payments on PFG credit line		(2,070,000	)		-
Principal payments on notes payable		(25,000	)		(9,000	)
Principal payments on capital leases		(208,000	)		(8,000	)
Net cash provided by financing activities		4,461,000			7,466,000
Cash flows from discontinued operations:
Net cash used in operating activities		(47,000	)		(1,965,000	)
Net cash used in investing activities		-			(8,000	)
Net cash used in discontinued operations		(47,000	)		(1,973,000	)
Effect of exchange rate changes on cash		1,000			163,000
Net increase (decrease) in cash and cash equivalents		11,000			(1,416,000	)
Cash and cash equivalents at beginning of period		136,000			1,738,000
Cash and cash equivalents at end of period	$	147,000		$	322,000
Non-cash investing and financing activities:
Equipment financed with capital leases	$	80,000		$	-
Conversion of notes and accrued interest to Series D Preferred stock	$	23,056,000		$	-
Conversion of notes to restricted stock	$	14,503,000		$	-
Employee stock based plan contribution	$	272,000		$	-
Conversion of notes and accrued interest to common stock	$			$	30,000
Common stock issued to pay accrued interest and operating expenses	$	556,000		$	963,000
Issuance of warrants to acquire Bivio Software assets	$	-		$	85,000
Senior Subordinated Note issued to settle accrued interest	$	-		$	291,000
Issuance of warrants in connection with Forbearance agreements	$	34,000		$	721,000
Non-cash conversion of preferred stock to common stock	$	-		$	60,000
Non-cash conversion of 2012 Notes to 2013 Notes, including paid in kind interest	$	-		$	5,571,000
Supplemental cash flow information:
Cash paid for interest	$	257,000		$	303,000
Cash paid for income taxes	$	3,000		$	3,000

See Accompanying Notes to Condensed Consolidated Financial Statements

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ISC8 INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1 — General

 The information contained in the following Notes to Condensed Consolidated Financial Statements is derived from that which appears in the accompanying unaudited condensed consolidated financial statements for ISC8 Inc. (“ISC8”), and its subsidiaries (together with ISC8, the “Company”), and 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 Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2013 (“Fiscal 2013”), filed with the SEC on December 24, 2013, including the risk factors contained therein, as updated in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2014. 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 three month periods ended March 31, 2014 and 2013 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, 2014, and the results of its operations and its cash flows for the three month periods ended March 31, 2014 as compared to the same period ended March 31, 2013.

 The accompanying September 30, 2013 balance sheet was derived from the audited fiscal 2013 financial statements.

Recent Developments

 New Location Established as ISC8 Malaysia. On October 28, 2013, the Company announced the opening of a new office in Kuala Lumpur, Malaysia in support of the projected growth of business within South East Asia (“ISC8 Malaysia”).  ISC8 Malaysia, a wholly owned subsidiary of the Company, will serve as a regional hub in South East Asia.

 Creation of Series D Convertible Preferred. On October 30, 2013, the Company filed the Certificate of Designations of Rights, Preferences, Privileges and Limitations of the Series D Convertible Preferred Stock (the "Certificate of Designations") with the Delaware Secretary of State to designate 4,000 shares of the Company's preferred stock as Series D Convertible Preferred Stock ("Series D Preferred"). The Series D Preferred votes alongside shares of the Company's common stock, par value $0.01 per share (“Common Stock”), on an as converted basis, and ranks junior to the Company's Series B Convertible Cumulative Preferred Stock, but is senior to all other classes of the Company's preferred stock. Each share of Series D Preferred has a stated value of $10,000 (the "Stated Value"), and is currently convertible, at the option of the holder, into that number of shares of Common Stock equal to the Stated Value divided by the Conversion Price set forth in the Certificate of Designations (the "Conversion Shares").

 Series D Preferred Financing. On October 31, 2013, the Company accepted subscription agreements from certain accredited investors (the "Investors") to purchase shares of Series D Preferred (the "Series D Offering") for $10,000 per share. As additional consideration, each Investor received one-year warrants to purchase 59,523 shares of Common Stock for $0.084 per share ("Warrant Shares") for every share of Series D Preferred purchased (the "Series D Warrants"). Through March 31, 2014, investors have purchased 477 shares of Series D Preferred, resulting in gross proceeds of approximately $4.77 million.

-5-

 Cancellation of Debt. In connection with the offer and sale of the Series D Preferred, certain holders of the Company's outstanding senior convertible debt agreed to exchange such debt, in the aggregate total of approximately $23.1 million in principal and accrued interest, for shares of Series D Preferred and Series D Warrants on substantially similar terms to the Series D Offering (the “Senior Note Conversion”). The Senior Note Conversion resulted in the issuance of approximately 2,300 shares of Series D Preferred and Series D Warrants to purchase approximately 137.2 million shares of Common Stock. Furthermore, certain holders of the Company’s junior subordinated convertible debt agreed to exchange an aggregate total of approximately $14.5 million in principal and accrued interest for approximately 101.4 million shares of Restricted Stock Units (“RSU”) that vests in the event the trading price of the Company’s Common Stock reaches $0.143 (the “Junior Note Conversion”).

 Amendments to Articles of Incorporation or Bylaws. On October 31, 2013, the Company amended Article III, Section 2 of the Company's Bylaws to decrease the fixed number of directors from ten to seven (the "Bylaw Amendment"). On June 5, 2014, the Company further amended Article III, Section 2 of the Company’s Bylaws to decrease the fixed number of directors from seven to three, and decrease the size of the Company's Board of Directors to no less than three, but no more than seven directors.

 Modification of PFG Loan Agreement. On November 1, 2013, the Company substantially modified its Loan Agreement with Partners for Growth III, L.P. (“PFG”) to provide, among other things, for a one-year extension of the maturity date under the Loan Agreement to December 31, 2014 (the “PFG Loan Modification”). In return, the Company made a $2.0 million repayment on the loan, deposited $500,000 with PFG as collateral for the loan, and, in the event the Company consummates a debt or equity financing, the Company agreed to pay to PFG 25% of the proceeds from such financing (“Financing Guarantee Fund”). PFG and the Company also modified the Guaranty Agreement executed in connection with the Loan Agreement in order to: (i) release Costa Brava Partnership III, LP (“Costa Brava”) from its guarantee of the Company's debt to PFG, (ii) reduce the maximum guarantee amount to $1.0 million, and (iii) affirm the obligations of the Griffin Fund LP, one of the Company's related party investors (“Griffin”), under the Guaranty Agreement.

 On February 7, 2014, the Company and PFG made further modification to the Loan Agreement by reducing the Financing Guarantee Fund payment from 25% of 10% and required the Company to make a $70,000 monthly payment toward the principal balance of the loan effective April 1, 2014 and a back end fee of 15% on any capital raise.  See Note 3 under the heading Revolving Credit Facility.

 Increase of Authorized Number of Common Shares. On January 16, 2014, the Company filed with the Delaware Secretary of State an amendment to its Certificate of Incorporation to the increase of the total number of authorized shares of capital stock from 801,000,000 to 2,001,000,000, of which 2,000,000,000 will be available for issuance as Common Stock (the “Amendment”).

 Amendment to 2011 Omnibus Incentive Plan and Option Exchange Program. On January 16, 2014, the Company implemented an amendment to its 2011 Omnibus Incentive Plan (the “2011 Plan”) to increase the number of shares of Common Stock issuable under the 2011 Plan to 446,500,000 (the “Plan Amendment”). In October 2013, in anticipation of stockholder approval of the Plan Amendment, the Company commenced an option exchange program (the “Option Exchange Program”) wherein holders of stock options previously issued under the Company’s equity compensation plans could, at the option of the holder, exchange outstanding options for new options to purchase shares of Common Stock for $0.042 per share. To date, the Company has canceled outstanding stock options to purchase 28.6 million shares of Common Stock, and issued new options under the 2011 Plan to purchase approximately 146.9 million shares of Common Stock for $0.042 per share.

Issuance of Senior Subordinated Secured Convertible Bridge Notes. On February 6, 2014, the Company’s Board of Directors approved the issuance of senior subordinated secured convertible bridge notes in the aggregate principal amount of up to $3.5 million (the “2014 First Bridge Notes”), of which, $1.5 million may be issued in exchange for the cancellation of certain outstanding senior notes.  The 2014 First Bridge Notes mature on July 31, 2014. As of March 31, 2014, the Company has issued 2014 First Bridge Notes in the aggregate principal amount of $0.6 million.  See Note 5 for further information regarding the 2014 First Bridge Notes.

On February 28, 2014, the Company’s Board of Directors approved the issuance of senior subordinated secured convertible bridge notes in the aggregate principal amount of up to $6.0 million (the “2014 Second Bridge Notes”), of which, $1.5 million may be issued in exchange for the cancellation of certain outstanding senior notes.  The 2014 Second Bridge Notes mature on July 31, 2014. As of June 5, 2014, the Company has issued 2014 Second Bridge Notes in the aggregate principal amount of $3.0 million. See Note 5 and Note 11 for further information regarding the 2014 Second Bridge Notes.

-6-

Forbearance Agreement.  As of March 31, 2014, $0.9 million of the outstanding Senior Subordinated Convertible Notes (as defined below in Note 3 - Senior Subordinated Secured Convertible Promissory Notes) had matured. The Company entered into a Forbearance Agreement with the respective holders of these Notes to extend the maturity date to July 31, 2014.  See Note 11 for further information regarding the Forbearance Agreement, and other information regarding the Senior Subordinated Secured Convertible Notes.

Summary of Significant Accounting Policies

 There have been no significant changes to the Company’s significant accounting policies during the three months ended March 31, 2014. For a comprehensive description of the Company’s significant accounting policies, see Note 1 to the Company’s Consolidated Financial Statements included in the Company’s 2013 Annual Report on Form 10-K, filed with the SEC on December 24, 2013.

 Consolidation. The consolidated financial statements include the accounts of ISC8 and its subsidiaries, Novalog, Inc. (“Novalog”), MicroSensors, Inc. (“MSI”), RedHawk Vision Systems, Inc. (“RedHawk”) iNetWorks Corporation (“iNetWorks”), ISC8 Europe Limited (“ISC8 Europe”) and ISC8 Malaysia SDN.BMD (“ISC8 Malaysia”). Of the Company’s subsidiaries, only ISC8 Europe and ISC8 Malaysia presently have operating activities and assets, separate employees and facilities. All significant intercompany transactions and balances have been eliminated in the consolidation. None of the Company’s subsidiaries accounted for more than 10% of the Company’s total assets at March 31, 2014 or March 31, 2013.

  Reclassifications. Certain amounts in the consolidated financial statements have been reclassified in order to conform to the current year presentation.

 Reportable Segments. The Company is presently managing its continuing 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.

 Use of Estimates. The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Management prepares estimates for a number of factors, including derivative liability, stock-based compensation, warrants valuation, revenue recognition, valuation of goodwill and other intangible assets, allowance for doubtful accounts and notes receivable, and deferred tax assets and liabilities. The Company believes its estimates of derivative liabilities, and warrants valuation to be the most sensitive estimates impacting financial position and results of operations in the near term.

 Subsequent Events. Management has evaluated events subsequent to March 31, 2014 through the date the accompanying financial statements were originally filed with the SEC on Form 10-Q for transactions and other events that may require adjustment of and/or disclosure in such financial statements. See Note 11 for a discussion of events occurring subsequent to March 31, 2014.

Note 2 – Going Concern

 The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company generated significant net losses in previous fiscal years.  For the six months ended March 31, 2014 and 2013, the Company had a loss from continuing operations of $5.1 million and $9.0 million, respectively, and negative cash flows from operations of $4.4 million and $7.3 million, respectively.  As of March 31, 2014, the Company also had negative working capital of approximately $9.9 million and stockholders’ deficit of $9.5 million.

-7-

 Management believes that the Company’s losses in recent years have primarily been the result of increased research and development expenditures related to the cyber technology and efforts to productize those technologies and bring them to market.  These losses were augmented by insufficient revenue to support the Company’s skilled and diverse technical staff, who are considered necessary to support commercialization of the Company’s technologies, and significant financing costs.  Unsuccessful commercialization efforts in past fiscal years have contributed to the stockholders’ deficit as of March 31, 2014.

 We currently have insufficient cash to execute our business plan and continue as a going concern, in the absence of securing additional financing, and we have significant debt coming due within 12 months. Management is therefore currently focused on raising additional capital to fund the Company’s working capital requirements, managing costs in line with estimated total revenues, including contingencies for cost reductions if projected revenues are not fully realized, as well as negotiating the restructuring of certain indebtedness currently due and payable.  However, there can be no assurance that management will be successful, that anticipated revenues will be realized, or that the Company will be able to successfully implement its plans.  In the event management is not successful in raising additional capital, or otherwise implementing its restructuring plan, the Company will be unable to continue as a going concern.

 The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. 

Note 3 — Debt Instruments

The following table summarizes debt instrument activity during the six months ended March 31, 2014:

	Principle Balance, Net of Discount at September 30, 2013		New Debt Issued(Principle Repayment), Net			Debt Converted to Series D Preferred Shares			Debt Converted to Restricted Stock			Debt Discount Amortization, Extinguishment or (Additions), Net			Principle Balance, Net of Discount at March 31, 2014
Senior Secured Revolving Credit Facility	$	4,908,000	$	(2,070,000	)	$	-		$	-		$	216,000		$	3,054,000
Senior Subordinated Secured Convertible Promissory 2013 Notes		15,793,000		175,000			(16,199,000	)		-			1,854,000			1,623,000
Senior Subordinated Secured Convertible Bridge Notes		-		1,858,000			-			-			(703,000	)		1,155,000
Senior Subordinated Secured Promissory Notes		5,392,000		-			(5,392,000	)		-			-			-
Subordinated Secured Convertible Promissory Notes		8,570,000		-			(381,000	)		(14,357,000	)		7,011,000			843,000
Total Gross Debt	$	34,663,000	$	(37,000	)		(21,972,000	)	$	(14,357,000	)	$	8,378,000		$	6,675,000
Accrued interest converted to equity							(1,084,000	)		(146,000	)
Gross adjustment to additional paid-in capital(1)						$	(23,056,000	)	$	(14,503,000	)

   (1) The net amount presented excludes the impact of unamortized debt discount, derivative liability and deferred issuance costs.

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Revolving Credit Facility

 In December 2011, the Company entered into the Loan Agreement with PFG to obtain the Revolving Credit Facility.   The Revolving Credit Facility was originally set to mature on December 14, 2013, however, in connection with the PFG Loan Modification, the maturity date was extended to December 31, 2014. Interest on the Revolving Credit Facility accrues at the rate of 12% per annum, payable monthly, with the principal balance payable on the Maturity Date.  As additional consideration for entering into the Revolving Credit Facility, the Company issued to PFG and two PFG affiliated entities seven-year warrants to purchase, for $0.11 per share, an aggregate of 15.0 million shares of the Company’s Common Stock (the “PFG Warrants”).

 To secure the payment of the Company’s obligations under the Loan Agreement, the Company granted to PFG a first position, continuing security interest in substantially all of the Company’s assets, including substantially all of its intellectual property. In addition, Costa Brava, Griffin and certain other existing creditors of the Company have agreed that, while any obligations remain outstanding by the Company to PFG under the Loan Agreement, their security interests in and liens on the Company’s assets shall be subordinated and junior to those of PFG.  During July 2013, Costa Brava deposited $1.0 million into an escrow account held by PFG (the “PFG Guarantee Fund”), which was used for the partial repayment of the $5.0 million revolving credit facility issued by PFG to the Company in December 2011 (the “Revolving Credit Facility”). Costa Brava irrevocably transferred the rights, title and interest of the PFG Guarantee Fund to the Company.  In exchange for funding the PFG Guarantee Fund, the Company issued a $1.0 million Senior Secured Convertible Note (defined below) to Costa Brava.  In October 2013, the Company deposited $1.5 million of the proceeds received from the Series D Offering into the PFG Guarantee Fund, and, in turn, made a $2.0 million payment on the Revolving Credit Facility.  Further during the quarter ended March 31, 2014, the Company made an additional repayment of $0.1 million, leaving the Revolving Credit Facility with a $2.9 million outstanding balance, excluding discounts and accrued fees.

On February 7, 2014 the Company entered into a second loan modification (the "Second Modification”) with an effective date of October 28, 2013, (the “Second Modification Effective Date”). In accordance with the terms of the Second Modification, in the event the Company consummates a debt or equity financing on or after the Second Modification Effective Date, the Company must pay to PFG 10% of the gross proceeds received from such financing and $70,000 monthly principal payment effective April 1, 2014.  PFG, however, waived the deposit requirement for the month of January 2014. In consideration for the Second Modification, the Company has agreed to pay PFG a back-end fee of 15% on any capital transaction consummated on or after February 1, 2014.

 As of and prior to the quarter ended March 31, 2014, the Company was not in compliance with certain debt covenants of the Revolving Credit Facility. As such, the table below summarizes the various waiver and forbearance extensions and all warrants (the “Waiver Warrants”) issued to PFG. The exercise price of the Waiver Warrants is equal to the lower of the next equity financing effective price (the "NEFEP") or a stated price per share determined on the date of issuance of each forbearance extension.  Prior to the consummation of the Series D Offering, the exercise price of the Waiver Warrants was not fixed, causing each Waiver Warrant to be accounted for as a derivative liability.  However, upon consummation of the Series D Offering, the exercise price of each Waiver Warrant became fixed at $0.042 per share and the Company reclassified the fair value of the derivative liability totaling $2,834,000 to paid-in capital.  In connection with the PFG Loan Modification, PFG waived its rights with respect to debt covenant compliance through December 31, 2014.

Forbearance	Extension Through Date	Exercise Price per share	Exercisable Shares
Waiver	September 30, 2012	$0.042		2,045,455
Forbearance Extension	October 31, 2012	$0.042		2,045,455
Second Forbearance Extension	December 15, 2012	$0.042		2,045,455
Third Forbearance Extension	January 31, 2013	$0.042		2,045,455
Fourth Forbearance Extension	February 28, 2013	$0.042		2,045,455
Fifth Forbearance Extension	March 31, 2013	$0.042		2,045,455
Sixth Forbearance Extension	April 30, 2013	$0.042		2,045,455
Seventh Forbearance Extension	May 31, 2013	$0.042		2,045,455
Eighth Forbearance Extension	June 30, 2013	$0.042		2,045,455
Ninth Forbearance Extension	October 28, 2013	$0.010		2,232,142
Total				20,641,237

 As of March 31, 2014, PFG has not exercised any Waiver Warrants.   See Note 11 below for further discussion of events during and subsequent to the quarter ended March 31, 2014 related to the Revolving Credit Facility.

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Senior Subordinated Secured Convertible Promissory

  Through October 31, 2013, we issued Senior Subordinated Secured Convertible Promissory Notes (the “Senior Subordinated Convertible Notes”) in the aggregate principal amount of $17.8 million to certain accredited investors, including Griffin. The Senior Subordinated Convertible Notes accrue interest at a rate of 12% per annum, and are secured by all of the Company’s assets.  The Senior Subordinated Convertible Notes are convertible, at the option of each respective holder, into that number of shares of Common Stock equal to the outstanding principal and accrued interest of the Senior Subordinated Notes, divided by the conversion price set forth in the note (the “Conversion Price”). The Senior Subordinated Convertible Notes had a conversion price until October 31, 2013 when the price was fixed at $0.042 as a result of the Series D Offering.

 On October 31, 2013, pursuant to the Senior Note Conversion, Senior Subordinated Convertible Notes in the aggregate total of approximately $17.2 million of principal and accrued interest (the “Outstanding Balance”) were canceled and exchanged for approximately 1,720 shares of Series D Preferred. The Company accounted for the conversion of these Senior Subordinated Convertible Notes, which was deemed an extinguishment of debt, in one of two methods. For the Senior Subordinated Convertible Notes in the aggregate principal amount of $5.5 million held by investors not otherwise related to the Company, the Company removed the net carrying value of the debt, including accrued interest, deferred financing cost and the derivative liability, and recorded the fair value of the shares of Series D Preferred issued in exchange for the cancellation thereof. The resulting difference of $0.4 million was recognized as a gain on debt extinguishment. The remaining Senior Subordinated Convertible Notes in the aggregate total of $11.7 million, which notes were held by related parties, were accounted for as capital transactions whereby the net carrying value of the debt, including accrued interest, deferred financing cost and the derivative liability, totaling $13.1 million, was recorded as an increase to paid-in capital.

  During Fiscal 2013, the Company and each respective holder of remaining Senior Subordinated Convertible Notes, including those sold to clients of J.P. Turner & Company, L.L.C. (“J.P. Turner”), entered into an amendment to extend the maturity date of the notes to January 31, 2014 (the “Amended Senior Subordinated Convertible Notes”). As additional consideration for this extension, the Company issued warrants to those holders of the Amended Senior Subordinated Convertible Notes to purchase an aggregate total of 63.8 million shares of Common Stock for $0.001 per share. On December 6, 2013, holders of certain Amended Senior Subordinated Convertible Notes in the aggregate principal amount of approximately $0.9 million notified the Company of their position that the Series D Offering meets the definition of a Qualified Financing, as such term is defined in the Amended Senior Subordinated Convertible Notes, and, as a result, the Amended Senior Subordinated Convertible Notes matured on November 1, 2013, a position the Company disputed. However, on April 11, 2014 the Company entered into a Forbearance Agreement with the respective holders of these notes to extend the maturity date to July 31, 2014.  See Note 11 for further information regarding subsequent events relating to these Amended Senior Subordinated Convertible Notes.

Senior Subordinated Secured Convertible Bridge Notes

 In February 2014, the Company’s Board of Directors approved the issuance of two distinct offerings of senior subordinated secured convertible bridge notes commonly referred to as the 2014 Bridge Notes.  These notes are comprised of (i) the 2014 First Bridge Notes and (ii) the 2014 Second Bridge Notes and are described further below.

2014 First Bridge Notes. On February 6, 2014, the Board of Directors approved the issuance of senior subordinated secured convertible bridge notes in the aggregate principal amount of up to $3.5 million, of which, $1.5 million may be issued in exchange for the cancellation of certain outstanding senior notes. The 2014 First Bridge Notes mature on July 31, 2014 and accrue interest at 12%. In the event the Company completes a $4.0 million equity financing, the 2014 First Bridge Notes will convert into shares of Series D Preferred at a fixed price of $0.042 at the election of the holder thereof in the event 50% or more of the holders elect to convert. As of March 31, 2014, the Company has issued 2014 First Bridges Notes in the aggregate principal amount of $0.6 million.

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 As additional consideration, each holder of 2014 First Bridge Notes will receive one share of Common Stock and a two year warrant to purchase one share of Common Stock at $0.042 for every $0.168 invested.  During the quarter ended March 31, 2014, the Company issued approximately 3,422,000 shares of Common Stock and warrants to purchase 3,422,000 shares of Common Stock in connection with the issuance of the 2014 First Bridge Notes.  The Company allocated the proceeds to the warrants based on their relative fair values and recorded a discount of $0.2 million to the 2014 First Bridge Notes.

2014 Second Bridge Notes. On February 28, 2014, the Board of Directors approved the issuance of senior subordinated secured convertible bridge notes in the aggregate principal amount of up to $6.0 million, of which, $1.5 million may be issued in exchange for the cancellation of certain outstanding senior notes.  The 2014 Second Bridge Notes mature on July 31, 2014 and accrue interest at 12% annually.

 The 2014 Second Bridge Notes were sold at an original issue discount of 25%.  Through March 31, 2014, the Company issued 2014 Second Bridge Notes in the aggregate principal amount of $1.3 million and received cash proceeds of approximately $1.0 million. To date, the Company has issued 2014 Second Bridge Notes in the aggregate principal amount of approximately $3.0 million for cash proceeds of approximately $2.3 million. The principal amount of the 2014 Second Bridge Notes, plus all accrued interest will convert into securities offered in our next capital raise that meets any one of the following two conditions: (i) gross proceeds to the Company of at least $4.0 million or (ii) the majority of the outstanding principal amount of the 2014 Second Bridge Notes convert into our next capital raise.  Due to the 2014 Second Bridge Notes’ floating conversion price, the Company recorded a $413,000 derivative liability to the related debt discount.

Subordinated Secured Convertible Promissory Notes

 In December 2010, the Company entered into a Securities Purchase Agreement with Costa Brava and Griffin, pursuant to which the Company issued and sold to Costa Brava and Griffin 12% Subordinated Secured Convertible Notes due December 23, 2015 (the “Subordinated Notes”) in the aggregate principal amount of $7.8 million and, in March 2011, the Company sold additional Subordinated Notes to Costa Brava and Griffin for an aggregate purchase price of $1.2 million. Subsequently, in July 2011, the Company sold Subordinated Notes to five accredited investors, including Costa Brava and Griffin, in the aggregate principal amount of $5.0 million. In addition, holders of certain of the Company’s then outstanding debt, with a principal balance of $1.1 million, converted such debt into Subordinated Notes during the year ended September 30, 2011.

 As of March 31, 2014, the principal and accrued but unpaid interest of the remaining unconverted Subordinated Notes was convertible at the option of the holder into shares of Common Stock at an initial conversion price of $0.07 per share. The conversion price is subject to a full price adjustment feature for certain price dilutive issuances of securities by the Company, and proportional adjustment for events such as stock splits, dividends, combinations, etc., and as such, are considered to be derivatives. Upon completion of the Series D Offering, the conversion price was adjusted to $0.042 per share.  The Company may force the conversion of the Subordinated Notes into Common Stock if certain customary equity conditions have been satisfied and the volume weighted average price of the Common Stock is $0.25 or greater for 30 consecutive trading days. As of March 31, 2014, the Company has not met the equity conditions to force the conversion of the Subordinated Notes.

 On October 31, 2013, Subordinated Notes in the aggregate total of $14.5 million in principal and accrued interest due to Costa Brava and Griffin were cancelled in exchange for approximately 101.5 million RSUs. The RSUs will vest in the event the trading price of the Company’s Common Stock reaches $0.143. Because the managing members of Costa Brava and Griffin served on the Company’s board of directors at the time of the exchange, the exchange was treated as a related party transaction, and the canceled $14.5 million principal and accrued interest and the related discount and derivative liability were treated as a contribution to paid-in capital.

 Also on October 31, 2013, the holder of a Subordinated Note totaling $0.4 million in principal and accrued interest, not otherwise related to the Company, exchanged such note for approximately 40 shares of Series D Preferred. The Company removed the net carrying value of the debt including accrued interest, deferred financing cost and the derivative liability, recorded the fair value of the Series D Preferred and the resulting difference of $37,000 was recognized as a loss on debt extinguishment.

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 As of March 31, 2014, Subordinated Notes in the aggregate principal amount of $1.4 million remain outstanding, of which $0.2 million mature during December 2015, $0.2 million mature during January 2016, $0.1 million mature during April 2016 and $0.9 million mature during July 2016.  The balance of the unconverted Subordinated Notes, net of unamortized discounts at March 31, 2014 was $0.9 million. The debt discounts will be amortized over the term of the unconverted Subordinated Notes, unless such amortization is accelerated due to earlier conversion of the Subordinated Notes pursuant to their terms.

Senior Subordinated Secured Promissory Notes

 In March 2011, the Company issued and sold 12% Senior Subordinated Secured Promissory Notes (the “Senior Subordinated Notes”) to Costa Brava and Griffin. In July 2011, the Senior Subordinated Notes were amended to permit the holders to demand repayment any time on or after July 16, 2012, in partial consideration for permitting the issuance of additional Subordinated Secured Convertible Promissory Notes.  The Senior Subordinated Notes are secured by substantially all of our assets pursuant to Security Agreements dated March 16, 2011 and March 31, 2011 between the Company and Costa Brava as representative of the Senior Subordinated Note holders. However, the liens securing the Senior Subordinated Notes are subordinate to the liens securing the Company’s indebtedness to PFG under the Revolving Credit Facility. Interest is calculated by adding the amount of such interest to the outstanding principal amount of the Senior Subordinated Notes as paid-in-kind interest. As a result of the addition of such interest, the outstanding principal amount of the Senior Subordinated Notes at October 31, 2013 was $5.4 million.

 On October 31, 2013, the outstanding Senior Subordinated Notes were converted to approximately 545 shares of Series D Preferred.  Since the holders of the remaining Senior Subordinated Notes were related parties to the Company at the time of the conversion, the Company accounted for the conversion of these notes as a capital transaction whereby the net carrying value of the debt including accrued interest was recorded as an increase to contributed capital.

Priority of Outstanding Debt

  As of March 31, 2014, our outstanding debt is ranked as follows: (i) the Revolving Credit Facility is senior to all other debt; (ii) the Senior Subordinated Convertible Notes and Subordinated Secured Notes rank pari passu with each other; and (iii) the 2014 Bridge Notes rank junior to all other debt.

Derivative Liability

 Certain instruments, including the embedded conversion feature in certain of the Company's outstanding debt and warrants, contain provisions that adjust the respective conversion or exercise prices in the event of certain dilutive issuances of securities, or exercise/conversion prices that are not fixed.  These provisions required the Company to record a derivative liability upon issuance.  The Company re-measured the fair value of the derivative liability to be $0.8 million as of March 31, 2014 and $19.2 million as of September 30, 2013 (see Note 11 below for a description of the Company's fair value measurements).

 The Company estimated the fair value of the derivative liability using the Binomial Lattice pricing model with the following significant inputs, as outlined below, to estimate the fair value of the derivative liability as of March 31, 2014 and September 30, 2013:  

	March 31, 2014		September 30, 2013
Risk free interest rate		0.36%		0.40%
Expected volatility		147% - 150%		94.8%
Expected dividends		None		None

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Note 4 — Convertible Preferred Stock

Series B Preferred

 The Series B Preferred is non-voting, except to the extent required by law. With respect to distributions upon a deemed dissolution, liquidation or winding-up of the Company, the Series B Preferred ranks senior to the Common Stock and Series D Preferred. The liquidation preference per share of Series B Preferred equals its stated value, $1,000 per share. The Series B Preferred is not entitled to any preferential cash dividends; however, the Series B Preferred is entitled to receive, pari passu with the Company’s Common Stock, such dividends on the Common Stock as may be declared from time to time by the Company’s Board of Directors.   

 Approximately 866 shares of Series B Preferred were outstanding at March 31, 2014, convertible into approximately 1,732,000 shares of the Company’s Common Stock.

Series D Preferred

 On October 30, 2013, we filed the Certificate of Designations with the Delaware Secretary of State to designate 4,000 shares of the Company's preferred stock as Series D Preferred. Each share of Series D Preferred has a Stated Value of $10,000 and votes alongside our Common Stock on an as-converted basis. The Series D Preferred ranks junior to our Series B Preferred, but is senior to all future classes of our preferred stock. The Series D Preferred is not redeemable at the election of the holder, but the Company may redeem the Series D Preferred, in whole or in part, in exchange for a cash payment equal to the Stated Value of the shared of Series D Preferred redeemed.  The holders of the Series D Preferred may elect, at any time, to convert the Series D Preferred into that number of shares of Common Stock equal to the Stated Value, divided by the current conversion price of $0.042 (the “Conversion Price”). The Series D Preferred also has a mandatory conversion provision that allows the Company to require conversion of all outstanding shares of Series D Preferred in the event the Company sells shares of Common Stock for at least $0.084 per share in a private financing or series of financings that result in aggregate gross proceeds of at least $10.0 million.

 As of March 31, 2014, there were 2,782 shares of Series D Preferred issued and outstanding.

 The following table summarizes equity activity for the quarter ended March 31, 2014 related to the sale of, and exchange of debt for, Series D Preferred and other equity activities.

	Series D Preferred Stock				Additional Paid-in Capital
	Shares		Amount
Balance, September 30, 2013		-		-		181,443,000
Cash Proceeds from sale of Series D Preferred Stock and warrants, net of issuance costs of $234,000		477		5		4,531,000
Convertible debt exchanged for Series D Preferred stock		2,305		23		24,705,000
Total Series D activity		2,782		28		29,236,000
All other equity activity:
Convertible debt exchanged for restricted stock		-		-		13,111,000
Stock based compensation		-		-		2,539,000
Warrant derivatives reclassified to equity		-		-		2,834,000
Other equity activity, net		-		-		2,747,000
Balance, March 31, 2014		2,782		28		231,910,000

Note 5 — Common Stock Warrants and Stock Based Compensation

  Common Stock Warrants. As of March 31, 2014 and 2013, warrants to purchase a total of 282.2 million shares of the Company’s Common Stock were outstanding, with a weighted average exercise price of $0.07 per share and exercise prices ranging from $0.001 per share to $0.55 per share.

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 Stock Incentive Plans. The Company’s stockholders approved the Company’s 2006 Omnibus Incentive Plan (the “2006 Plan”), which is designed to serve as a comprehensive equity incentive program to attract and retain the services of individuals essential to the Company’s long-term growth and financial success. Upon approval of the 2006 Plan, the Company’s 2003 Stock Incentive Plan (the “2003 Plan”) was terminated, but existing options issued pursuant to the Prior Plans remain outstanding in accordance with the terms of their original grants.

 As of March 31, 2014, there were 74,000 outstanding and exercisable options to purchase the Company’s Common Stock under the 2003 Plan with exercise prices ranging from $17.00 to $26.40.

 As of March 31, 2014, there were 441,000 outstanding and exercisable options to purchase the Company’s Common Stock under the 2006 Plan with exercise prices ranging from $0.16 to $13.00.

  In December 2010, the Company’s Board adopted the Company’s 2010 Non-Qualified Stock Option Plan (the “2010 Plan”) under which the Company’s eligible officers, directors and employees, consultants and advisors who qualify as “accredited investors” within the meaning of Rule 501 under the Securities Act, may be granted non-qualified stock options. 18,500,000 shares of the Company’s Common Stock were reserved for issuance under the 2010 Plan, and options to purchase 18,500,000 shares of the Company’s Common Stock at an exercise price of $0.09 per share were issued to certain of the Company’s officers and directors in December 2010 pursuant to the 2010 Plan. As of March 31, 2014, there are 9,000,000 outstanding and exercisable options to purchase the Company’s Common Stock under the 2010 Plan at an exercise price of $0.09 per share. No further grants may presently be made under the 2010 Plan.

 In March 2011, the Company’s stockholders approved the Company’s 2011 Omnibus Incentive Plan (the “2011 Plan”). The number of shares reserved for issuance under the 2011 Plan was increased to 446,500,000 shares, effective January 16, 2014. The 2011 Plan is designed to promote the interests of the Company and its stockholders by serving as a comprehensive equity incentive program to attract and retain the services of individuals capable of assuring the future success of the Company and to afford such persons an opportunity to acquire a proprietary interest, or otherwise increase their proprietary interest, in the Company. The 2011 Plan permits grants of stock options (including both incentive and non-qualified stock options), stock-only appreciation rights, restricted stock, restricted stock units, dividend equivalents, performance awards of cash, stock or property, other stock grants and other stock-based awards. As of March 31, 2014, there were options to purchase 142,717,000 shares of the Company’s Common Stock outstanding under the 2011 Plan, of which options to purchase 91,917,000 shares were exercisable, at exercise prices ranging from $0.042 to $0.150 per share. The aggregate number of shares of Common Stock issuable under all stock-based awards that may be made under the 2011 Plan at March 31, 2014 is 503,027,000 shares.

 Below is a summary of stock option transactions during the six months ended March 31, 2014:

	Number of Shares			Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Life (yrs)		Aggregate Intrinsic Value
Outstanding at September 30, 2013		51,752,000		$	0.20		7.7	$	-
Granted		149,438,000			0.04		9.6		-
Exercised		-			-		-		-
Forfeited/Cancelled		(48,958,000	)		0.10		8.3		-
Outstanding at March 31, 2014		152,232,000			0.07		9.2		-
Vested and expected to vest, March 31, 2014		129,398,000			0.07		9.2		-
Exercisable, March 31, 2014		101,432,000			0.08		9.0		-

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For the six months ended March 31, 2014 and 2013, the Company utilized the Black-Scholes valuation model for estimating the fair value of share-based compensation with the following assumptions:

	Six Months Ended March 31,
	2014	2013
Expected life	5.4 years	6.7 years
Expected volatility	169%	88.1% -99.3%
Expected dividend	None	None
Risk-free rate	1.6%	1.1%-1.3%

 The Company issues new shares of Common Stock to satisfy option exercises. Based on historical experience of option cancellations, the Company has estimated an annualized forfeiture rate of 15% and 7% for employee options for the three months ended March 31, 2014 and 2013, respectively.  Forfeiture rates are adjusted over the requisite service period when actual forfeitures differ, or are expected to differ, from the estimate.

 During the six months ended March 31, 2014, a total of 149.4 million options to purchase shares of the Company’s Common Stock were granted under the 2011 Plan, with an exercise price of $0.042.  Of the total options granted, 146.9 million were issued in exchange for the cancellation of previously granted options to purchase 27.1 million shares of Common Stock that were both vested and unvested, pursuant to the Option Exchange Program.  One-third of the grant vests immediately and the remaining two thirds vest in equal monthly installments over two years and expire on October 21, 2023.  The Company treated these exchanges as a modification to the existing options.  The Company recorded the incremental cost of the modification measured by the excess of the fair value of the modified award over the fair value of the original award immediately before the modification as additional compensation cost recognized over the requisite service period.  For the six months ended March 31, 2014, $1.5 million in stock option expense was recognized related to these transactions under the Option Exchange Program.

 Employee Stock Benefit Plan. The Company has established an employee retirement plan (the “ESBP”). This plan provides for annual contributions to the Company’s Employee Stock Bonus Trust (“SBT”) to be determined by the Board of Directors and which will not exceed 15% of total payroll.  As of March 31, 2014, the Company has not made any contributions to the SBT for the year ended September 30, 2014.  In Fiscal 2013, the Company made a contribution of 9.1 million shares of Common Stock with an estimated market value of $272,000 to the SBT.

 Deferred Compensation Plan. In September 2002, the Company established a deferred compensation plan, the Non-Qualified Deferred Compensation Plan, for certain key employees with long-term service with the Company. Annual contributions of Common Stock of the Company were made to a Rabbi Trust under such plan to be held for the benefit of the deferred compensation plan participants. During Fiscal 2013 the Board of Directors authorized a contribution of 14,000 shares to the Non- Qualified Deferred Compensation Plan. Participants’ potential distributions from the Rabbi Trust represent unsecured claims against the Company. The Rabbi Trust was established by the Company and is subject to creditors’ claims. Shares in this plan may be distributed to each plan beneficiary when they retire from service with the Company. At March 31, 2014, and September 30, 2013 there were 44,000 shares of the Company’s Common Stock were in the Rabbi Trust.

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Note 6 — Loss per Share

 Since the Company had a net loss from continuing operations for the six months ended March 31, 2014 and 2013, there was no difference between basic and diluted loss per share in each of these fiscal years.

The following table sets forth the computation of basic and diluted loss per common share:

	Three Months Ended March 31,						Six Months Ended March 31,
	2014			2013			2014			2013
Net Loss Numerator:
Loss from continuing operations	$	(4,602,000	)	$	(8,400,000	)	$	(5,115,000	)	$	(9,017,000	)
Loss from discontinued operations		-			(1,191,000	)		-			(2,738,000	)
Net loss	$	(4,602,000	)	$	(9,591,000	)	$	(5,115,000	)	$	(11,755,000	)
Net Loss Denominator:
Weighted average number of common shares outstanding, basic and diluted		245,122,000			153,688,000			234,858,000			147,541,000
Basic and diluted loss per share
Loss from continuing operations	$	(0.02	)	$	(0.05	)	$	(0.02	)	$	(0.06	)
Earnings (loss) from discontinued operations	$	-		$	(0.01	)	$	-		$	(0.02	)
Net loss per common share	$	(0.02	)	$	(0.06	)	$	(0.02	)	$	(0.08	)

 Options, warrants and convertible instruments outstanding at March 31, 2014 and September 30, 2013 to purchase approximately 1,123,686,000 and 594,951,000 shares of the Company’s Common Stock, respectively, were not included in the above computation because they were anti-dilutive.

Note 7 — Discontinued Operations

 On March 19, 2013, the Company announced that it had discontinued the Government Business, and instead focus on the Company’s cyber-security business.  As a result of the Company’s decision, the Company’s Government Business is classified as a discontinued operation in the consolidated financial statements of the Company.

 The following summarized financial information relates to discontinued operations, consisting of the Government Business:

	Three Months Ended March 31,					Six Months Ended March 31,
	2014		2013			2014		2013
Total revenues	$	-	$	732,000		$	-	$	1,514,000
Cost of revenues		-		1,278,000			-		2,606,000
General and administrative expense		-		323,000			-		882,000
Research and development expense		-		322,000			-		764,000
Total costs and expenses		-		1,923,000			-		4,252,000
Net (loss) from discontinued operations (net of $0 tax)	$	-	$	(1,191,000	)	$	-	$	(2,738,000	)

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 Included in the consolidated balance sheets are the following major classes of assets and liabilities associated with the Government Business as of March 31, 2014 and September 30, 2013:

	March 31, 2014		September 30, 2013
Accounts receivable, net	$	-	$	-
Prepaid expenses and other current assets		-		-
Current assets of discontinued operations		-		-
Unbilled revenues on uncompleted contracts		290,000		290,000
Property and equipment, net		-		7,000
Other assets		-		-
Non-current assets of discontinued operations		290,000		297,000
Accounts payable		87,000		141,000
Accrued expenses		438,000		438,000
Advance billings on uncompleted contracts		99,000		99,000
Current liabilities from discontinued operations	$	624,000	$	678,000

Note 8 — Commitments and Contingencies

 The Company leases certain facilities and equipment under cancelable and non-cancelable operating leases, with escalating rent provisions for facility and capital leases. Future minimum payments under capital lease obligations and operating lease commitments for the next five years as of March 31, 2014 are as follows:

Fiscal Year	Capital Leases			Operating Leases
2014 (remaining six months)	$	242,000		$	135,000
2015		128,000			251,000
2016		42,000			238,000
2017		25,000			175,000
2018		-			149,000
2019 and beyond		-			-
Less amounts representing interest		(41,000	)		-
Future minimum lease payments	$	396,000		$	948,000

 Total rent expense for operating leases amounted to $136,000 and $495,000 for the six months ended March 31, 2014 and 2013, respectively. Rent expense is recognized on a straight-line basis over the lease period. Deferred rent amounts are immaterial.

Litigation

 The Company has been, and may from time to time, become a party to various other legal proceedings arising in the ordinary course of its business. The Company does not presently know of any such other matters, the disposition of which would be likely to have a material effect on the Company’s consolidated financial position, results of operations or liquidity.

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Disputes

 On December 6, 2013, a certain holder of Senior Subordinated Convertible Promissory Notes (the “Notes”) who chose not to convert into the Series D Offering (the “Non-Converting Note Holder”), totaling approximately $0.9 million, notified the Company that they interpreted the Notes to require the Company to use the net proceeds from the Series D Offering, to repay certain outstanding debts.   In August 2013, however, the Company and the Non-Converting Note Holder amended the terms of the Notes to extend the maturity date of the Notes to January 31, 2014 (the “Amendment”), regardless of the consummation of a Qualified Financing, as such term is defined in the Notes.  The Non-Converting Note Holders objected to the Company’s interpretation of the Amendment, and took the position that the Notes were then currently due and payable from proceeds of the Qualified Financing, notwithstanding the Company’s position that Amendment extended the maturity date of the Notes to January 31, 2014.  The Company, however, failed to pay all amounts due and owing under the terms of the Notes on January 31, 2014.    On April 11, 2014, the Company entered into a Forbearance Agreement with the respective holders of the Notes to extend the maturity date of the Notes to July 31, 2014.  See Note 11 - Subsequent Events below.

 On November 15, 2013,the Company failed to meet a contractual first year minimum payment obligation of $100,000 with a certain vendor resulting in a contractual breach, which requires that we pay all fees and guarantee payment of totaling $1.8 million (the “Guarantee Payment”) immediately. We have not cured the breach of contract, but we have successfully negotiated a payment plan (the “Payment Plan”) with this vendor which consists of four equal monthly payments of $25,000 plus interest beginning February 2014. Due to our limited working capital, if we are unable to meet the requirements of the Payment Plan, we will be required to pay the Guarantee Payment in full, which could have a materially adverse impact on our business, financial condition and results of operations.

Note 9 — Fair Value Measurements

 The Company measures the fair value of applicable financial and non-financial assets and liabilities based on the following levels of inputs.

• Level 1 inputs: Level 1 inputs are quoted market prices in active markets for identical assets or liabilities that are accessible at the measurement date.

• Level 2 inputs: Level 2 inputs are from other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.

• Level 3 inputs: Level 3 inputs are unobservable and should be used to measure fair value to the extent that observable inputs are not available.

 The hierarchy noted above requires the Company to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. There were no transfers between Level 1, Level 2 and/or Level 3 during the six months ended March 31, 2014. Financial liabilities carried at fair value as of March 31, 2014 are classified below:

	Level 1		Level 2		Level 3		Total
Derivative liabilities	$	-	$	-	$	797,000	$	797,000

 The table below sets forth a summary of changes in the fair value of our Level 3 financial instruments for the six months ended March 31, 2014:

	September 30, 2013		Recorded New Derivative Liabilities		Warrant Derivatives Reclassified to Equity			Conversion of Debt to Series D Preferred and RSUs			Change in Estimated Fair Value Recognized in Results of Operations			March 31, 2014
Derivative liabilities	$	19,245,000	$	445,000	$	(2,833,509	)	$	(8,383,000	)	$	(7,676,000	)	$	797,000

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  Fair Value of Financial Instruments. The Company estimates the fair value of financial instruments that are not required to be carried in the condensed consolidated balance sheet at fair value on either a recurring or non-recurring basis as follows:

	March 31, 2014				September 30, 2013				Level in Fair Value Hierarchy
	Carrying amount		Fair Value		Carrying amount		Fair value
Cash and cash equivalents	$	147,000	$	147,000	$	136,000	$	136,000		1
Accounts Receivable, net	$	-	$	-	$	119,000	$	119,000		2
Accounts Payable	$	1,331,000	$	1,331,000	$	1,024,000	$	1,024,000		2

 The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to their short-term nature.

Note 10 — Noncontrolling Interest in Subsidiaries

 At March 31, 2014, the Company owned 96% of Novalog’s common stock, 98% of MSI’s common stock, 81% of RedHawk’s common stock, and 95% of iNetWorks’ common stock.

 For the three and six months ended March 31, 2014 and 2013, Novalog, MSI, RedHawk, and iNetWorks did not have any operating activities.

Note 11 — Subsequent Events

Forbearance Agreement.  On December 6, 2013, a disagreement arose between the Company and the Non-Converting Note Holders regarding the maturity date of the Notes held by the Non-Converting Note Holders.  On April 11, 2014, the Company entered into a forbearance agreement with the Non-Converting Note Holders to extend the maturity date of the Notes to July 31, 2014.  As consideration for the forbearance, the Company issued to the Non-Converting Note Holders five-year warrants to purchase an aggregate total of 43.1 million shares of Common Stock for $0.001 per share.

Griffin Advisory Agreement. On April 11, 2014, the Company entered into an advisory agreement with Griffin, wherein Griffin will offer certain advisory and consulting services to the Company pertaining to the Company’s current capital restructuring.  As compensation for Griffin’s services, the Company agreed to pay Griffin and aggregate total of $100,000, to be paid periodically, in order to enable the Company to effectively manage its ongoing cash requirement.  Griffin is affiliated with the Griffin Fund, LP, a principal shareholder of the Company.

Revolving Credit Facility Payment.  In May 2014, the Company failed to pay to PFG amounts due for April 2014 interest, and 10% of the gross proceeds received from the issuance of the 2014 Bridge Notes and the $70,000 principal payment, as required by the Second Modification.

Issuance of Additional 2014 Second Bridge Notes.  Since March 31, 2014, the Company has issued 2014 Second Bridge Notes in the aggregate principal amount of approximately $1.7 million, resulting in gross proceeds to the Company of approximately $1.29 million.

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 In this report, the terms “ISC8 Inc.,” “ISC8,” “Irvine Sensors,” “Irvine Sensors Corporation,” “Company,” “we,” “us” and “our” refer to ISC8 Inc. (“ISC8”) and its subsidiaries.

Introduction

 The following information should be read in conjunction with our unaudited condensed consolidated financial statements and notes thereto in Part I, Item 1 of this Quarterly Report on Form 10-Q (“Quarterly Report”), and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended September 30, 2013, filed with the SEC on December 24, 2013.

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Overview

 We are engaged in the design, development, and sale of a family of security products, consisting of cyber security solutions for government and commercial applications. Our current operations are located in California, Texas, and Italy with other employees and consultants in various other locations globally. Our operation in Italy was acquired in connection with our acquisition of certain software assets of Bivio Software in October 2012, described below.

Critical Accounting Estimates

 Our consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). As such, management is required to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The significant accounting policies that are most critical to aid in fully understanding and evaluating reported financial results are the same as those disclosed in our Form 10-K for the fiscal year ended September 30, 2013 filed with the SEC on December 24, 2013.

Results of Continuing Operations

Overview of Results of Continuing Operations for Three and Six Months Ended March 31, 2014 and March 31, 2013

Condensed Consolidated Results of Continuing Operations

 The continuing operating results of our business for the three months ended March 31, 2014 and 2013 is as follows:

	Three Months Ended March 31,						Increase (Decrease)
	2014			2013			Change			% Change
Revenues	$	78,000		$	102,000		$	(24,000	)		-23.5	%
Cost of revenues		45,000			44,000			1,000			2.3
Gross profit		33,000			58,000			(25,000	)		-43.1
Operating expenses:
General and administrative expense		2,532,000			2,320,000			212,000			9.1
Research and development expense		1,223,000			1,799,000			(576,000	)		-32.0
Total operating expense		3,755,000			4,119,000			(364,000	)		-8.8
Operating loss		(3,722,000	)		(4,061,000	)		(339,000	)		-8.3
Interest and other (income) expense:
Interest expense		621,000			3,806,000			(3,185,000	)		-83.7
Gain from change in fair value of derivative liability		261,000			466,000			(205,000	)		-44.0
Other (income) expense, net		(2,000	)		64,000			(66,000	)		-103.1
Total interest and other (income) expense		880,000			4,336,000			(3,456,000	)		-79.7
Loss from continuing operations before provision for income taxes		(4,602,000	)		(8,397,000	)		(3,795,000	)		-45.2
Provision for income taxes		-			3,000			(3,000	)		-100.0
Loss from continuing operations		(4,602,000	)		(8,400,000	)		(3,798,000	)		-45.2
Loss from discontinued operations		-			(1,191,000	)		1,191,000			100.0
Net loss	$	(4,602,000	)	$	(9,591,000	)	$	(4,989,000	)		-52.0	%
Basic and diluted net loss per share:
Loss from continuing operations	$	(0.02	)	$	(0.05	)	$	(0.03	)		-60.0	%
Loss from discontinued operations		-			(0.01	)		0.01			100.0
Net loss per share	$	(0.02	)	$	(0.06	)	$	(0.04	)		-66.7	%
Basic and diluted weighted average common shares outstanding		245,122,000			153,688,000			91,434,000			59.5	%

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 The continuing operating results of our business for the six months ended March 31, 2014 and 2013 is as follows:

	Six Months Ended March 31,						Increase (Decrease)
	2014			2013			Change			% Change
Revenues	$	171,000		$	196,000		$	(25,000	)		-12.8	%
Cost of revenues		93,000			81,000			12,000			14.8
Gross profit		78,000			115,000			(37,000	)		-32.2
Operating expenses:
General and administrative expense		4,907,000			4,290,000			617,000			14.4
Research and development expense		3,121,000			3,464,000			(343,000	)		-9.9
Total operating expense		8,028,000			7,754,000			274,000			3.5
Operating loss		(7,950,000	)		(7,639,000	)		311,000			4.1
Interest and other (income) expense:
Interest expense		4,549,000			5,793,000			(1,244,000	)		-21.5
Gain from change in fair value of derivative liability		(7,073,000	)		(4,481,000	)		2,592,000			57.8
Gain on extinguishment of debt		(316,000	)		-			(316,000	)		100.0
Other (income) expense, net		2,000			63,000			(61,000	)		-96.8
Total interest and other (income) expense		(2,838,000	)		1,375,000			(4,213,000	)		-306.4
Loss from continuing operations before provision for income taxes		(5,112,000	)		(9,014,000	)		(3,902,000	)		-43.3
Provision for income taxes		3,000			3,000			-			-
Loss from continuing operations		(5,115,000	)		(9,017,000	)		(3,902,000	)		-43.3
Loss from discontinued operations		-			(2,738,000	)		2,738,000			100.0
Net loss	$	(5,115,000	)	$	(11,755,000	)	$	(6,640,000	)		-56.5	%
Basic and diluted net loss per share:
Loss from continuing operations	$	(0.02	)	$	(0.06	)	$	(0.04	)		-66.7	%
Loss from discontinued operations		-			(0.02	)		0.02			100.0
Net loss per share	$	(0.02	)	$	(0.08	)	$	(0.06	)		-75.0	%
Basic and diluted weighted average common shares outstanding		234,858,000			147,541,000			87,317,000			59.2	%

  The following discussions relate to our results of continuing operations after reclassifying the operations of our Government Business as discontinued operations upon the discontinuance of the Government Business on March 19, 2013.

 Total Revenues. Revenue is generated from software maintenance revenue of our cyber security products primarily resulting from the acquisition of Bivio Software. Effective March 19, 2013, we discontinued our Government Business and completed our goal of transforming the Company into a pure cyber security company.   We are continuing to focus on the development of the Cyber adAPT® product suite and are currently promoting sales of our other recently introduced products, Cyber NetFalcon® and Cyber NetControlTM. We believe these products will gain acceptance in the market for cyber security products, and therefore result in a substantial increase in our total revenue; however, no assurances can be given that such outcome will materialize during the year ended September 30, 2014, or at all.

 Cost of Revenues. Cost of revenue includes wages and related benefits of our personnel directly incurred in support of our software maintenance revenue.

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  General and Administrative Expense. General and administrative expense largely consists of wages and related benefits for our executive, financial, administrative and marketing staff, as well as professional fees, primarily legal and accounting fees and costs, plus various fixed costs such as rent, utilities and telephone. General and administrative expense for the three months ended March 31, 2014 increased slightly compared to the 2013 period as a result of additional stock compensation expense related to the acceleration of unvested options for the Company’s former CEO upon his separation, and increased expense for outside services, offset by a decrease in salaries and benefits as a result of reduced headcount.  General and administrative expense for the six months ended March 31, 2014 increased compared to 2013 due to (i) the cancel and re-grant of employee stock options as part of an option exchange program in addition to the CEO option acceleration discussed above, (ii) 100% reserve recorded for certain receivables from the discontinued Government Business, and (iii) offset by a decrease in salaries and benefits as a result of reduced headcount.

 Research and Development Expense. Research and development expense primarily consists of wages and related benefits for our research and development staff, independent contractor consulting fees and subcontractor and vendor expenses directly incurred in support of internally funded research and development projects, plus associated overhead expenses. For the three and six months ended March 31, 2014, research and development expense was approximately $1.2 million and $3.1 million, respectively, a $0.6 million and $0.3 million decrease, respectively, from the comparable 2013 periods due to decreased salaries and benefits as a result of the discontinuance of the Government Business in March 2013.

 Interest Expense. For the three and six months ended March 31, 2014 interest expense decreased $3.2 million and $1.2 million, respectively, compared to the prior year periods as a result of the conversion of $22.0 million in debt principle in exchange for shares of Series D Preferred and Series D Warrants in October 2013.

 Change in Fair Value of Derivative Liability. For the three months ended March 31, 2014, our gain from the change in fair value of derivative liability decreased to $0.2 million from $0.5 million for the three months ended March 31, 2013. The expense or loss in both periods is a result of quarterly fluctuations in our stock price.  For the six months ended March 31, 2014, the change in fair value increased $2.6 million to a gain of $7.1 million, or 58%, from a gain of $4.5 million in the comparable 2013 period.  On October 31, 2013, we completed the Series D Offering, considered to be a qualified financing, which fixed the conversion price of certain convertible notes and warrants, and, in turn, eliminated the embedded derivative therein. As a result of the Series D Offering, we revalued our embedded derivatives contained in the Senior Subordinated Convertible Notes issued during fiscal 2013 (the “2013 Notes”), converted Senior Subordinated Notes and warrants as of October 31, 2013. In the first quarter of fiscal 2014, we recognized a $6.8 million gain associated with the change in fair value related to these derivatives due to our lower stock price. The resulting fair value of these derivatives as of October 31, 2013 was extinguished in one of two methods.  For the portion of the derivative securities held by related parties, we recognized the balance as contributed capital.  For the portion of the derivative securities held by parties not otherwise related to the Company, we recognized the balance as a gain on extinguishment of debt. However, the conversion price of the remaining Senior Subordinated Notes will be based on the price of the next qualified financing consummated by the Company.  Therefore, we revalued the embedded derivative on the remaining Senior Subordinated Notes as of March 31, 2014.  The difference in the fair value results in a $0.4 million net gain for the six months ended due to the fluctuations in our stock price.  The remaining Senior Subordinated Notes continue to have derivative features that can result in additional changes in the fair value of our derivative liability that we may be required to record in future reporting periods, unless and until our convertible debt instruments mature, are repaid, or are converted into common or preferred stock. No assurances can be given that we will not enter into additional convertible notes and warrants that have an embedded derivative feature in the future.

 Extinguishment of Debt. For the six months ended March 31, 2014, our gain on extinguishment of debt was $0.3 million.  All of the debt converted into shares of Series D Preferred held by investors not related to the Company were treated as an extinguishment of debt.  As such, the aggregate principal balance, accrued interest, unamortized discount, deferred cost, and respective derivative liability were compared to the fair value of the shares of Series D Preferred received in exchange for such cancelled debt, and resulted in a $0.3 million gain on extinguishment of debt.

 Net Loss from Continuing Operations. Our net loss from continuing operations for the three and six months ended March 31, 2014 decreased $3.8 million and $3.9 million, respectively, compared to the prior year periods primarily due to a gain from the change in fair value of derivative instruments and gain on extinguishment of debt offset by higher interest expense of associated with debt conversions.

 Loss per Share. Basic and diluted loss per share from continuing operations for the three months ended March 31, 2014 decreased by $0.03 to $0.02, from $0.05 for the same period in 2013. Basic and diluted loss per share from discontinued operations decreased to $0.00 for the three months ended March 31, 2014, from $0.01 for the same period in 2013. Basic and diluted loss per share decreased by $0.04 to $0.02 for the three months ended March 31, 2014, from $0.06 for the same period in 2013.

Basic and diluted loss per share from continuing operations for the six months ended March 31, 2014 decreased by $0.04 to $0.02, from $0.06 for the same period in 2013. Basic and diluted loss per share from discontinued operations decreased to $0.00 for the six months ended March 31, 2014, from $0.02 for the same period in 2013. Basic and diluted loss per share decreased by $0.06 to $0.02 for the six months ended March 31, 2014, from $0.08 for the same period in 2013.

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Liquidity and Capital Resources

 Our liquidity in terms of both cash and cash equivalents and working capital deficit increased in the first six months ended March 31, 2014, largely as a result of the timing of payments on our current payables and cash generated from our equity and debt financing. We continued to have a working capital deficit for the current period because we continued to generate losses as shown in the following table and discussed more fully below:

	Cash and Cash Equivalents		Working Capital (Deficit)
September 30, 2013	$	136,000	$	(29,713,000	)
Net Dollar increase as of March 31, 2014		11,000		19,830,000
March 31, 2014	$	147,000	$	(9,883,000	)
Percentage increase as of March 31, 2014		8%		67%

 Cash at March 31, 2014 is essentially unchanged compared to September 30, 2013 as a result of the following components: (i) cash used in operating activities of $4.4 million offset by cash provided from financing activities of $4.5 million,  (ii) cash used in operating activities consisted of a $5.1 million net loss from continuing operations, (iii) $3.8 million in non-cash interest expense, (iv) $2.5 million in stock based compensation expense and (v) a net change in operating assets and liabilities of $1.3 million, offset by $7.1 million change in fair value of derivative liability and other less significant factors related to various timing and cash deployment effects.    Cash provided by financing activities was a result of $4.5 million in proceeds from the sale of shares of Series D Preferred and $1.7 million in proceeds from the issuance of the Senior Subordinated Secured Convertible Promissory Notes, partially offset by $2.1 million of principle payments on the PFG revolving credit facility.

  For the six months ended March 31, 2014, our loss from continuing operations was $5.1 million, as compared to a $9.0 million loss for the six months ended March 31, 2013. As of March 31, 2014 we had negative working capital and stockholders’ deficit of approximately $9.9 million and $9.5 million, respectively, compared to $29.7 million and $55.6 million, respectively, at September 30, 2013. The increases in working capital and stockholders’ deficit was the due to the extinguishment of debt which were converted to Series D Preferred and RSUs, and the elimination of the related derivative liability resulting from the debt conversion.

 As of March 31, 2014 we have used all of the cash obtained from the sale of the Thermal Imaging Division, the Revolving Credit Facility and 2013 Notes to fund our operations, and have raised additional capital through the issuance of an aggregate of $1.9 million principal amount of the 2014 Bridge Notes, and have been unable to maintain positive cash flow during the six month period due to insufficient revenues. We do not have adequate funds to satisfy our working capital requirements for the next 12 months.  To continue to fund anticipated operating expenses and satisfy indebtedness, we are currently seeking additional financing, and no assurances can be given that such financing will be available on a timely basis, on terms that are acceptable, or at all. Failure to do so and meet the repayment or other obligations of our existing debt, of which a significant amount is due within 12 months, could result in default and acceleration of debt maturity, which could materially adversely affect our business, and financial condition, and threaten our viability as a going concern.

Contractual Obligations and Commitments

 Debt.

At March 31, 2014, we had approximately $7.9 million of debt, exclusive of discounts and fees, which consisted of (i) the Revolving Credit Facility, in the principal amount of $3.0 million; (ii) Senior Subordinated Secured Convertible Notes issued with an aggregate principal balance of approximately $1.6 million; (iii) 2014 Senior Subordinated Secured Bridge Notes of approximately $1.9 million and (iii)  Subordinated Secured Convertible Notes with an aggregate principal balance of approximately $1.4 million.  These instruments are more fully described below.

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   Revolving Credit Facility

On November 1, 2013, the Company substantially modified its Loan Agreement in accordance with the PFG Loan Modification to provide, among other things, for a one-year extension of the maturity date under the Loan Agreement to December 31, 2014. In return, the Company made a $2.0 million repayment on the loan, deposited $500,000 with PFG as collateral for the loan, and, in the event the Company consummates a debt or equity financing, the Company agreed to pay to PFG 25% of the proceeds from such financing. PFG and the Company also modified the Guaranty Agreement executed in connection with the Loan Agreement in order to: (i) release Costa Brava from its guarantee of the Company's debt to PFG, (ii) reduce the maximum guarantee amount to $1.0 million, and (iii) affirm the obligations of Griffin under the Guaranty Agreement.

 On February 7, 2014 the Company entered into the Second Modification to the Loan Agreement on the Second Modification Date. In accordance with the terms of the Second Modification, in the event the Company consummates a debt or equity financing on or after the Second Modification Effective Date, the Company must pay to PFG 10% of the gross proceeds received from such financing. PFG, however, waived the deposit requirement for the month of January 2014. In consideration for the Second Modification, the Company has agreed to pay PFG a back-end fee of 15% on any capital transaction consummated on or after February 1, 2014.

 As of March 31, 2014, the Revolving Credit Facility had an outstanding balance of approximately $3.0 million.

 Senior Subordinated Secured Convertible Notes

  During the year ended September 30, 2013, we issued Senior Subordinated Notes, which notes are a part of a series of notes, in the aggregate amount of $10.0 million. As of March 31, 2014, Senior Subordinated Notes in the aggregate principal amount of $1.6 million were outstanding, and matured on January 31, 2014.  On April 11, 2014, we entered into a Forbearance Agreement with the respective holders of these Notes to extend the maturity date to July 31, 2014.  As consideration for the forbearance, the Company issued five-year warrants to purchase 43.1 million shares of Common Stock for $0.001 per share.

 Senior Subordinated Secured Convertible Bridge Notes

 In February 2014, we issued 2014 Bridge Notes, which notes are a part of two distinct offerings in aggregate principle amount of up to, respectively, $3.5 million and $6.0 million.  As of March 31, 2014, Bridge Notes in the aggregate principal amount of $1.9 million were outstanding and will mature on July 31, 2014.

 Subordinated Secured Convertible Notes

As of March 31, 2014, Subordinated Notes in the aggregate principal amount of $1.4 million were outstanding, of which $0.2 million will mature in December 2015, $0.2 will mature in January 2016, $0.1 million will mature in April 2016 and $0.9 million will mature in July 2016.

Priority of Outstanding Debt

 As of March 31, 2014, our outstanding debt is ranked as follows: (i) the Revolving Credit Facility is senior to all other debt; (ii) the Senior Subordinated Convertible Notes and Subordinated Secured Notes rank pari passu with each other; and (iii) the Subordinated Notes rank junior to all other debt.

 Currently, the Company does not have the ability or resources to repay its debt if a demand is made for repayment when due.  The default of all or significant portions of debt could result in the foreclosure of the Company assets.

Capital Lease Obligations. The outstanding principal balance on our capital lease obligations of $0.4 million at March 31, 2014 relates primarily to computer equipment and software, and is included as part of current and non-current liabilities within our consolidated balance sheet.

Operating Lease Obligations. We have various operating leases covering equipment and facilities located at our offices in California, Texas, Italy, and Dubai.

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Deferred Compensation. We have a deferred compensation plan, the Executive Salary Continuation Plan (the “ESCP”), for select key employees. Benefits payable under the ESCP are established on the basis of years of service with us, age at retirement and base salary, subject to a maximum benefits limitation of $137,000 per year for any individual. The ESCP is an unfunded plan. The recorded liability for future expense under the ESCP is determined based on expected lifetimes of participants using Social Security mortality tables and discount rates comparable to those of rates of return on high quality investments providing yields in amount and timing equivalent to expected benefit payments. At the end of each fiscal year, we determine the assumed discount rate to be used to discount the ESCP liability. We considered various sources in making this determination for six months ended March 31, 2014, including the Citigroup Pension Liability Index, which at March 31, 2014 was 4.54%. Based on this review, we used a 4.54% discount rate for determining the ESCP liability at March 31, 2014. Presently, two of our retired executives are receiving benefits aggregating $185,000 per annum under the ESCP. As of March 31, 2014, $1.1 million has been accrued in the accompanying consolidated balance sheet for the ESCP, of which amount $185,000 is a current liability included in accrued expenses in the attached Condensed Consolidated Balance Sheets as we expect to pay during Fiscal 2014.

Off-Balance Sheet Arrangements

 Our conventional operating leases are either immaterial to our financial statements or do not contain the types of guarantees, retained interests or contingent obligations that would require their disclosures as an “off-balance sheet arrangement” pursuant to Regulation S-K Item 303(a)(4). As of March 31, 2014 and 2012, we did not have any other relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Stock-Based Compensation

 Aggregate stock-based compensation attributable to continuing operations for the six month periods ended March 31, 2014 and 2013 was $2.5 million and $0.3 million, respectively.

 All transactions in which goods or services are the consideration received for equity instruments issued to non-employees are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date used to determine the fair value of any such equity instrument is the earliest to occur of (i) the date on which the third-party performance is complete, (ii) the date on which it is probable that performance will occur, or (iii) if different, the date on which the compensation has been earned by the non-employee.

 We calculate stock option-based compensation by estimating the fair value of each option granted using the Black-Scholes option valuation model and various assumptions. Once the compensation cost of an option is determined, we recognize that cost on a straight-line basis over the requisite service period of the option, which is typically the vesting period for options granted by us. We calculate compensation expense of both vested and non-vested stock grants by determining the fair value of each such grant as of their respective dates of grant using our stock price at such dates with no discount. We recognize compensation expense on a straight-line basis over the requisite service period of a non-vested stock award.

 For the six months ended March 31, 2014, stock-based compensation included compensation costs attributable to such periods for those options that were not fully vested upon adoption of ASC 718, Compensation — Stock Compensation, adjusted for estimated forfeitures. We have estimated forfeitures to be 15%. We granted options to purchase 149.4 million shares and we canceled 28.6 million shares during the six-month period ended March 31, 2014 pursuant to the Option Exchange Program.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 As a "smaller reporting company" as defined by the rule and regulations of the SEC, we are not required to provide this information. 

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ITEM 4.  CONTROLS AND PROCEDURES

 Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended, which we refer to as the Exchange Act) that are designed to ensure that information required to be disclosed in our periodic reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that this information is accumulated and communicated to our management, including our principal executive/financial officer, to allow timely decisions regarding required disclosure.

 Our management, with the participation and supervision of our Chief Executive Officer and Chief Financial Officer (“Certifying Officers”), evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 Based upon that evaluation, our Certifying Officers concluded that as of the end of the period covered by this Quarterly Report, our disclosure controls and procedures were not effective.   Our primary material weakness has been due to our limited number of personnel and, therefore, segregation of duties. We plan to remediate this issue when and if we obtain sufficient working capital in the future.

 Changes in Internal Control over Financial Reporting. The Company’s Certifying Officers have determined that, other than step necessary to correct the material weakness identified above, there have been no changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2014 in connection with the evaluation described in the above paragraph that have materially affected, or are reasonably likely to materially affect, Company’s internal control over financial reporting.

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PART II

OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

 None.

ITEM 1A. RISK FACTORS

Risks Related to the Company

 We need to raise capital to fund our operations, service our debt, and continue as a going concern. If such capital is not available to us on a timely basis, on acceptable terms or at all, we will not be able to continue as a going concern.

 Despite capital received from recent debt and equity financings, we require additional capital to meet our working capital needs, fund our operations and meet our debt service obligations. No assurances can be given that any additional capital from financings or other sources will be available on a timely basis, on acceptable terms, or at all, or that the proceeds from any financings will be sufficient to address our near term liquidity requirements. If we are unable to obtain needed additional capital, our business, financial condition and results of operations will be materially and adversely affected, and we will not be able to continue as a going concern.

 We anticipate that our future capital requirements will depend on many factors, including but not limited to:

• our ability to meet our current obligations, including trade payables, payroll and fixed costs;

• our required service and settlement on our debt and capital leases payable over the next twelve months;

• our ability to obtain revenue, and the timing of our deliverables to earn the revenue;

• our ability to attract investors by demonstrating our technology’s proof point through the generation of sales revenue;

• the timing of payments from our customers;

• our ability to control costs;  

• our ability to commercialize our technologies and achieve broader market acceptance for those technologies; 

• our ability to divest assets as we deem necessary;

• technological advancements and competitors’ responses to our products;

• our relationships with customers and suppliers;

• general economic conditions including the effects of potential future economic slowdowns, acts of war or terrorism and the current international conflicts; and

• general regulatory conditions that can impact our ability to sell cyber security technologies.

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 Our ability to raise additional capital may be limited because, as a company that is quoted on the OTCQB marketplace (“OTCQB”), we are no longer eligible to use Form S-3 to register the resale of securities issued in private financings. Even if available, financings can involve significant costs and expenses, such as legal and accounting fees, diversion of management’s time and efforts, or substantial transaction costs or break-up fees in certain instances. Financings may also involve substantial dilution to existing stockholders, and may cause additional dilution through adjustments to certain of our existing securities under the terms of their anti-dilution provisions. If adequate funds are unavailable on a timely basis on acceptable terms, or at all, our business and revenues may be adversely affected and we may be unable to continue our operations at current levels, develop or enhance our products, expand our sales and marketing programs, capitalize on our future opportunities or respond to competitive pressures.

 We failed to timely file our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, and, as a result, may be in breach of certain contracts.

Our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 (“March 2014 10-Q”) was due to be filed with the SEC on May 20, 2014. However, we were unable to file the March 2014 10-Q on the prescribed due date, and, as a result, we may be in breach of any agreement wherein we agreed to continually file our periodic reports under the Exchange Act in a timely manner. Furthermore, our failure to timely file the March 2014 10-Q may negatively impact our ability to raise additional capital needed to meet our working capital needs, fund our operations and meet our debt service obligations. Any breach of an existing agreement or circumstance that inhibits our ability to raise capital could materially and adversely impact our financial condition and results of operations.

 We are currently in breach of a contract with a vendor, which could, in turn, have a materially adverse effect on our business, financial condition and results of operation. Although we have negotiated a repayment plan, no assurances can be given that we can cure the breach or otherwise satisfy our remaining obligation.

On November 15, 2013, we failed to satisfy a first year minimum payment obligation of $100,000 under a contract with a certain vendor, resulting in a contractual breach and a requirement that we immediately pay all fees and a guarantee payment of $1.8 million (the “Guarantee Payment”). We have not cured this breach of contract, but have successfully negotiated a payment plan with this vendor (the “Payment Plan”) of four equal monthly payments of $25,000, plus interest, beginning February 2014. Due to our anemic working capital, if we are unable to make payments under the Payment Plan as they come due we will be required to pay the Guarantee Payment in full and our business, financial condition and results of operations could be materially and adversely affected.

 Weare delinquent in paying many additional critical vendors.  In the event we are unable to obtain financing to pay such vendors, or otherwise restructure the payables, we may not be able to obtain critical services necessary to continue as a going concern.

 We are currently behind in majority of our vendor payments, including rent, equipment leasing, and many others necessary for us to operate our business.  While a Company is currently seeking financing to pay such vendors, and working on an extended payment term with these vendors, no assurances can be given that the Company will be successful.  Failure to obtain necessary financing to pay our vendors, or successfully negotiate payment terms, may result in our inability to obtain critical services necessary for us to continue as a going concern. 

 In the event that we are unable to repay our debt when due, we will have to seek additional financing, and no assurances can be given that such financing would be available on a timely basis, on terms that are acceptable or at all.

 Failure to meet the repayment or other obligations of our existing debt upon demand by any of our creditors on or before its due date could have a material adverse effect our business, results of operations and financial condition and threaten our financial viability.

            We may consider divesting certain assets in the future to improve our liquidity to focus our business operations.

 To address our working capital needs, we sold a large portion of our patent portfolio in 2009 and assets relating to our former thermal imaging business (the “Thermal Imaging Business”) in January 2012. We may enter into agreements to sell other assets in the future. We also may wish to divest assets to focus our resources on selected business opportunities, as we did in March 2013 with the cessation of our government-focused business (the “Government Business”), and focus on our cyber-security business. We may not be able to complete other divestitures, if any, on acceptable terms, on a timely basis or at all, and such sales, if any, could materially adversely affect our future revenues. Furthermore, we have lenders with security interests in substantially all of our assets, and such sales would therefore require such lenders’ consent and are unlikely to generate any direct benefits to stockholders and could materially impair our ability to maintain our current operations.

 We have historically generated substantial losses, which, if continued, could make it difficult to fund our operations or successfully execute our business plan, and could adversely affect our stock price.

 Since our inception, we have generated net losses in most of our fiscal periods. We experienced a net loss of approximately $28.0 million in fiscal 2013 and $5.1 million during the six-months ended March 31, 2014. We can provide no assurance that we will be able to achieve or sustain profitability in the future. In addition, because we have significant expenses that are fixed or difficult to change rapidly, we are generally unable to reduce expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues. We are dependent on support from subcontractors to meet our operating plans and susceptible to losses when such support is delayed or withheld. These factors could cause us to continue to experience net losses in future periods, which would make it difficult to fund our operations and execute our business plan, and could cause the market price of our Common Stock to decline.

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We are currently under audit of final indirect rates for fiscal years 2005 through 2012, related to our legacy government businesses.

We are currently under audit by the Defense Contract Audit Agency (“DCAA”) for our final indirect rate submissions for fiscal years 2005 through 2012. We believe the indirect costs have been properly recorded for the outstanding audit years. If the outcome of the outstanding audits results in unfavorable adjustments, there could be a material adverse effect on our results of operation and cash flow.

            As a result of the discontinuation of our Government and Thermal Imaging Businesses, we are dependent on our cyber-security business. If we are unable to commercialize our technology, we may not be able to generate or increase our revenues or achieve or sustain profitability.

 As a result of the discontinuance of our Government and Thermal Imaging Businesses, we are now dependent on our cyber security business for future revenue growth. No assurances can be given that our cyber security business will be successful, or if successful, that we will derive sufficient revenue to generate positive cash flow from operations. In prior years, we have made significant investments to commercialize our technologies without significant success. Furthermore, a majority of our historical total revenues have been generated directly or indirectly from U.S. government customers.

 Our ability to raise capital to fund continuing operations will be negatively impacted if we are unable to successfully develop our cyber security products.

 Our ability to raise additional capital to fund our continuing operations and continue as a going concern will be negatively affected if we are unable to successfully develop our cyber security products. Additionally, our goodwill and intangible assets will be subject to impairment if we are unable to successfully develop our cyber security products.

           We have engaged in multiple financings, which have significantly diluted existing stockholders and will likely result in substantial additional dilution in the future.

Assuming conversion or exercise of all of our existing convertible securities currently authorized and outstanding as of March 31, 2014, approximately 1,231.3 million additional shares of Common Stock (or a total of approximately 1,486.3 million shares) would be outstanding, as compared to 255.1 million shares of Common Stock issued and outstanding as of March 31, 2014. From October 1, 2013 through March 31, 2014, we have issued approximately 49.5 million shares of Common Stock, largely to fund our operations, from warrant exercises and for convertible debt financings, resulting in dilution to our existing stockholders. Any future equity or convertible debt financings would likely result in further dilution to our stockholders. Existing stockholders likely would suffer significant dilution in ownership interests and voting rights, and our stock price could decline as a result of any potential future application of price anti-dilution features of the related debt instruments, if they are not waived.

Through participation in our debt financings, our primary investors obtained majority control over stockholder voting and substantial control over Board decisions.

As of February 19, 2014, Costa Brava and Griffin, our largest stockholders and debt holders, collectively controlled approximately 53% of our issued and outstanding Common Stock and have the ability, following conversion of certain derivative securities, to substantially increase their aggregate percentage ownership. In addition, certain stockholders, including Griffin, have nominated three of the four directors that presently serve on our Board of Directors. Accordingly, Costa Brava and Griffin have significant influence over the outcome of matters that require a stockholder vote or actions by our Board of Directors, and the ability of other stockholders to influence such outcomes has been correspondingly diminished.

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 If we fail to scale our operations adequately, we may be unable to meet competitive challenges or exploit potential market opportunities, and our business could be materially and adversely affected.

 Our consolidated total revenues in fiscal 2013 and the three months ended December 31, 2013 were $501,000 and $93,000, respectively. To become and remain profitable, we need to materially grow our total revenues or substantially reduce our operating expenses. Such challenges are expected to place a significant strain on management, personnel, infrastructure and resources. To implement our current business and product plans, we need to expand, train, manage and motivate our workforce, and expand our operational and financial systems, as well as our manufacturing and service capabilities. All of these endeavors will require substantial additional capital and considerable effort by our management. If we are unable to effectively manage changes in our operations, we may be unable to scale our business quickly enough to meet competitive challenges or exploit potential market opportunities, and our current or future business could be materially and adversely affected.

 We are subject to risk of misuse of our technologies by our employees and related partners, which may materially affect our competitiveness in the marketplace.

 We treat technical data as confidential and generally rely on internal nondisclosure safeguards, including confidentiality agreements with employees, and on laws protecting trade secrets, to protect our proprietary information and maintain barriers to competition. However, we cannot assure you that these measures will adequately protect the confidentiality of our proprietary information, or that others will not independently develop products or technology that are equivalent or superior to ours.

 Our ability to exploit our own technologies may be constrained by the rights of third parties who could prevent us from selling our products in certain markets or could require us to obtain costly licenses.

 Other companies may hold or obtain patents or inventions, or may otherwise claim proprietary rights to technology useful or necessary to our business. We cannot predict the extent to which we may be required to seek licenses under such proprietary rights of third parties and the cost or availability of these licenses. While it may be necessary or desirable in the future to obtain licenses relating to one or more proposed products or relating to current or future technologies, we cannot assure you that we will be able to do so on commercially reasonable terms, if at all. If our technology is found to infringe upon the rights of third parties, or if we are unable to obtain sufficient rights to use key technologies, our ability to compete would be harmed and our business, financial condition and results of operations would be materially and adversely affected.

 Producing, enforcing, and protecting patents and other proprietary information can be costly. If we are unable to adequately protect or enforce our proprietary information or if we become subject to infringement claims by others, our business, results of operations and financial condition may be materially adversely affected.

 We may need to engage in future litigation to enforce our intellectual property rights or the rights of our customers, to protect our trade secrets or to determine the validity and scope of proprietary rights of others, including our customers. No assurances can be given that, in the future, we will be able to continue to pursue patents to protect our various cyber security technologies from infringement by our competitors. We may also need to engage in litigation to enforce patent rights with respect to future patents, if any. In addition, we may receive communications from third parties asserting that our products infringe the proprietary rights of third parties. We cannot assure you that any such claims would not result in protracted and costly litigation. Any such litigation could result in substantial costs and diversion of our resources and could materially and adversely affect our business, financial condition and results of operations. Furthermore, we cannot assure you that we will have the financial resources to vigorously defend our proprietary information.

-30-

 We are subject to significant competition that could harm our ability to obtain new business or attract strategic partnerships and could increase the price pressure on our products.

 We face strong competition from a wide variety of competitors, including large cyber-security and security technology firms. Most of our competitors have considerably greater financial, marketing and technological resources than we do, which may make it difficult for us to win new customers or to attract strategic partners. This competition impacts our ability to increase the average selling prices for our products. We cannot assure you that we will be able to compete successfully with these companies. Certain of our competitors have a presence in key markets, greater name recognition, larger customer bases and significantly greater financial, sales and marketing, distribution, technical and other resources than us. As a result, these competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources to the promotion and sale of their products. Increased competition has, in the past, resulted in price reductions, reduced gross margins and loss of market share. This trend may continue in the future. We cannot assure you that we will be able to compete successfully or that competitive pressures will not materially and adversely affect our business, financial condition and results of operations.

 We must continually adapt to unforeseen technological advances, or we may be unable to successfully compete with our competitors.

 We operate in industries characterized by rapid and continuing technological development and advancements. Accordingly, we anticipate that we will be required to devote substantial resources to improve already technologically complex products. Many companies in these industries devote considerably greater resources to research and development than we do. Developments by any of these companies could have a materially adverse effect on us if we are unable to keep up with the same developments. Our future success will depend on our ability to successfully adapt to any new technological advances in a timely manner.

 If we are not able to attract and retain key personnel as required, we may be unable to implement our business plan and our results of operations could be materially and adversely affected.

 We depend to a large extent on the abilities and continued participation of our key employees, including our executive officers. The loss of any key employee could have a material adverse effect on our business. While we have adopted employee equity incentive plans designed to attract and retain key employees, our stock price has declined in recent periods, and no assurances can be given that options or non-vested stock granted under our plans will be effective in retaining key employees. We believe that, as our activities increase and change in character, additional experienced personnel will be required to implement our business plan. Competition for such personnel is intense and we cannot assure you that they will be available when required, or that we will have the ability to attract and retain them.

 If we are not successful in transitioning product research and development within our organization and retain our remaining engineering personnel, our business could be materially and adversely affected.

 On May 9, 2014, we terminated a substantial portion of our research and development staff in the Plano, Texas facility and transferred responsibility for our cyber-security products including, but not limited to Cyber adAPTTM, to our Milan, Italy office in an effort to reduce operating costs.  If we are unable to successfully transition the research and development work and retain our remaining engineering personnel, our ability to develop our products and bring them to market, including Cyber adAPTTM, may be delayed.

Risks Relating to Our Common Stock

 Because our Common Stock is traded on the OTCQB marketplace, your ability to sell your shares of our Common Stock may be limited due to “penny stock” restrictions and our ability to raise additional capital similarly may be compromised.

 Our Common Stock falls within the definition of “penny stock” under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and is covered by Rule 15g-9 promulgated under the Exchange Act. That rule imposes additional sales practice requirements on broker-dealers who sell securities to persons other than established customers and accredited investors. For transactions covered by Rule 15g-9, a broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s written agreement to the transaction prior to the sale. Consequently, Rule 15g-9 potentially affects the ability or willingness of broker-dealers to sell our securities, which would also affect the ability of stockholders to sell their securities in the public market. These additional procedures could also limit our ability to raise additional capital in the future.

-31-

            Significant sales of our Common Stock in the public market would likely cause our stock price to fall.

The average trading volume of our shares in September 2013 was approximately 108,000 shares per day, compared to the approximately 205,581,000 shares outstanding and the additional approximately 605,714,000 shares potentially outstanding on a fully diluted basis at September 30, 2013. Other than volume limitations imposed on our affiliates, many of the issued and issuable shares of our Common Stock are freely tradable. If the holders of freely tradable shares were to sell a significant number of shares of our Common Stock in the public market, the market price of our Common Stock would likely decline. We have obligations to certain of our debt holders that could require us to register shares of Common Stock held by them and shares issuable upon conversion of their respective debt instruments for resale in a registration statement.

            Our stock price has been subject to significant volatility.

The trading price of our Common Stock has been subject to wide fluctuations in the past. The current market price of our Common Stock may not increase in the future. As such, you may not be able to resell your shares of Common Stock at or above the price you paid for them. The market price of our Common Stock could continue to fluctuate or decline in the future in response to various factors, including, but not limited to:

● our cash resources and ability to raise additional funding and repay indebtedness;

● our ability to control costs and improve cash flow;

● our ability to introduce and commercialize new products and achieve broad market acceptance for our products;

● announcements of technological innovations or new products by us or our competitors;

● quarterly variations in operating results;

● changes in investor perceptions;

● economic and political instability, including acts of war, terrorism and continuing international conflicts;

● changes in the fair value of derivative instruments expense; and

● reduced trading volume on the OTCQB.

 The trading markets for the equity securities of high technology companies have continued to experience volatility. Such volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our Common Stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. We were subject to such a class action lawsuit in the past, and no assurances can be given that we will not be subject to similar class action lawsuits in the future.

 Future issuances of our shares may lead to future dilution in the value of our Common Stock, and will lead to a reduction in shareholder voting power.

 Your investment in our shares may be substantially diluted due to the following:

● issuance of Common Stock, or securities convertible into Common Stock, in connection with funding agreements with third parties and future issuances of Common Stock and preferred stock by the Board of Directors; and

● the Board of Directors has the power to issue additional shares of Common Stock and preferred stock, and the right to determine the voting, dividend, conversion, liquidation, preferences and other conditions of the shares without shareholder approval.

 Stock issuances may result in reduction of the book value or market price of outstanding shares of Common Stock.  If the Company issues any additional shares of Common Stock or Preferred Stock, proportionate ownership of Common Stock and voting power will be reduced.  Further, any new issuance of Common Stock or Preferred Stock may prevent a change in control or management.

-32-

            We do not plan to pay dividends to holders of Common Stock.

 We do not anticipate paying cash dividends to the holders of the Common Stock at any time. Accordingly, investors in our securities must rely upon subsequent sales after price appreciation as the sole method to realize a gain on investment. There are no assurances that the price of Common Stock will ever appreciate in value.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

 None.

ITEM 4.  MINE SAFETY DISCLOSURES

 Not applicable.

ITEM 5.  OTHER INFORMATION

 None.

ITEM 6.  EXHIBITS

3.1	Certificate of Amendment to the Certificate of Incorporation of ISC8 Inc., dated January 16, 2014, attached as Exhibit 3.1 to the Current Report on Form 8-K, filed with the Securities and Exchange Commission on January 21, 2014, and incorporated by reference herein.
3.2	Amendment to the ByLaws of ISC8 Inc., dated June 5, 2014
31.1	Certification of the Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of the Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith).
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema
101.CAL	XBRL Taxonomy Extension Calculation Linkbase
101.DEF	XBRL Taxonomy Extension Definition Linkbase
101.LAB	XBRL Taxonomy Extension Label Linkbase
101.PRE	XBRL Taxonomy Extension Presentation Linkbase

-33-

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ISC8 INC.
By:	/s/ Kirsten Bay Kirsten Bay Chief Executive Officer and President (Principal Executive Officer) Dated: June 5, 2014
By:	/s/ John Vong John Vong Chief Financial Officer (Principal Financial Officer) Dated: June 5, 2014

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EX-3.2

Exhibit 3.2

AMENDMENTS TO THE BYLAWS

OF

ISC8 INC.

Section 2 of Article III of the Bylaws of ISC8 Inc. (the “Corporation”) is hereby amended and restated in its entirety to read in full as follows:

“SECTION 2. NUMBER OF DIRECTORS. The Board of Directors shall consist of not less than three (3) nor more than seven (7). The exact number of directors shall be set by resolutions duly adopted by the Board of Directors or by the stockholders.”

IN WITNESS WHEREOF, the undersigned has hereunto subscribed his name this 5th day of June, 2014.

/s/ John Vong

John Vong, Chief Financial Officer

EX-31.1

EXHIBIT 31.1

CERTIFICATION PURSUANT TO

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

(EXCHANGE ACT RULE 13a-14(a) or 15d-14(a))

I, Kirsten Bay, certify that:

1. I have reviewed this quarterly report on Form 10-Q of ISC8, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ Kirsten Bay

Kirsten Bay,

Chief Executive Officer and President

(Principal Executive Officer)

Date: June 5, 2014

EX-31.2

EXHIBIT 31.2

CERTIFICATION PURSUANT TO

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

(EXCHANGE ACT RULE 13a-14(a) or 15d-14(a))

I, John Vong certify that:

1. I have reviewed this quarterly report on Form 10-Q of ISC8, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ John Vong

John Vong

Chief Financial Officer

(Principal Financial Officer)

Date: June 5, 2014

EX-32

EXHIBIT 32

CERTIFICATIONS PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 In connection with the Quarterly Report on Form 10-Q of ISC8, Inc. (the “Company”) for the quarter ended March 31, 2014, as filed with the Securities and Exchange Commission (the “SEC”) on the date hereof (the “Report”), I, Kirsten Bay, Chief Executive Officer and President of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:

	(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
	(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: June 5, 2014			/s/ Kirsten Bay
			Kirsten Bay
			Chief Executive Officer and President

A signed original of this written statement required by Section 906 has been provided to ISC8, Inc. and will be retained by ISC8, Inc. and furnished to the SEC or its staff upon request.

 In connection with the Quarterly Report on Form 10-Q of ISC8, Inc. (the “Company”) for the quarter ended March 31, 2014, as filed with the Securities and Exchange Commission (the “SEC”) on the date hereof (the “Report”), I, John Vong, Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:

	(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
	(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: June 5, 2014			/s/ John Vong
			John Vong
			Chief Financial Officer

A signed original of this written statement required by Section 906 has been provided to ISC8, Inc. and will be retained by ISC8, Inc. and furnished to the SEC or its staff upon request.

XML

Discontinued Operations (Details) (USD $)	3 Months Ended		6 Months Ended
	Mar. 31, 2014	Mar. 31, 2013	Mar. 31, 2014	Mar. 31, 2013
Summarized financial information related to discontinued operations, consisting of Government Business
Total revenues		$ 1,514,000		$ 732,000
Cost and expenses
Cost of revenues		2,606,000		1,278,000
General and administrative expense		882,000		323,000
Research and development expense		764,000		322,000
Total costs and expenses		4,252,000		1,923,000
Net loss from discontinued operations (net of $0 tax)		$ (2,738,000)		$ (1,191,000)

XML

Non-Controlling Interest in Subsidiaries (Details Narrative)	Mar. 31, 2014
Novalog [Member]
Percentage of ownership by investor	96.00%
MSI [Member]
Percentage of ownership by investor	98.00%
RedHawk [Member]
Percentage of ownership by investor	81.00%
iNetWorks [Member]
Percentage of ownership by investor	95.00%

XML

Convertible Preferred Stock (Details Narrative) (USD $)	Mar. 31, 2014
Stated value of Series D Preferred	$ 0.01
Series D [Member]
Shares designated as Series D Preferred	4,000
Stated value of Series D Preferred	$ 10,000
mandatory conversion provision price per share	$ 0.084
mandatory conversion provision aggregate gross proceeds	$ 10,000,000
Series D Preferred issued and outstanding	2,782
Series B [Member]
FY 2013 Series B Shares converted	866
FY 2013 common stock shares converted from Series B	1,732,000
Liquidation preference	$ 1,000

XML

Fair Value Measurements (Tables)

6 Months Ended

Mar. 31, 2014

Fair Value Disclosures [Abstract]

Financial liabilities recurring basis

	Level 1		Level 2		Level 3		Total
Derivative liabilities	$	-	$	-	$	797,000	$	797,000

Derivative liability changes

	September 30, 2013		Recorded New Derivative Liabilities		Warrant Derivatives Reclassified to Equity			Conversion of Debt to Series D Preferred and RSUs			Change in Estimated Fair Value Recognized in Results of Operations			March 31, 2014
Derivative liabilities	$	19,245,000	$	445,000	$	(2,833,509	)	$	(8,383,000	)	$	(7,676,000	)	$	797,000

Fair Value Measurements, Recurring and Nonrecurring

	March 31, 2014				September 30, 2013				Level in Fair Value Hierarchy
	Carrying amount		Fair Value		Carrying amount		Fair value
Cash and cash equivalents	$	147,000	$	147,000	$	136,000	$	136,000		1
Accounts Receivable, net	$	-	$	-	$	119,000	$	119,000		2
Accounts Payable	$	1,331,000	$	1,331,000	$	1,024,000	$	1,024,000		2

XML

Commitments and Contingencies (Details Narrative) (USD $)	6 Months Ended
	Mar. 31, 2014	Mar. 31, 2013
Commitments And Contingencies Details Narrative
Total rent expense for operating leases	$ 136,000	$ 495,000
Non-converting note holder share amount	900,000
first year minimum payment obligation failed to pay	100,000
Guarantee payment	1,800,000
Quarterly payment amount	$ 25,000

XML

Loss per Share (Details) (USD $)	3 Months Ended		6 Months Ended
	Mar. 31, 2014	Mar. 31, 2013	Mar. 31, 2014	Mar. 31, 2013
Basic Net Income (Loss) Numerator:
Loss from continuing operations	$ (4,602,000)	$ (8,400,000)	$ (5,115,000)	$ (9,017,000)
Loss from discontinued operations		(1,191,000)		(2,738,000)
Net loss	(4,602,000)	(9,591,000)	(5,115,000)	(11,755,000)
Diluted Net Income (Loss) Numerator:
Loss from continuing operations	(4,602,000)	(8,400,000)	(5,115,000)	(9,017,000)
Loss from discontinued operations		(1,191,000)		(2,738,000)
Net Loss	$ (4,602,000)	$ (9,591,000)	$ (5,115,000)	$ (11,755,000)
Net Income (loss) Denominator:
Weighted average number of common shares outstanding, basic	245,122,000	153,688,000	234,858,000	147,541,000
Weighted average number of common shares outstanding, diluted	245,122,000	153,688,000	234,858,000	147,541,000
Basic income (loss) per share:
Loss from continuing operations	$ (0.02)	$ (0.05)	$ (0.02)	$ (0.06)
Net Income from discontinued operations		$ (0.01)		$ (0.02)
Basic net loss per share	$ (0.02)	$ (0.06)	$ (0.02)	$ (0.08)
Diluted income (loss) per share:
Loss from continuing operations	$ (0.02)	$ (0.05)	$ (0.02)	$ (0.06)
Net Income from discontinued operations		$ (0.01)		$ (0.02)
Diluted net loss per share	$ (0.02)	$ (0.06)	$ (0.02)	$ (0.08)

XML

Subsequent Events (Details Narrative) (USD $)	1 Months Ended
	May 12, 2014
Subsequent Events Details Narrative
Warrants issued as consideration for forbearance	43,100,000
Warrant exercise price	$ 0.001
Griffin payment amount	$ 100,000
Principal payment, PFG Default	70,000
Second Bridge Notes, principal amount	1,700,000
Second Bridge Notes, gross proceeds	$ 1,290,000

XML

Debt Instruments

6 Months Ended

Mar. 31, 2014

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Note 3 - Debt Instruments

The following table summarizes debt instrument activity during the six months ended March 31, 2014:

	Principle Balance, Net of Discount at September 30, 2013		New Debt Issued (Principle Repayment), Net			Debt Converted to Series D Preferred Shares			Debt Converted to Restricted Stock			Debt Discount Amortization, Extinguishment or (Additions), Net			Principle Balance, Net of Discount at March 31, 2014
Senior Secured Revolving Credit Facility	$	4,908,000	$	(2,070,000	)	$	-		$	-		$	216,000		$	3,054,000
Senior Subordinated Secured Convertible Promissory 2013 Notes		15,793,000		175,000			(16,199,000	)		-			1,854,000			1,623,000
Senior Subordinated Secured Convertible Bridge Notes		-		1,858,000			-			-			(703,000	)		1,155,000
Senior Subordinated Secured Promissory Notes		5,392,000		-			(5,392,000	)		-			-			-
Subordinated Secured Convertible Promissory Notes		8,570,000		-			(381,000	)		(14,357,000	)		7,011,000			843,000
Total Gross Debt	$	34,663,000	$	(37,000	)		(21,972,000	)	$	(14,357,000	)	$	8,378,000		$	6,675,000
Accrued interest converted to equity							(1,084,000	)		(146,000	)
Gross adjustment to paid-in capital(1)						$	(23,056,000	)	$	(14,503,000	)

   (1) The net amount presented excludes the impact of unamortized debt discount, derivative liability and deferred issuance costs.

 Revolving Credit Facility

In December 2011, the Company entered into the Loan Agreement with PFG to obtain the Revolving Credit Facility.  The Revolving Credit Facility was originally set to mature on December 14, 2013, however, in connection with the PFG Loan Modification, the maturity date was extended to December 31, 2014. Interest on the Revolving Credit Facility accrues at the rate of 12% per annum, payable monthly, with the principal balance payable on the Maturity Date. As additional consideration for entering into the Revolving Credit Facility, the Company issued to PFG and two PFG affiliated entities seven year warrants to purchase, for $0.11 per share, an aggregate of 15.0 million shares of the Company’s Common Stock (the “PFG Warrants”).

To secure the payment of the Company’s obligations under the Loan Agreement, the Company granted to PFG a first position, continuing security interest in substantially all of the Company’s assets, including substantially all of its intellectual property. In addition, Costa Brava, Griffin and certain other existing creditors of the Company have agreed that, while any obligations remain outstanding by the Company to PFG under the Loan Agreement, their security interests in and liens on the Company’s assets shall be subordinated and junior to those of PFG. During July 2013, Costa Brava deposited $1.0 million into an escrow account held by PFG (the “PFG Guarantee Fund”), which was used for the partial repayment of the $5.0 million revolving credit facility issued by PFG to the Company in December 2011 (the “Revolving Credit Facility”). Costa Brava irrevocably transferred the rights, title and interest of the PFG Guarantee Fund to the Company.  In exchange for funding the PFG Guarantee Fund, the Company issued a $1.0 million Senior Secured Convertible Note (defined below) to Costa Brava.  In October 2013, the Company deposited $1.5 million of the proceeds received from the Series D Offering into the PFG Guarantee Fund, and, in turn, made a $2.0 million payment on the Revolving Credit Facility. Further during the quarter ended March 31, 2014, the Company made an additional repayment of $0.1 million, leaving the Revolving Credit Facility with a $2.9 million outstanding balance, excluding discounts and accrued fees.

On February 7, 2014 the Company entered into a second loan modification (the "Second Modification”) with an effective date of October 28, 2013, (the “Second Modification Effective Date”). In accordance with the terms of the Second Modification, in the event the Company consummates a debt or equity financing on or after the Second Modification Effective Date, the Company must pay to PFG 10% of the gross proceeds received from such financing and $70,000 monthly principal payment effective April 1, 2014. PFG, however, waived the deposit requirement for the month of January 2014. In consideration for the Second Modification, the Company has agreed to pay PFG a back-end fee of 15% on any capital transaction consummated on or after February 1, 2014.

As of and prior to the quarter ended March 31, 2014, the Company was not in compliance with certain debt covenants of the Revolving Credit Facility. As such, the table below summarizes the various waiver and forbearance extensions and all warrants (the “Waiver Warrants”) issued to PFG. The exercise price of the Waiver Warrants is equal to the lower of the next equity financing effective price (the "NEFEP") or a stated price per share determined on the date of issuance of each forbearance extension.  Prior to the consummation of the Series D Offering, the exercise price of the Waiver Warrants was not fixed, causing each Waiver Warrant to be accounted for as a derivative liability.  However, upon consummation of the Series D Offering, the exercise price of each Waiver Warrant became fixed at $0.042 per share and the Company reclassified the fair value of the derivative liability totaling $2,834,000 to paid-in capital. In connection with the PFG Loan Modification, PFG waived its rights with respect to debt covenant compliance through December 31, 2014.

Forbearance	Extension Through Date	Exercise Price per share	Exercisable Shares
Waiver	September 30, 2012	$0.042		2,045,455
Forbearance Extension	October 31, 2012	$0.042		2,045,455
Second Forbearance Extension	December 15, 2012	$0.042		2,045,455
Third Forbearance Extension	January 31, 2013	$0.042		2,045,455
Fourth Forbearance Extension	February 28, 2013	$0.042		2,045,455
Fifth Forbearance Extension	March 31, 2013	$0.042		2,045,455
Sixth Forbearance Extension	April 30, 2013	$0.042		2,045,455
Seventh Forbearance Extension	May 31, 2013	$0.042		2,045,455
Eighth Forbearance Extension	June 30, 2013	$0.042		2,045,455
Ninth Forbearance Extension	October 28, 2013	$0.010		2,232,142
Total				20,641,237

 As of March 31, 2014, PFG has not exercised any Waiver Warrants. See Note 11 for further discussion of events subsequent to the quarter ended March 31, 2014 related to the Revolving Credit Facility.

Senior Subordinated Secured Convertible Promissory

Through October 31, 2013, we issued Senior Subordinated Secured Convertible Promissory Notes (the “Senior Subordinated Convertible Notes”) in the aggregate principal amount of $17.8 million to certain accredited investors, including Griffin. The Senior Subordinated Convertible Notes accrue interest at a rate of 12% per annum, and are secured by all of the Company’s assets.  The Senior Subordinated Convertible Notes are convertible, at the option of each respective holder, into that number of shares of Common Stock equal to the outstanding principal and accrued interest of the Senior Subordinated Notes, divided by the conversion price set forth in the note (the “Conversion Price”). The Senior Subordinated Convertible Notes had a conversion price until October 31, 2013 when the price was fixed at $0.042 as a result of the Series D Offering.

On October 31, 2013, pursuant to the Senior Note Conversion, Senior Subordinated Convertible Notes in the aggregate total of approximately $17.2 million of principal and accrued interest (the “Outstanding Balance”) were canceled and exchanged for approximately 1,720 shares of Series D Preferred. The Company accounted for the conversion of these Senior Subordinated Convertible Notes, which was deemed an extinguishment of debt, in one of two methods. For the Senior Subordinated Convertible Notes in the aggregate principal amount of $5.5 million held by investors not otherwise related to the Company, the Company removed the net carrying value of the debt, including accrued interest, deferred financing cost and the derivative liability, and recorded the fair value of the shares of Series D Preferred issued in exchange for the cancellation thereof. The resulting difference of $0.4 million was recognized as a gain on debt extinguishment. The remaining Senior Subordinated Convertible Notes in the aggregate total of $11.7 million, which notes were held by related parties, were accounted for as capital transactions whereby the net carrying value of the debt, including accrued interest, deferred financing cost and the derivative liability, totaling $13.1 million, was recorded as an increase to paid-in capital.

During Fiscal 2013, the Company and each respective holder of remaining Senior Subordinated Convertible Notes, including those sold to clients of J.P. Turner & Company, L.L.C. (“J.P. Turner”), entered into an amendment to extend the maturity date of the notes to January 31, 2014 (the “Amended Senior Subordinated Convertible Notes”). As additional consideration for this extension, the Company issued warrants to those holders of the Amended Senior Subordinated Convertible Notes to purchase an aggregate total of 63.8 million shares of Common Stock for $0.001 per share. On December 6, 2013, holders of certain Amended Senior Subordinated Convertible Notes in the aggregate principal amount of approximately $0.9 million notified the Company of their position that the Series D Offering meets the definition of a Qualified Financing, as such term is defined in the Amended Senior Subordinated Convertible Notes, and, as a result, the Amended Senior Subordinated Convertible Notes matured on November 1, 2013, a position the Company disputed. However, on April 11, 2014 the Company entered into a Forbearance Agreement with the respective holders of these notes to extend the maturity date to July 31, 2014.  See Note 11 for further information regarding subsequent events relating to these Amended Senior Subordinated Convertible Notes.

Senior Subordinated Secured Convertible Bridge Notes

In February 2014, the Company’s Board of Directors approved the issuance of two distinct offerings of senior subordinated secured convertible bridge notes commonly referred to as the 2014 Bridge Notes. These notes are comprised of (i) the 2014 First Bridge Notes and (ii) the 2014 Second Bridge Notes and are described further below.

2014 First Bridge Notes. On February 6, 2014, the Board of Directors approved the issuance of senior subordinated secured convertible bridge notes in the aggregate principal amount of up to $3.5 million, of which, $1.5 million may be issued in exchange for the cancellation of certain outstanding senior notes.  The 2014 First Bridge Notes mature on July 31, 2014 and accrue interest at 12%. In the event the Company completes a $4.0 million equity financing, the 2014 First Bridge Notes will convert into shares of Series D Preferred at a fixed price of $0.042 at the election of the holder thereof in the event 50% or more of the holders elect to convert. As of March 31, 2014, the Company has issued 2014 First Bridges Notes in the aggregate principal amount of $0.6 million.

 As additional consideration, each holder of 2014 First Bridge Notes will receive one share of Common Stock and a two year warrant to purchase one share of Common Stock at $0.042 for every $0.168 invested.  During the quarter ended March 31, 2014, the Company issued approximately 3,422,000 shares of Common Stock and warrants to purchase 3,422,000 shares of Common Stock in connection with the issuance of the 2014 First Bridge Notes.  The Company allocated the proceeds to the warrants based on their relative fair values and recorded a discount of $0.2 million to the 2014 First Bridge Notes.

 2014 Second Bridge Notes. On February 28, 2014, the Board of Directors approved the issuance of senior subordinated secured convertible bridge notes in the aggregate principal amount of up to $6.0 million, of which, $1.5 million may be issued in exchange for the cancellation of certain outstanding senior notes.  The 2014 Second Bridge Notes mature on July 31, 2014 and accrue interest at 12% annually.

The 2014 Second Bridge Notes were sold at an original issue discount of 25%.  Through March 31, 2014, the Company issued 2014 Second Bridge Notes in the aggregate principal amount of $1.3 million and received cash proceeds of approximately $1.0 million. To date, the Company has issued 2014 Second Bridge Notes in the aggregate principal amount of approximately $3.0 million for cash proceeds of approximately $2.3 million. The principal amount of the 2014 Second Bridge Notes, plus all accrued interest will convert into securities offered in our next capital raise that meets any one of the following two conditions: (i) gross proceeds to the Company of at least $4.0 million or (ii) the majority of the outstanding principal amount of the 2014 Second Bridge Notes convert into our next capital raise.  Due to the 2014 Second Bridge Notes’ floating conversion price, the Company recorded a $413,000 derivative liability to the related debt discount.

Subordinated Secured Convertible Promissory Notes

In December 2010, the Company entered into a Securities Purchase Agreement with Costa Brava and Griffin, pursuant to which the Company issued and sold to Costa Brava and Griffin 12% Subordinated Secured Convertible Notes due December 23, 2015 (the “Subordinated Notes”) in the aggregate principal amount of $7.8 million and, in March 2011, the Company sold additional Subordinated Notes to Costa Brava and Griffin for an aggregate purchase price of $1.2 million. Subsequently, in July 2011, the Company sold Subordinated Notes to five accredited investors, including Costa Brava and Griffin, in the aggregate principal amount of $5.0 million. In addition, holders of certain of the Company’s then outstanding debt, with a principal balance of $1.1 million, converted such debt into Subordinated Notes during the year ended September 30, 2011.

As of March 31, 2014, the principal and accrued but unpaid interest of the remaining unconverted Subordinated Notes was convertible at the option of the holder into shares of Common Stock at an initial conversion price of $0.07 per share. The conversion price is subject to a full price adjustment feature for certain price dilutive issuances of securities by the Company, and proportional adjustment for events such as stock splits, dividends, combinations, etc., and as such, are considered to be derivatives. Upon completion of the Series D Offering, the conversion price was adjusted to $0.042 per share.  The Company may force the conversion of the Subordinated Notes into Common Stock if certain customary equity conditions have been satisfied and the volume weighted average price of the Common Stock is $0.25 or greater for 30 consecutive trading days. As of March 31, 2014, the Company has not met the equity conditions to force the conversion of the Subordinated Notes. 

 On October 31, 2013, Subordinated Notes in the aggregate total of $14.5 million in principal and accrued interest due to Costa Brava and Griffin were cancelled in exchange for approximately 101.5 million RSUs. The RSUs will vest in the event the trading price of the Company’s Common Stock reaches $0.143. Because the managing members of Costa Brava and Griffin served on the Company’s board of directors at the time of the exchange, the exchange was treated as a related party transaction, and the canceled $14.5 million principal and accrued interest and the related discount and derivative liability were treated as a contribution to paid-in capital.

Also, on October 31, 2013, the holder of a Subordinated Note totaling $0.4 million in principal and accrued interest, not otherwise related to the Company, exchanged such note for approximately 40 shares of Series D Preferred. The Company removed the net carrying value of the debt including accrued interest, deferred financing cost and the derivative liability, recorded the fair value of the Series D Preferred and the resulting difference of $37,000 was recognized as a loss on debt extinguishment.

 As of March 31, 2014, Subordinated Notes in the aggregate principal amount of $1.4 million remain outstanding, of which $0.2 million mature during December 2015, $0.2 million mature during January 2016, $0.1 million mature during April 2016 and $0.9 million mature during July 2016.  The balance of the unconverted Subordinated Notes, net of unamortized discounts at March 31, 2014 was $0.9 million. The debt discounts will be amortized over the term of the unconverted Subordinated Notes, unless such amortization is accelerated due to earlier conversion of the Subordinated Notes pursuant to their terms.

Senior Subordinated Secured Promissory Notes

 In March 2011, the Company issued and sold 12% Senior Subordinated Secured Promissory Notes (the “Senior Subordinated Notes”) to Costa Brava and Griffin. In July 2011, the Senior Subordinated Notes were amended to permit the holders to demand repayment any time on or after July 16, 2012, in partial consideration for permitting the issuance of additional Subordinated Secured Convertible Promissory Notes.  The Senior Subordinated Notes are secured by substantially all of our assets pursuant to Security Agreements dated March 16, 2011 and March 31, 2011 between the Company and Costa Brava as representative of the Senior Subordinated Note holders. However, the liens securing the Senior Subordinated Notes are subordinate to the liens securing the Company’s indebtedness to PFG under the Revolving Credit Facility. Interest is calculated by adding the amount of such interest to the outstanding principal amount of the Senior Subordinated Notes as paid-in-kind interest. As a result of the addition of such interest, the outstanding principal amount of the Senior Subordinated Notes at October 31, 2013 was $5.4 million.

 On October 31, 2013, the outstanding Senior Subordinated Notes were converted to approximately 545 shares of Series D Preferred.  Since the holders of the remaining Senior Subordinated Notes were related parties to the Company at the time of the conversion, the Company accounted for the conversion of these notes as a capital transaction whereby the net carrying value of the debt including accrued interest was recorded as an increase to contributed capital.

Priority of Outstanding Debt

 As of March 31, 2014, our outstanding debt is ranked as follows: (i) the Revolving Credit Facility is senior to all other debt; (ii) the Senior Subordinated Convertible Notes and Subordinated Secured Notes rank pari passu with each other; and (iii) the 2014 Bridge Notes rank junior to all other debt.

Derivative Liability

 Certain instruments, including the embedded conversion feature in certain of the Company's outstanding debt and warrants, contain provisions that adjust the respective conversion or exercise prices in the event of certain dilutive issuances of securities, or exercise/conversion prices that are not fixed.  These provisions required the Company to record a derivative liability upon issuance.  The Company re-measured the fair value of the derivative liability to be $0.8 million as of March 31, 2014 and $19.2 million as of September 30, 2013 (see Note 11 below for a description of the Company's fair value measurements).

 The Company estimated the fair value of the derivative liability using the Binomial Lattice pricing model with the following significant inputs, as outlined below, to estimate the fair value of the derivative liability as of March 31, 2014 and September 30, 2013:  

	March 31, 2014		September 30, 2013
Risk free interest rate		0.36%		0.40%
Expected volatility		147% - 150%		94.8%
Expected dividends		None		None

XML

Fair Value Measurements (Details) (USD $)	Mar. 31, 2014	Sep. 30, 2013
Liabilities, Fair Value Disclosure [Abstract]
Derivative liabilities	$ 797,000	$ 19,245,000
Fair Value, Inputs, Level 2 [Member]
Liabilities, Fair Value Disclosure [Abstract]
Derivative liabilities
Fair Value, Inputs, Level 1 [Member]
Liabilities, Fair Value Disclosure [Abstract]
Derivative liabilities
Fair Value, Inputs, Level 3 [Member]
Liabilities, Fair Value Disclosure [Abstract]
Derivative liabilities	$ 797,000

XML

Debt Instruments (Details 1) (USD $)	6 Months Ended
	Mar. 31, 2014
Exercise price per share equal to NEFEP or price	$ 0.042
Exercisable Forbearance extension warrant shares	20,641,237
Subordinated Notes 5 [Member]
Extension date	2012-09-30T00:00:00
Exercisable Forbearance extension warrant shares	2,045,455
Forbearance 1 [Member]
Extension date	2012-10-31T00:00:00
Exercise price per share equal to NEFEP or price	$ 0.042
Exercisable Forbearance extension warrant shares	2,045,455
Forbearance 2 [Member]
Extension date	2012-12-15T00:00:00
Exercise price per share equal to NEFEP or price	$ 0.042
Exercisable Forbearance extension warrant shares	2,045,455
Forbearance 3 [Member]
Extension date	2013-01-31T00:00:00
Exercise price per share equal to NEFEP or price	$ 0.042
Exercisable Forbearance extension warrant shares	2,045,455
Forbearance 4 [Member]
Extension date	2013-01-28T00:00:00
Exercise price per share equal to NEFEP or price	$ 0.042
Exercisable Forbearance extension warrant shares	2,045,455
Forbearance 5 [Member]
Extension date	2013-03-31T00:00:00
Exercise price per share equal to NEFEP or price	$ 0.042
Exercisable Forbearance extension warrant shares	2,045,455
Forbearance 6 [Member]
Extension date	2013-04-30T00:00:00
Exercise price per share equal to NEFEP or price	$ 0.042
Exercisable Forbearance extension warrant shares	2,045,455
Forbearance 7 [Member]
Extension date	2013-05-31T00:00:00
Exercise price per share equal to NEFEP or price	$ 0.042
Exercisable Forbearance extension warrant shares	2,045,455
Forbearance 8 [Member]
Extension date	2013-06-30T00:00:00
Exercise price per share equal to NEFEP or price	$ 0.042
Exercisable Forbearance extension warrant shares	2,045,455
Forbearance 9 [Member]
Extension date	2013-10-28T00:00:00
Exercise price per share equal to NEFEP or price	$ 0.01
Exercisable Forbearance extension warrant shares	2,232,142

XML

Debt Instruments (Details) (USD $)	6 Months Ended
	Mar. 31, 2014
Debt Instrument 1 [Member]
Balance at beginning of period, net of unamortized discount	$ 4,908,000
New Debt Issued (Principal Repayment), Net	(2,070,000)
Debt converted into Series D Preferred
Debt converted to restricted Common Stock
Debt Discount Amortization, Extinguishment or (Additions), Net	216,000
Net Balance	3,054,000
Debt Instrument 2 [Member]
Balance at beginning of period, net of unamortized discount	15,793,000
New Debt Issued (Principal Repayment), Net	175,000
Debt converted into Series D Preferred	(16,199,000)
Debt converted to restricted Common Stock
Debt Discount Amortization, Extinguishment or (Additions), Net	1,584,000
Net Balance	1,623,000
Debt Instrument 3 [Member]
Balance at beginning of period, net of unamortized discount
New Debt Issued (Principal Repayment), Net	1,858,000
Debt converted into Series D Preferred
Debt converted to restricted Common Stock
Debt Discount Amortization, Extinguishment or (Additions), Net	(703,000)
Net Balance	1,155,000
Debt Instrument 4 [Member]
Balance at beginning of period, net of unamortized discount	5,392,000
New Debt Issued (Principal Repayment), Net
Debt converted into Series D Preferred	(5,392,000)
Debt converted to restricted Common Stock
Debt Discount Amortization, Extinguishment or (Additions), Net
Net Balance
Debt Instrument 5 [Member]
Balance at beginning of period, net of unamortized discount	8,570,000
New Debt Issued (Principal Repayment), Net
Debt converted into Series D Preferred	(381,000)
Debt converted to restricted Common Stock	(14,357,000)
Debt Discount Amortization, Extinguishment or (Additions), Net	7,011,000
Net Balance	843,000
Debt Instrument 6 [Member]
Balance at beginning of period, net of unamortized discount	34,663,000
New Debt Issued (Principal Repayment), Net	(37,000)
Debt converted into Series D Preferred	(21,972,000)
Debt converted to restricted Common Stock	(14,357,000)
Debt Discount Amortization, Extinguishment or (Additions), Net	8,378,000
Net Balance	6,675,000
Accrued interest converted to equity, preferred	(1,084,000)
Accrued interest converted to equity, common stock	(146,000)
Gross adjustment to paid-in capital, preferred conversion	(23,056,000)
Gross adjustment to paid-in capital, common stock conversion	$ (14,503,000)

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Fair Value Measurements (Details 1) (USD $)	6 Months Ended
	Mar. 31, 2014
Fair Value Measurements Details 1
Derivative liabilities, beginning of period	$ 19,245,000
Recorded new derivative liabilities	445,000
Warrant Derivatives Reclassified to equity	(2,833,509)
Extinguished in Conversion of debt to Series D Preferred and RSUs	(8,383,000)
Change in estimated fair value recognized in results of operations	(7,676,000)
Derivative liabilities, end of period	$ 797,000

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Debt Instruments (Details 2) (USD $)	Mar. 31, 2014	Sep. 30, 2013
Derivative Instruments and Hedging Activities Disclosure [Abstract]
Risk free interest rate	0.36%	0.40%
Expected volatility	147.00%	94.80%
Expected volatility, maximum	150.00%
Expected dividends

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Debt Instruments (Details Narrative) (USD $)	1 Months Ended	3 Months Ended		6 Months Ended
	May 12, 2014	Mar. 31, 2014	Mar. 31, 2013	Mar. 31, 2014	Mar. 31, 2013	Sep. 30, 2013
Warrant exercise price	$ 0.001
Exercise price per share equal to NEFEP or price				$ 0.042
Derivative liability		$ 800,000		$ 800,000		$ 19,200,000
Gain on extinguishment of debt				(316,000)
Paid in Kind Interest				3,790,000	5,255,000
Monthly principal payment		70,000		70,000
Revolving Credit Facility issued by PFG		5,000,000		5,000,000
Senior secured convertible note issued in exchange for PFG Guarantee Fund				1,000,000
proceeds from Series D Offering deposited into PFG Guarantee Fund				1,500,000
Payment on Revolving Credit Facility				2,000,000
Revolving Credit Facility outstanding balance		2,900,000		2,900,000
PCF LOC Modification [Member]
Percent of proceeds payable from financing		10.00%		10.00%
Capital transaction fee payable		15.00%		15.00%
Derivative liability		2,834,000		2,834,000
CB Griffon Notes 2013 [Member]
Warrants issued				63,800,000
Warrant exercise price				$ 0.001
Rate of interest				12.00%
Debt instrument principal amount		17,800,000		17,800,000
Note conversion price		$ 0.12		$ 0.12
Qualified Financing minimum		900,000		900,000
Notes cancelled and exchanged		17,200,000		17,200,000
Preferred stock issued for conversion of notes		1,720		1,720
Gain on extinguishment of debt				400,000
Increase to paid-in capital				13,100,000
Remaining to maturity				1 year 7 months
Notes matured		900,000		900,000
Subordinated Notes [Member]
Debt instrument principal amount		7,800,000		7,800,000
Note conversion price		$ 0.12		$ 0.12
Weighted average price of common stock conversion trigger				$ 0.25
Notes cancelled and exchanged		14,500,000		14,500,000
Restricted stock issued for conversion of notes				101,500,000
Increase to paid-in capital				14,500,000
Remaining to maturity				1 year 8 months
Subordinated Notes 2 [Member]
Debt instrument principal amount		1,200,000		1,200,000
Note conversion price		$ 0.12		$ 0.12
Notes cancelled and exchanged		400,000		400,000
Preferred stock issued for conversion of notes		40		40
Gain on extinguishment of debt				(37,000)
Outstanding principal amount including paid in kind interest		1,400,000		1,400,000
Remaining to maturity				1 year 11 months
Subordinated Notes 3 [Member]
Debt instrument principal amount		500,000		500,000
Note conversion price		$ 0.07		$ 0.07
Remaining to maturity				2 years 1 month
Subordinated Notes 4 [Member]
Note conversion price		$ 0.042		$ 0.042
Notes cancelled and exchanged		1,100,000		1,100,000
Subordinated Notes 5 [Member]
Debt instrument principal amount		5,400,000		5,400,000
Notes cancelled and exchanged		5,400,000		5,400,000
Preferred stock issued for conversion of notes		545		545
Convertible 2012 Notes [Member]
Debt instrument principal amount		1,200,000		1,200,000
Note conversion price		$ 0.12		$ 0.12
Notes cancelled and exchanged		1,100,000		1,100,000
CBandGriffinNote4 [Member]
Debt instrument principal amount		5,000,000		5,000,000
Convertible 2014 Notes [Member]
Warrant exercise price				$ 0.042
Debt instrument, maturity date				Jul. 31, 2014
Debt instrument principal amount		600,000		600,000
Notes matured		1,500,000		1,500,000
Convertible 2014 Notes 2 [Member]
Warrant exercise price				$ 0.042
Debt instrument, maturity date				Jul. 31, 2014
Debt instrument principal amount		3,000,000		3,000,000
Derivative liability		413,000		413,000
Paid in Kind Interest				0.12
Notes matured		$ 1,500,000		$ 1,500,000
PFG [Member]
Warrants issued				15,000,000
Warrant exercise price				$ 0.11
Debt instrument, maturity date				Dec. 31, 2014
Rate of interest				12.00%

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Going Concern

6 Months Ended

Mar. 31, 2014

Organization, Consolidation and Presentation of Financial Statements [Abstract]

Note 2 - Going Concern

The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company generated significant net losses in previous fiscal years.  For the six months ended March 31, 2014 and 2013, the Company had a loss from continuing operations of $5.1 million and $9.0 million, respectively, and negative cash flows from operations of $4.4 million and $7.3 million, respectively. As of March 31, 2014, the Company also had negative working capital of approximately $9.9 million and stockholders’ deficit of $9.5 million.

 Management believes that the Company’s losses in recent years have primarily been the result of increased research and development expenditures related to the cyber technology and efforts to productize those technologies and bring them to market.  These losses were augmented by insufficient revenue to support the Company’s skilled and diverse technical staff, who are considered necessary to support commercialization of the Company’s technologies, and significant financing costs.  Unsuccessful commercialization efforts in past fiscal years have contributed to the stockholders’ deficit as of March 31, 2014.

 We currently have insufficient cash to execute our business plan and continue as a going concern, in the absence of securing additional financing, and we have significant debt coming due within 12 months.  Management is therefore currently focused on raising additional capital to fund the Company’s working capital requirements, managing costs in line with estimated total revenues, including contingencies for cost reductions if projected revenues are not fully realized, as well as negotiating the restructuring of certain indebtedness currently due and payable.  However, there can be no assurance that management will be successful, that anticipated revenues will be realized, or that the Company will be able to successfully implement its plans.  In the event management is not successful in raising additional capital, or otherwise implementing its restructuring plan, the Company will be unable to continue as a going concern.

 The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. 

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Convertible Preferred Stock (Details) (USD $)	6 Months Ended
	Mar. 31, 2014
Series D Preferred Stock, Shares
Balance at beginning of period
Cash Proceeds from sale of Series D Preferred Stock and warrants, net of issuance costs of $219,000	477
Convertible debt exchanged	2,305
Total Series D activity	2,782
Balance at end of period	2,782
Series D Preferred Stock, Amount
Balance at beginning of period	0
Cash Proceeds from sale of Series D Preferred Stock and warrants, net of issuance costs of $291,000	$ 5
Convertible debt exchanged	23
Total Series D activity	28
Balance at end of period	28
Series D Preferred Stock, Paid-in Capital
Balance at beginning of period	181,443,000
Cash Proceeds from sale of Series D Preferred Stock and warrants, net of issuance costs of $291,000	4,531,000
Convertible debt exchanged for Series D Preferred stock	24,705,000
Convertible debt exchanged for restricted stock	13,111,000
Total Series D activity	29,236,000
Stock based compensation	2,539,000
Warrant derivatives reclassified to equity	2,834,000
Other equity activity, net	2,764,000
Balance at end of period	$ 231,910,000

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Discontinued Operations (Details 1) (USD $)	Mar. 31, 2014	Sep. 30, 2013
Accounts receivable, net		$ 119,000	[1]
Prepaid expenses and other current assets	335,000	561,000	[1]
Property and equipment, net	553,000	753,000	[1]
Other assets	32,000	126,000	[1]
Government Business [Member]
Accounts receivable, net
Prepaid expenses and other current assets
Current assets of discontinued operations
Unbilled revenues on uncompleted contracts	290,000	290,000
Property and equipment, net		7,000
Other assets
Non-current assets of discontinued operations	290,000	297,000
Accounts payable	87,000	141,000
Accrued expenses	438,000	438,000
Advance billings on uncompleted contracts	99,000	99,000
Current liabilities from discontinued operations	$ 624,000	$ 678,000

[1] The condensed consolidated balance sheet as of September 30, 2013 was derived from the audited consolidated financial statement included in the Company's 2013 Annual Report on Form 10-K, filed with the SEC on December 24, 2013 adjusted to reflect discontinued operations. In March 2013, the Company ceased operations of its government focused business, including Secure Memory Systems, Cognitive Systems and Microsystems business units (the "Government Business"). In accordance with the provisions of the Presentation of Financial Statements Topic 205 of the Accounting Standards Codification ("ASC"), the assets and liabilities related to the Government Business are now presented as discontinued operations for all periods presented in the consolidated financial statements.

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Condensed Consolidated Balance Sheets (Unaudited) (USD $)	Mar. 31, 2014		Sep. 30, 2013
Current assets:
Cash and cash equivalents	$ 147,000		$ 136,000	[1]
Accounts receivable, net			119,000	[1]
Deposit on PFG Credit Line	523,000		1,000,000	[1]
Prepaid expenses and other current assets	335,000		561,000	[1]
Total current assets	1,005,000		1,816,000	[1]
Restricted cash	75,000		75,000	[1]
Property and equipment, net	553,000		753,000	[1]
Goodwill	393,000		393,000	[1]
Intangible assets, net	727,000		790,000	[1]
Deferred financing costs	51,000		715,000	[1]
Other assets	32,000		126,000	[1]
Non-current assets from discontinued operations	290,000		297,000	[1]
Total assets	3,126,000		4,965,000	[1]
Current liabilities:
Accounts payable	1,331,000		1,024,000	[1]
Accrued expenses	1,837,000		3,066,000	[1]
Deferred revenue	17,000		221,000	[1]
Senior secured revolving credit facility loan, net of discount	3,054,000		4,908,000	[1]
Senior subordinated secured convertible promissory notes, net of discount	1,623,000		15,793,000	[1]
Senior subordinated secured convertible bridge notes, net of discount	1,155,000			[1]
Subordinated secured convertible promissory notes, net of discount	843,000			[1]
Senior subordinated secured promissory notes			5,392,000	[1]
Capital lease obligations, current portion	329,000		447,000	[1]
Other current liabilities	75,000			[1]
Current liabilities from discontinued operations	624,000		678,000	[1]
Total current liabilities	10,888,000		31,529,000	[1]
Subordinated secured convertible promissory notes, net of discount			8,570,000	[1]
Capital lease obligations, less current portion	67,000		77,000	[1]
Derivative liability	797,000		19,245,000	[1]
Executive Salary Continuation Plan liability	910,000		957,000	[1]
Other liabilities			139,000	[1]
Total liabilities	12,662,000		60,517,000	[1]
Stockholders' deficit
Convertible preferred stock, $0.01 par value, 1,000,000 shares authorized, 900 shares of Series B Convertible Cumulative Preferred Stock issued and outstanding as of March 31, 2014 and September 30, 2013, liquidation preference of $866,000, and 2,800 and 0 shares of Series D Convertible Preferred Stock issued and outstanding, liquidation preference of $27,820,000 and $0, as of March 31, 2014 and September 30, 2013, respectively(2)		[2]		[1],[2]
Common stock, $0.01 par value, 2,000,000,000 and 800,000,000 shares authorized; 255,080,000 and 205,581,000 shares issued and outstanding at March 31, 2014 and September 30, 2013, respectively (3)	2,551,000	[3]	2,056,000	[1],[3]
Paid-in capital	231,910,000		181,443,000	[1]
Accumulated other comprehensive income (loss)	46,000		(123,000)	[1]
Accumulated deficit	(244,367,000)		(239,252,000)	[1]
ISC8 stockholders' deficit	(9,860,000)		(55,876,000)	[1]
Noncontrolling interest	324,000		324,000	[1]
Total stockholders' deficit	(9,536,000)		(55,552,000)	[1]
Total liabilities, non-controlling interest, and stockholders' deficit	$ 3,126,000		$ 4,965,000	[1]

[1] The condensed consolidated balance sheet as of September 30, 2013 was derived from the audited consolidated financial statement included in the Company's 2013 Annual Report on Form 10-K, filed with the SEC on December 24, 2013 adjusted to reflect discontinued operations. In March 2013, the Company ceased operations of its government focused business, including Secure Memory Systems, Cognitive Systems and Microsystems business units (the "Government Business"). In accordance with the provisions of the Presentation of Financial Statements Topic 205 of the Accounting Standards Codification ("ASC"), the assets and liabilities related to the Government Business are now presented as discontinued operations for all periods presented in the consolidated financial statements.

[2] The number of shares of Convertible Preferred Stock issued and outstanding has been rounded to the nearest one hundred (100).

[3] The number of shares of common stock issued and outstanding has been rounded to the nearest one thousand (1000).

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Fair Value Measurements (Details 2) (USD $)	Mar. 31, 2014	Sep. 30, 2013
Cash and Cash Equivalents [Member]
Carrying amount	$ 147,000	$ 136,000
Fair value	147,000	136,000
Level in fair value heirarchy	1	1
Accounts Receivable [Member]
Carrying amount		119,000
Fair value		119,000
Level in fair value heirarchy	2	2
Accounts Payable [Member]
Carrying amount	1,331,000	1,024,000
Fair value	$ 1,331,000	$ 1,024,000
Level in fair value heirarchy	2	2

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Condensed Consolidated Statements of Cash Flows (Unaudited) (USD $)	6 Months Ended
	Mar. 31, 2014		Mar. 31, 2013
Cash flows from operating activities:
Net loss	$ (5,115,000)		$ (11,755,000)
(Income) loss from discontinued operations			2,738,000
Loss from continuing operations	(5,115,000)		(9,017,000)
Adjustments to reconcile loss from continuing operations to net cash used in operating activities:
Depreciation and amortization	339,000		95,000
Provision for bad debt	174,000
Non-cash interest expense	3,790,000		5,255,000
Gain on extinguishment of debt	(316,000)
Change in fair value of derivative liability	(7,073,000)		(4,481,000)
Non-cash stock-based compensation	2,539,000		300,000
Loss on disposal of property and equipment	4,000
Accounts receivable	(55,000)		(127,000)
Prepaid expenses and other assets	194,000		60,000
Other Assets	262,000
Accounts payable and accrued expenses	1,029,000		643,000
Other current liabilities	75,000
Deferred revenue	(204,000)		67,000
Executive Salary Continuation Plan liability	(47,000)		(7,000)
Net cash used in operating activities	(4,404,000)		(7,332,000)
Cash flows from investing activities:
Property and equipment expenditures			45,000
Proceeds from sale of Thermal assets			1,200,000
Net cash related to acquisition of Bivio			(569,000)
Net cash used in investing activities			586,000
Cash flows from financing activities
Proceeds from unsecured convertible promissory notes	1,738,000		7,380,000
Proceeds from Series D Convertible Preferred Stock	4,533,000
Proceeds from options and warrants exercised	16,000		103,000
Net change in deposit on PFG credit line	477,000
Principal payments on PFG credit line	(2,070,000)
Principal payments of notes payable	25,000		9,000
Principal payments of capital leases	208,000		8,000
Net cash provided by financing activities	4,461,000		7,466,000
Cash flows from discontinued operations:
Net cash used in operating activities	(47,000)		(1,965,000)
Net cash used in investing activities			(8,000)
Net cash used in discontinued operations	(47,000)		(1,973,000)
Effect of exchange rate changes on cash	1,000		163,000
Net increase (decrease) in cash and cash equivalents	11,000		(1,416,000)
Cash and cash equivalents at beginning of period	136,000	[1]	1,738,000
Cash and cash equivalents at end of period	147,000		322,000
Non-cash investing and financing activities:
Equipment financed with capital leases	80,000
Conversion of notes and accrued interest to Series D Preferred Stock	23,056,000
Conversion of notes to restricted stock	14,503,000
Employee stock based plan contribution	272,000
Conversion of notes and accrued interest to common stock			30,000
Common stock issued to pay accrued interest and operating expenses	556,000		963,000
Issuance of warrants to acquire Bivio Software assets			85,000
Senior Subordinated Note issued to settle accrued interest			291,000
Issuance of warrants in connection with Forbearance agreements	34,000		721,000
Non-cash conversion of preferred stock to common stock			60,000
Non-cash conversion of 2012 Notes to 2013 Notes, including paid in kind interest			5,571,000
Supplemental cash flow information:
Cash paid for interest	257,000		303,000
Cash paid for income taxes	$ 3,000		$ 3,000

[1] The condensed consolidated balance sheet as of September 30, 2013 was derived from the audited consolidated financial statement included in the Company's 2013 Annual Report on Form 10-K, filed with the SEC on December 24, 2013 adjusted to reflect discontinued operations. In March 2013, the Company ceased operations of its government focused business, including Secure Memory Systems, Cognitive Systems and Microsystems business units (the "Government Business"). In accordance with the provisions of the Presentation of Financial Statements Topic 205 of the Accounting Standards Codification ("ASC"), the assets and liabilities related to the Government Business are now presented as discontinued operations for all periods presented in the consolidated financial statements.

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Common Stock Warrants and Stock Based Compensation (Details 1)	6 Months Ended
	Mar. 31, 2014	Mar. 31, 2013
Expected life	5 years 4 months 24 days	6 years 8 months 12 days
Expected volatility	169.00%
Expected dividend
Risk-free rate	1.60%
Minimum [Member]
Expected volatility	88.10%
Expected dividend
Risk-free rate	1.10%
Maximum [Member]
Expected volatility	99.30%
Expected dividend
Risk-free rate	1.30%

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Loss per Share (Tables)

6 Months Ended

Mar. 31, 2014

Earnings Per Share [Abstract]

Basic and diluted loss per common share

	Three Months Ended March 31,						Six Months Ended March 31,
	2014			2013			2014			2013
Net Loss Numerator:
Loss from continuing operations	$	(4,602,000	)	$	(8,400,000	)	$	(5,115,000	)	$	(9,017,000	)
Loss from discontinued operations		-			(1,191,000	)		-			(2,738,000	)
Net loss	$	(4,602,000	)	$	(9,591,000	)	$	(5,115,000	)	$	(11,755,000	)
Net Loss Denominator:
Weighted average number of common shares outstanding, basic and diluted		245,122,000			153,688,000			234,858,000			147,541,000
Basic and diluted loss per share
Loss from continuing operations	$	(0.02	)	$	(0.05	)	$	(0.02	)	$	(0.06	)
Earnings (loss) from discontinued operations	$	-		$	(0.01	)	$	-		$	(0.02	)
Net loss per common share	$	(0.02	)	$	(0.06	)	$	(0.02	)	$	(0.08	)

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Common Stock Warrants and Stock Based Compensation (Details Narrative) (USD $)	6 Months Ended					6 Months Ended			6 Months Ended
	Mar. 31, 2014	Mar. 31, 2014 2006 Plan [Member]	Mar. 31, 2014 2006 Plan [Member] Minimum [Member]	Mar. 31, 2014 2006 Plan [Member] Maximum [Member]	Mar. 31, 2014 The 2010 Plan [Member]	Mar. 31, 2014 2011 Plan [Member]	Mar. 31, 2014 2011 Plan [Member] Minimum [Member]	Mar. 31, 2014 2011 Plan [Member] Maximum [Member]	Mar. 31, 2014 Employee Stock Benefit Plan [Member]	Mar. 31, 2014 Common Stock Warrants [Member]	Sep. 30, 2013 Common Stock Warrants [Member]	Mar. 31, 2014 Common Stock Warrants [Member] Minimum [Member]	Sep. 30, 2013 Common Stock Warrants [Member] Minimum [Member]	Mar. 31, 2014 Common Stock Warrants [Member] Maximum [Member]	Sep. 30, 2013 Common Stock Warrants [Member] Maximum [Member]	Mar. 31, 2014 Employee Stock Benefit Plan [Member]	Sep. 30, 2013 Employee Stock Benefit Plan [Member]	Mar. 31, 2014 RabbiTrust [Member]
Shares authorized																		14,000
Shares outstanding		74,000			18,500,000	142,717,000				282,200,000	71,194,000							44,000
Weighted average exercise price per share, warrants										$ 0.07	$ 0.10
Exercise price			$ 17	$ 26.40	$ 0.09		$ 0.042	$ 0.15				$ 0.001	$ 0.001	$ 0.55	$ 0.55
Shares reserved for issuance					18,500,000	646,500,000
Options exercisable	101,432,000				9,000,000	91,917,000
Shares exercisable		441,000			9,000,000	503,027,000
Shares exercisable, exercise price	$ 0.08		$ 0.16	$ 13
Share increase FY 2010		485,000
Share increase FY 2011		1,250,000
Share increase FY 2012		1,250,000
Options granted						149,400,000
option exercise price	$ 0.04					$ 0.042
stock option expense related to the OEP						$ 1,500,000
Exchange options granted						146,900,000
Shares of common stock cancelled by issuance of options						27,100,000
Contribution, common stock																0	9,100,000
Contribution market value																$ 0	$ 272,000
Maximum payroll limit contribution plan									15.00%

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Commitments and Contingencies (Tables)

6 Months Ended

Mar. 31, 2014

Commitments And Contingencies Tables

Future minimum payments under capital lease obligations

Fiscal Year	Capital Leases			Operating Leases
2014 (remaining six months)	$	242,000		$	135,000
2015		128,000			251,000
2016		42,000			238,000
2017		25,000			175,000
2018		-			149,000
2019 and beyond		-			-
Less amounts representing interest		(41,000	)		-
Future minimum lease payments	$	396,000		$	948,000

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General

6 Months Ended

Mar. 31, 2014

Accounting Policies [Abstract]

Note 1 - General

 The information contained in the following Notes to Condensed Consolidated Financial Statements is derived from that which appears in the accompanying unaudited condensed consolidated financial statements for ISC8 Inc. (“ISC8”), and its subsidiaries (together with ISC8, the “Company”), and 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 Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2013 (“Fiscal 2013”), filed with the SEC on December 24, 2013, including the risk factors contained therein, as updated in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2014. 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 three month periods ended March 31, 2014 and 2013 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, 2014, and the results of its operations and its cash flows for the three month periods ended March 31, 2014 as compared to the same period ended March 31, 2013.

 The accompanying September 30, 2013 balance sheet was derived from the audited fiscal 2013 financial statements.

Recent Developments

 New Location Established as ISC8 Malaysia. On October 28, 2013, the Company announced the opening of a new office in Kuala Lumpur, Malaysia in support of the projected growth of business within South East Asia (“ISC8 Malaysia”).  ISC8 Malaysia, a wholly owned subsidiary of the Company, will serve as a regional hub in South East Asia.

 Creation of Series D Convertible Preferred. On October 30, 2013, the Company filed the Certificate of Designations of Rights, Preferences, Privileges and Limitations of the Series D Convertible Preferred Stock (the "Certificate of Designations") with the Delaware Secretary of State to designate 4,000 shares of the Company's preferred stock as Series D Convertible Preferred Stock ("Series D Preferred"). The Series D Preferred votes alongside shares of the Company's common stock, par value $0.01 per share (“Common Stock”), on an as converted basis, and ranks junior to the Company's Series B Convertible Cumulative Preferred Stock, but is senior to all other classes of the Company's preferred stock. Each share of Series D Preferred has a stated value of $10,000 (the "Stated Value"), and is currently convertible, at the option of the holder, into that number of shares of Common Stock equal to the Stated Value divided by the Conversion Price set forth in the Certificate of Designations (the "Conversion Shares").

 Series D Preferred Financing. On October 31, 2013, the Company accepted subscription agreements from certain accredited investors (the "Investors") to purchase shares of Series D Preferred (the "Series D Offering") for $10,000 per share. As additional consideration, each Investor received one-year warrants to purchase 59,523 shares of Common Stock for $0.084 per share ("Warrant Shares") for every share of Series D Preferred purchased (the "Series D Warrants"). Through March 31, 2014, investors have purchased 477 shares of Series D Preferred, resulting in gross proceeds of approximately $4.77 million.

Cancellation of Debt. In connection with the offer and sale of the Series D Preferred, certain holders of the Company's outstanding senior convertible debt agreed to exchange such debt, in the aggregate total of approximately $23.1 million in principal and accrued interest, for shares of Series D Preferred and Series D Warrants on substantially similar terms to the Series D Offering (the “Senior Note Conversion”). The Senior Note Conversion resulted in the issuance of approximately 2,300 shares of Series D Preferred and Series D Warrants to purchase approximately 137.2 million shares of Common Stock. Furthermore, certain holders of the Company’s junior subordinated convertible debt agreed to exchange an aggregate total of approximately $14.5 million in principal and accrued interest for approximately 101.4 million shares of Restricted Stock Units (“RSU”) that vests in the event the trading price of the Company’s Common Stock reaches $0.143 (the “Junior Note Conversion”).

Amendments to Articles of Incorporation or Bylaws. On October 31, 2013, the Company amended Article III, Section 2 of the Company's Bylaws to decrease the fixed number of directors from ten to seven (the "Bylaw Amendment"). On June 5, 2014, the Company further amended Article III, Section 2 of the Company’s Bylaws to decrease the fixed number of directors from seven to three, and decrease the size of the Company’s Board of Directors to no less than three, but no more than seven directors.

Modification of PFG Loan Agreement. On November 1, 2013, the Company substantially modified its Loan Agreement with Partners for Growth III, L.P. (“PFG”) to provide, among other things, for a one-year extension of the maturity date under the Loan Agreement to December 31, 2014 (the “PFG Loan Modification”). In return, the Company made a $2.0 million repayment on the loan, deposited $500,000 with PFG as collateral for the loan, and, in the event the Company consummates a debt or equity financing, the Company agreed to pay to PFG 25% of the proceeds from such financing (“Financing Guarantee Fund”). PFG and the Company also modified the Guaranty Agreement executed in connection with the Loan Agreement in order to: (i) release Costa Brava Partnership III, LP (“Costa Brava”) from its guarantee of the Company's debt to PFG, (ii) reduce the maximum guarantee amount to $1.0 million, and (iii) affirm the obligations of the Griffin Fund LP, one of the Company’s related party investors (“Griffin”), under the Guaranty Agreement.

On February 7, 2014, the Company and PFG made further modification to the Loan Agreement by reducing the Financing Guarantee Fund payment from 25% of 10% and required the Company to make a $70,000 monthly payment toward the principal balance of the loan effective April 1, 2014 and a back end fee of 15% on any capital raise. See Note 3 under the heading Revolving Credit Facility.

Increase of Authorized Number of Common Shares. On January 16, 2014, the Company filed with the Delaware Secretary of State an amendment to its Certificate of Incorporation to the increase of the total number of authorized shares of capital stock from 801,000,000 to 2,001,000,000, of which 2,000,000,000 will be available for issuance as Common Stock (the “Amendment”).

Amendment to 2011 Omnibus Incentive Plan and Option Exchange Program. On January 16, 2014, the Company implemented an amendment to its 2011 Omnibus Incentive Plan (the “2011 Plan”) to increase the number of shares of Common Stock issuable under the 2011 Plan to 446,500,000 (the “Plan Amendment”). In October 2013, in anticipation of stockholder approval of the Plan Amendment, the Company commenced an option exchange program (the “Option Exchange Program”) wherein holders of stock options previously issued under the Company’s equity compensation plans could, at the option of the holder, exchange outstanding options for new options to purchase shares of Common Stock for $0.042 per share. To date, the Company has canceled outstanding stock options to purchase 28.6 million shares of Common Stock, and issued new options under the 2011 Plan to purchase approximately 146.9 million shares of Common Stock for $0.042 per share.

Issuance of Senior Subordinated Secured Convertible Bridge Notes. On February 6, 2014, the Company’s Board of Directors approved the issuance of senior subordinated secured convertible bridge notes in the aggregate principal amount of up to $3.5 million (the “2014 First Bridge Notes”), of which, $1.5 million may be issued in exchange for the cancellation of certain outstanding senior notes.  The 2014 First Bridge Notes mature on July 31, 2014. As of March 31, 2014, the Company has issued 2014 First Bridge Notes in the aggregate principal amount of $0.6 million. See Note 5 for further information regarding the 2014 First Bridge Notes.

On February 28, 2014, the Company’s Board of Directors approved the issuance of senior subordinated secured convertible bridge notes in the aggregate principal amount of up to $6.0 million (the “2014 Second Bridge Notes”), of which, $1.5 million may be issued in exchange for the cancellation of certain outstanding senior notes.  The 2014 Second Bridge Notes mature on July 31, 2014. As of June 5, 2014, the Company has issued 2014 Second Bridge Notes in the aggregate principal amount of $3.0 million. See Note 5 and Note 11 for further information regarding the 2014 Second Bridge Notes.

Forbearance Agreement.  As of March 31, 2014, $0.9 million of the outstanding Senior Subordinated Convertible Notes  (as defined below in Note 3-Senior Subordinated Secured Convertible Promissory Notes) had matured. The Company entered into a Forbearance Agreement with the respective holders of these Notes to extend the maturity date to July 31, 2014.  See Note 11 for further information regarding the Forbearance Agreement, and other information regarding the Senior Subordinated Secured Convertible Notes.

Summary of Significant Accounting Policies

 There have been no significant changes to the Company’s significant accounting policies during the three months ended March 31, 2014. For a comprehensive description of the Company’s significant accounting policies, see Note 1 to the Company’s Consolidated Financial Statements included in the Company’s 2013 Annual Report on Form 10-K, filed with the SEC on December 24, 2013.

 Consolidation. The consolidated financial statements include the accounts of ISC8 and its subsidiaries, Novalog, Inc. (“Novalog”), MicroSensors, Inc. (“MSI”), RedHawk Vision Systems, Inc. (“RedHawk”) iNetWorks Corporation (“iNetWorks”), ISC8 Europe Limited (“ISC8 Europe”) and ISC8 Malaysia SDN.BMD (“ISC8 Malaysia”). Of the Company’s subsidiaries, only ISC8 Europe and ISC8 Malaysia presently have operating activities and assets, separate employees and facilities. All significant intercompany transactions and balances have been eliminated in the consolidation. None of the Company’s subsidiaries accounted for more than 10% of the Company’s total assets at March 31, 2014 or March 31, 2013.

 Reclassifications. Certain amounts in the consolidated financial statements have been reclassified in order to conform to the current year presentation.

 Reportable Segments. The Company is presently managing its continuing 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.

 Use of Estimates. The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Management prepares estimates for a number of factors, including derivative liability, stock-based compensation, warrants valuation, revenue recognition, valuation of goodwill and other intangible assets, allowance for doubtful accounts and notes receivable, and deferred tax assets and liabilities. The Company believes its estimates of derivative liabilities, and warrants valuation to be the most sensitive estimates impacting financial position and results of operations in the near term.

 Subsequent Events. Management has evaluated events subsequent to March 31, 2014 through the date of this Quarterly Report on Form 10-Q for transactions and other events that may require adjustment of and/or disclosure in such financial statements. See Note 11 for a discussion of events occurring subsequent to March 31, 2014. 

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Condensed Consolidated Balance Sheets (Unaudited) (Parenthetical) (USD $)	Mar. 31, 2014	Sep. 30, 2013
Common stock, par value	$ 0.01	$ 0.01
Common stock, shares authorized	2,000,000,000	800,000,000
Common stock, shares issued	255,080,000	205,581,000
Common stock, shares outstanding	255,080,000	205,581,000
Convertible preferred stock, par value	$ 0.01
Convertible preferred stock, shares authorized	1,000,000
Series D Preferred Stock [Member]
Convertible preferred stock, shares issued	2,800	0
Convertible preferred stock, shares outstanding	2,800	0
Convertible preferred Stock, Liquidation Preference, Value	$ 27,820,000	$ 0
Series B Preferred Stock Shares Issued (1)
Convertible preferred stock, shares issued	900	900
Convertible preferred stock, shares outstanding	900	900

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Subsequent Events

6 Months Ended

Mar. 31, 2014

Subsequent Events [Abstract]

Note 11 - Subsequent Events

Forbearance Agreement.  On December 6, 2013, a disagreement arose between the Company and the Non-Converting Note Holders regarding the maturity date of the Notes held by the Non-Converting Note Holders.  On April 11, 2014, the Company entered into a forbearance agreement with the Non-Converting Note Holders to extend the maturity date of the Notes to July 31, 2014.  As consideration for the forbearance, the Company issued to the Non-Converting Note Holders five-year warrants to purchase an aggregate total of 43.1 million shares of Common Stock for $0.001 per share

Griffin Advisory Agreement. On April 11, 2014, the Company entered into an advisory agreement with Griffin, wherein Griffin will offer certain advisory and consulting services to the Company pertaining to the Company’s current capital restructuring.  As compensation for Griffin’s services, the Company agreed to pay Griffin and aggregate total of $100,000, to be paid periodically, in order to enable the Company to effectively manage its ongoing cash requirement.  Griffin is affiliated with the Griffin Fund, LP, a principal shareholder of the Company.

Revolving Credit Facility Payment.  In May 2014, the Company failed to pay to PFG amounts due for April 2014 interest, and 10% of the gross proceeds received from the issuance of the 2014 Bridge Notes and the $70,000 principal payment, as required by the Second Modification.

Issuance of Additional 2014 Second Bridge Notes. Since March 31, 2014, the Company has issued 2014 Second Bridge Notes in the aggregate principal amount of approximately $1.7 million, resulting in gross proceeds to the Company of approximately $1.29 million.

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Document and Entity Information	6 Months Ended
	Mar. 31, 2014	Jun. 04, 2014
Document And Entity Information
Entity Registrant Name	ISC8 INC. /DE
Entity Central Index Key	0000357108
Document Type	10-Q
Document Period End Date	Mar. 31, 2014
Amendment Flag	false
Document Fiscal Year Focus	2013
Document Fiscal Period Focus	Q2
Current Fiscal Year End Date	--09-30
Entity a Well-known Seasoned Issuer	No
Entity a Voluntary Filer	No
Entity's Reporting Status Current	Yes
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		256,580,728

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General (Policies)

6 Months Ended

Mar. 31, 2014

Organization, Consolidation and Presentation of Financial Statements [Abstract]

Consolidation

 Consolidation. The consolidated financial statements include the accounts of ISC8 and its subsidiaries, Novalog, Inc. (“Novalog”), MicroSensors, Inc. (“MSI”), RedHawk Vision Systems, Inc. (“RedHawk”) iNetWorks Corporation (“iNetWorks”), ISC8 Europe Limited (“ISC8 Europe”) and ISC8 Malaysia SDN.BMD (“ISC8 Malaysia”). Of the Company’s subsidiaries, only ISC8 Europe and ISC8 Malaysia presently have operating activities and assets, separate employees and facilities. All significant intercompany transactions and balances have been eliminated in the consolidation. None of the Company’s subsidiaries accounted for more than 10% of the Company’s total assets at March 31, 2014 or March 31, 2013.

Reclassifications

 Reclassifications. Certain amounts in the consolidated financial statements have been reclassified in order to conform to the current year presentation.

Reportable Segments

 Reportable Segments. The Company is presently managing its continuing 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.

Use of Estimates

 Use of Estimates. The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Management prepares estimates for a number of factors, including derivative liability, stock-based compensation, warrants valuation, revenue recognition, valuation of goodwill and other intangible assets, allowance for doubtful accounts and notes receivable, and deferred tax assets and liabilities. The Company believes its estimates of derivative liabilities, and warrants valuation to be the most sensitive estimates impacting financial position and results of operations in the near term.

Subsequent Events

 Subsequent Events. Management has evaluated events subsequent to March 31, 2014 through the date of this Quarterly Report on Form 10-Q for transactions and other events that may require adjustment of and/or disclosure in such financial statements. See Note 13 for a discussion of events occurring subsequent to March 31, 2014. 

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Condensed Consolidated Statements of Operations (Unaudited) (USD $)	3 Months Ended		6 Months Ended
	Mar. 31, 2014	Mar. 31, 2013	Mar. 31, 2014	Mar. 31, 2013
Income Statement [Abstract]
Revenues	$ 78,000	$ 102,000	$ 171,000	$ 196,000
Cost of revenues	45,000	44,000	93,000	81,000
Gross profit	33,000	58,000	78,000	115,000
Operating expenses:
General and administrative expense	2,532,000	2,320,000	4,907,000	4,290,000
Research and development expense	1,223,000	1,799,000	3,121,000	3,464,000
Total operating expenses	3,755,000	4,119,000	8,028,000	7,754,000
Operating Loss	(3,722,000)	(4,061,000)	(7,950,000)	(7,639,000)
Interest and other (income) expense
Interest expense	621,000	3,806,000	4,549,000	5,793,000
Change in fair value of derivative liability	261,000	466,000	(7,073,000)	(4,481,000)
Gain on extinguishment of debt			(316,000)
Other (income) expense	(2,000)	(64,000)	2,000	63,000
Total interest and other (income) expenses	880,000	4,336,000	(2,838,000)	1,375,000
Loss from continuing operations before provision for income taxes	(4,602,000)	(8,397,000)	(5,112,000)	(9,014,000)
Provision for income taxes		3,000	3,000	3,000
Loss from continuing operations	(4,602,000)	(8,400,000)	(5,115,000)	(9,017,000)
Loss from discontinued operations		(1,191,000)		(2,738,000)
Net loss	$ (4,602,000)	$ (9,591,000)	$ (5,115,000)	$ (11,755,000)
Basic and Diluted net loss per share:
Loss from continuing operations	$ (0.02)	$ (0.05)	$ (0.02)	$ (0.06)
Loss from discontinued operations		$ (0.01)		$ (0.02)
Net loss per share	$ (0.02)	$ (0.06)	$ (0.02)	$ (0.08)
Basic and diluted weighted average number of common shares outstanding	245,122,000	153,688,000	234,858,000	147,541,000

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Loss per Share

6 Months Ended

Mar. 31, 2014

Earnings Per Share [Abstract]

Note 6 - Loss per Share

Since the Company had a net loss from continuing operations for the six months ended March 31, 2014 and 2013, there was no difference between basic and diluted loss per share in each of these fiscal years.

The following table sets forth the computation of basic and diluted loss per common share:

	Three Months Ended March 31,						Six Months Ended March 31,
	2014			2013			2014			2013
Net Loss Numerator:
Loss from continuing operations	$	(4,602,000	)	$	(8,400,000	)	$	(5,115,000	)	$	(9,017,000	)
Loss from discontinued operations		-			(1,191,000	)		-			(2,738,000	)
Net loss	$	(4,602,000	)	$	(9,591,000	)	$	(5,115,000	)	$	(11,755,000	)
Net Loss Denominator:
Weighted average number of common shares outstanding, basic and diluted		245,122,000			153,688,000			234,858,000			147,541,000
Basic and diluted loss per share
Loss from continuing operations	$	(0.02	)	$	(0.05	)	$	(0.02	)	$	(0.06	)
Earnings (loss) from discontinued operations	$	-		$	(0.01	)	$	-		$	(0.02	)
Net loss per common share	$	(0.02	)	$	(0.06	)	$	(0.02	)	$	(0.08	)

 Options, warrants and convertible instruments outstanding at March 31, 2014 and September 30, 2013 to purchase approximately 1,123,686,000 and 594,951,000 shares of the Company’s Common Stock, respectively, were not included in the above computation because they were anti-dilutive.

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Common Stock Warrants, Stock Options, and Employee Stock Benefit Plan

6 Months Ended

Mar. 31, 2014

Senior Secured Revolving Credit Facility Loan Net Of Unamortized Discount Of

Note 5 - Common Stock Warrants and Stock Based Compensation

Common Stock Warrants. As of March 31, 2014, warrants to purchase a total of 282.2 million shares of the Company’s Common Stock were outstanding, with a weighted average exercise price of $0.07 per share and exercise prices ranging from $0.001 per share to $0.55 per share.

Stock Incentive Plans. The Company’s stockholders approved the Company’s 2006 Omnibus Incentive Plan (the “2006 Plan”), which is designed to serve as a comprehensive equity incentive program to attract and retain the services of individuals essential to the Company’s long-term growth and financial success. Upon approval of the 2006 Plan, the Company’s 2003 Stock Incentive Plan (the “2003 Plan”), 2001 Non-Qualified Stock Option Plan (the “2001 Non-Qualified Plan”), was terminated, but existing options issued pursuant to the Prior Plans remain outstanding in accordance with the terms of their original grants.

 As of March 31, 2014, there were 74,000 outstanding and exercisable options to purchase the Company’s Common Stock under the 2003 Plan with exercise prices ranging from $17.00 to $26.40.

 As of March 31, 2014, there were 441,000 outstanding and exercisable options to purchase the Company’s Common Stock under the 2006 Plan with exercise prices ranging from $0.16 to $13.00.

 In December 2010, the Company’s Board adopted the Company’s 2010 Non-Qualified Stock Option Plan (the “2010 Plan”) under which the Company’s eligible officers, directors and employees, consultants and advisors who qualify as “accredited investors” within the meaning of Rule 501 under the Securities Act, may be granted non-qualified stock options. 18,500,000 shares of the Company’s Common Stock were reserved for issuance under the 2010 Plan, and options to purchase 18,500,000 shares of the Company’s Common Stock at an exercise price of $0.09 per share were issued to certain of the Company’s officers and directors in December 2010 pursuant to the 2010 Plan. As of March 31, 2014, there are 9,000,000 outstanding and exercisable options to purchase the Company’s Common Stock under the 2010 Plan at an exercise price of $0.09 per share. No further grants may presently be made under the 2010 Plan.

 In March 2011, the Company’s stockholders approved the Company’s 2011 Omnibus Incentive Plan (the “2011 Plan”). The number of shares reserved for issuance under the 2011 Plan was increased to 646,500,000 shares, effective January 16, 2014. The 2011 Plan is designed to promote the interests of the Company and its stockholders by serving as a comprehensive equity incentive program to attract and retain the services of individuals capable of assuring the future success of the Company and to afford such persons an opportunity to acquire a proprietary interest, or otherwise increase their proprietary interest, in the Company. The 2011 Plan permits grants of stock options (including both incentive and non-qualified stock options), stock-only appreciation rights, restricted stock, restricted stock units, dividend equivalents, performance awards of cash, stock or property, other stock grants and other stock-based awards. As of March 31, 2014, there were options to purchase 142,717,000 shares of the Company’s Common Stock outstanding under the 2011 Plan, of which options to purchase 91,917,000 shares were exercisable, at exercise prices ranging from $0.042 to $0.150 per share. The aggregate number of shares of Common Stock issuable under all stock-based awards that may be made under the 2011 Plan at March 31, 2014 is 503,027,000 shares.

 Below is a summary of stock option transactions during the six months ended March 31, 2014:

	Number of Shares			Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Life (yrs)		Aggregate Intrinsic Value
Outstanding at September 30, 2013		51,752,000		$	0.20		7.7	$	-
Granted		149,438,000			0.04		9.6		-
Exercised		-			-		-		-
Forfeited/Cancelled		(48,958,000	)		0.10		8.3		-
Outstanding at March 31, 2014		152,232,000			0.07		9.2		-
Vested and expected to vest, March 31, 2014		129,398,000			0.07		9.2		-
Exercisable, March 31, 2014		101,432,000			0.08		9.0		-

For the six months ended March 31, 2014 and 2013, the Company utilized the Black-Scholes valuation model for estimating the fair value of share-based compensation with the following assumptions:

	Six Months Ended March 31,
	2014		2013
Expected life	5.4 years		6.7 years
Expected volatility		169%		88.1% -99.3%
Expected dividend	None		None
Risk-free rate		1.6%		1.1%-1.3%

 The Company issues new shares of Common Stock to satisfy option exercises. Based on historical experience of option cancellations, the Company has estimated an annualized forfeiture rate of 15% and 7% for employee options for the three months ended March 31, 2014 and 2013, respectively.  Forfeiture rates are adjusted over the requisite service period when actual forfeitures differ, or are expected to differ, from the estimate.

 During the six months ended March 31, 2014, a total of 149.4 million options to purchase shares of the Company’s Common Stock were granted under the 2011 Plan, with an exercise price of $0.042.  Of the total options granted, 146.9 million were issued in exchange for the cancellation of previously granted options to purchase 27.1 million shares of Common Stock that were both vested and unvested, pursuant to the Option Exchange Program.  One-third of the grant vests immediately and the remaining two thirds vest in equal monthly installments over two years and expire on October 21, 2023.  The Company treated these exchanges as a modification to the existing options.  The Company recorded the incremental cost of the modification measured by the excess of the fair value of the modified award over the fair value of the original award immediately before the modification as additional compensation cost recognized over the requisite service period.  For the six months ended March 31, 2014, $1.5 million in stock option expense was recognized related to these transactions under the Option Exchange Program.

 Employee Stock Benefit Plan. The Company has established an employee retirement plan (the “ESBP”). This plan provides for annual contributions to the Company’s Employee Stock Bonus Trust (“SBT”) to be determined by the Board of Directors and which will not exceed 15% of total payroll.  As of March 31, 2014, the Company has not made any contributions to the SBT for the year ended September 30, 2014.  In Fiscal 2013, the Company made a contribution of 9.1 million shares of Common Stock with an estimated market value of $272,000 to the SBT.

 Deferred Compensation Plan. In September 2002, the Company established a deferred compensation plan, the Non-Qualified Deferred Compensation Plan, for certain key employees with long-term service with the Company. Annual contributions of Common Stock of the Company were made to a Rabbi Trust under such plan to be held for the benefit of the deferred compensation plan participants. During Fiscal 2013 the Board of Directors authorized a contribution of 14,000 shares to the Non- Qualified Deferred Compensation Plan. Participants’ potential distributions from the Rabbi Trust represent unsecured claims against the Company. The Rabbi Trust was established by the Company and is subject to creditors’ claims. Shares in this plan may be distributed to each plan beneficiary when they retire from service with the Company. At March 31, 2014, and September 30, 2013 there were 44,000 shares of the Company’s Common Stock were in the Rabbi Trust.

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Discontinued Operations (Tables)

6 Months Ended

Mar. 31, 2014

Discontinued Operations Tables

Summarized financial information related to discontinued operations, consisting of Government Business

The following summarized financial information relates to discontinued operations, consisting of the Government Business:

	Three Months Ended March 31,					Six Months Ended March 31,
	2014		2013			2014		2013
Total revenues	$	-	$	732,000		$	-	$	1,514,000
Cost of revenues		-		1278,000			-		2,606,000
General and administrative expense		-		323,000			-		882,000
Research and development expense		-		322,000			-		764,000
Total costs and expenses		-		1,923,000			-		4,252,000
Net (loss) from discontinued operations (net of $0 tax)	$	-	$	(1,191,000	)	$	-	$	(2,738,000	)

 Included in the consolidated balance sheets are the following major classes of assets and liabilities associated with the Government Business as of March 31, 2014 and September 30, 2013:

	March 31, 2014		September 30, 2013
Accounts receivable, net	$	-	$	-
Prepaid expenses and other current assets		-		-
Current assets of discontinued operations		-		-
Unbilled revenues on uncompleted contracts		290,000		290,000
Property and equipment, net		-		7,000
Other assets		-		-
Non-current assets of discontinued operations		290,000		297,000
Accounts payable		87,000		141,000
Accrued expenses		438,000		438,000
Advance billings on uncompleted contracts		99,000		99,000
Current liabilities from discontinued operations	$	624,000	$	678,000

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Debt Instruments (Tables)

6 Months Ended

Mar. 31, 2014

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Senior Note Conversion and Junior Note Conversion activity

The following table summarizes debt instrument activity during the six months ended March 31, 2014:

	Principle Balance, Net of Discount at September 30, 2013		New Debt Issued (Principle Repayment), Net			Debt Converted to Series D Preferred Shares			Debt Converted to Restricted Stock			Debt Discount Amortization, Extinguishment or (Additions), Net			Principle Balance, Net of Discount at March 31, 2014
Senior Secured Revolving Credit Facility	$	4,908,000	$	(2,070,000	)	$	-		$	-		$	216,000		$	3,054,000
Senior Subordinated Secured Convertible Promissory 2013 Notes		15,793,000		175,000			(16,199,000	)		-			1,854,000			1,623,000
Senior Subordinated Secured Convertible Bridge Notes		-		1,858,000			-			-			(703,000	)		1,155,000
Senior Subordinated Secured Promissory Notes		5,392,000		-			(5,392,000	)		-			-			-
Subordinated Secured Convertible Promissory Notes		8,570,000		-			(381,000	)		(14,357,000	)		7,011,000			843,000
Total Gross Debt	$	34,663,000	$	(37,000	)		(21,972,000	)	$	(14,357,000	)	$	8,378,000		$	6,675,000
Accrued interest converted to equity							(1,084,000	)		(146,000	)
Gross adjustment to paid-in capital(1)						$	(23,056,000	)	$	(14,503,000	)

(1) The net amount presented excludes the impact of unamortized debt discount, derivative liability and deferred issuance costs.

Forbearance extenstions and warrants

Forbearance	Extension Through Date	Exercise Price per share	Exercisable Shares
Waiver	September 30, 2012	$0.042		2,045,455
Forbearance Extension	October 31, 2012	$0.042		2,045,455
Second Forbearance Extension	December 15, 2012	$0.042		2,045,455
Third Forbearance Extension	January 31, 2013	$0.042		2,045,455
Fourth Forbearance Extension	February 28, 2013	$0.042		2,045,455
Fifth Forbearance Extension	March 31, 2013	$0.042		2,045,455
Sixth Forbearance Extension	April 30, 2013	$0.042		2,045,455
Seventh Forbearance Extension	May 31, 2013	$0.042		2,045,455
Eighth Forbearance Extension	June 30, 2013	$0.042		2,045,455
Ninth Forbearance Extension	October 28, 2013	$0.010		2,232,142
Total				20,641,237

Fair value of derivative liability

	March 31, 2014		September 30, 2013
Risk free interest rate		0.36%		0.40%
Expected volatility		147% - 150%		94.8%
Expected dividends		None		None

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Fair Value Measurements

6 Months Ended

Mar. 31, 2014

Fair Value Disclosures [Abstract]

Note 9 - Fair Value Measurements

The Company measures the fair value of applicable financial and non-financial assets and liabilities based on the following levels of inputs.

• Level 1 inputs: Level 1 inputs are quoted market prices in active markets for identical assets or liabilities that are accessible at the measurement date.

• Level 2 inputs: Level 2 inputs are from other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.

• Level 3 inputs: Level 3 inputs are unobservable and should be used to measure fair value to the extent that observable inputs are not available.

 The hierarchy noted above requires the Company to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. There were no transfers between Level 1, Level 2 and/or Level 3 during the six months ended March 31, 2014. Financial liabilities carried at fair value as of March 31, 2014 are classified below:

	Level 1		Level 2		Level 3		Total
Derivative liabilities	$	-	$	-	$	797,000	$	797,000

 The table below sets forth a summary of changes in the fair value of our Level 3 financial instruments for the six months ended March 31, 2014:

	September 30, 2013		Recorded New Derivative Liabilities		Warrant Derivatives Reclassified to Equity			Conversion of Debt to Series D Preferred and RSUs			Change in Estimated Fair Value Recognized in Results of Operations			March 31, 2014
Derivative liabilities	$	19,245,000	$	445,000	$	(2,833,509	)	$	(8,383,000	)	$	(7,676,000	)	$	797,000

 Fair Value of Financial Instruments. The Company estimates the fair value of financial instruments that are not required to be carried in the condensed consolidated balance sheet at fair value on either a recurring or non-recurring basis as follows:

	March 31, 2014				September 30, 2013				Level in Fair Value Hierarchy
	Carrying amount		Fair Value		Carrying amount		Fair value
Cash and cash equivalents	$	147,000	$	147,000	$	136,000	$	136,000		1
Accounts Receivable, net	$	-	$	-	$	119,000	$	119,000		2
Accounts Payable	$	1,331,000	$	1,331,000	$	1,024,000	$	1,024,000		2

 The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and approximated fair value due to their short-term nature.

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Discontinued Operations

6 Months Ended

Mar. 31, 2014

Business Combinations [Abstract]

Note 7 - Discontinued Operations

On March 19, 2013, the Company announced that it had discontinued the Government Business, and instead focus on the Company’s cyber-security business.  As a result of the Company’s decision, the Company’s Government Business is classified as a discontinued operation in the consolidated financial statements of the Company.

 The following summarized financial information relates to discontinued operations, consisting of the Government Business:

	Three Months Ended March 31,					Six Months Ended March 31,
	2014		2013			2014		2013
Total revenues	$	-	$	732,000		$	-	$	1,514,000
Cost of revenues		-		1278,000			-		2,606,000
General and administrative expense		-		323,000			-		882,000
Research and development expense		-		322,000			-		764,000
Total costs and expenses		-		1,923,000			-		4,252,000
Net (loss) from discontinued operations (net of $0 tax)	$	-	$	(1,191,000	)	$	-	$	(2,738,000	)

 Included in the consolidated balance sheets are the following major classes of assets and liabilities associated with the Government Business as of March 31, 2014 and September 30, 2013:

	March 31, 2014		September 30, 2013
Accounts receivable, net	$	-	$	-
Prepaid expenses and other current assets		-		-
Current assets of discontinued operations		-		-
Unbilled revenues on uncompleted contracts		290,000		290,000
Property and equipment, net		-		7,000
Other assets		-		-
Non-current assets of discontinued operations		290,000		297,000
Accounts payable		87,000		141,000
Accrued expenses		438,000		438,000
Advance billings on uncompleted contracts		99,000		99,000
Current liabilities from discontinued operations	$	624,000	$	678,000

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Commitments and Contingencies

6 Months Ended

Mar. 31, 2014

Commitments and Contingencies Disclosure [Abstract]

Note 8 - Commitments and Contingencies

The Company leases certain facilities and equipment under cancelable and non-cancelable operating leases, with escalating rent provisions for facility and caiptal leases. Future minimum payments under capital lease obligations and operating lease commitments for the next five years as of March 31, 2014 are as follows:

Fiscal Year	Capital Leases			Operating Leases
2014 (remaining six months)	$	242,000		$	135,000
2015		128,000			251,000
2016		42,000			238,000
2017		25,000			175,000
2018		-			149,000
2019 and beyond		-			-
Less amounts representing interest		(41,000	)		-
Future minimum lease payments	$	396,000		$	948,000

 Total rent expense for operating leases amounted to $136,000 and $495,000 for the six months ended March 31, 2014 and 2013, respectively. Rent expense is recognized on a straight-line basis over the lease period. Deferred rent amounts are immaterial.

Litigation

 The Company has been, and may from time to time, become a party to various other legal proceedings arising in the ordinary course of its business. The Company does not presently know of any such other matters, the disposition of which would be likely to have a material effect on the Company’s consolidated financial position, results of operations or liquidity.

Disputes

On December 6, 2013, a certain holder of Senior Subordinated Convertible Promissory Notes (the “Notes”) who chose not to convert into the Series D Offering (the “Non-Converting Note Holder”), totaling approximately $0.9 million, notified the Company that they interpreted the Notes to require the Company to use the net proceeds from the Series D Offering, to repay certain outstanding debts.   In August 2013, however, the Company and the Non-Converting Note Holder amended the terms of the Notes to extend the maturity date of the Notes to January 31, 2014 (the “Amendment”), regardless of the consummation of a Qualified Financing, as such term is defined in the Notes.  The Non-Converting Note Holders objected to the Company’s interpretation of the Amendment, and took the position that the Notes were then currently due and payable from proceeds of the Qualified Financing, notwithstanding the Company’s position that Amendment extended the maturity date of the Notes to January 31, 2014.  The Company, however, failed to pay all amounts due and owing under the terms of the Notes on January 31, 2014.    On April 11, 2014, the Company entered into a Forbearance Agreement with the respective holders of the Notes to extend the maturity date of the Notes to July 31, 2014.  See Note 11- Subsequent Events below.

On November 15, 2013 the Company failed to meet a contractual first year minimum payment obligation of $100,000 with a certain vendor resulting in a contractual breach, which requires that we pay all fees and guarantee payment of totaling $1.8 million (the “Guarantee Payment”) immediately. We have not cured the breach of contract, but we have successfully negotiated a payment plan (the “Payment Plan”) with this vendor which consists of four equal monthly payments of $25,000 plus interest beginning February 2014. Due to our limited working capital, if we are unable to meet the requirements of the Payment Plan, we will be required to pay the Guarantee Payment in full, which could have a materially adverse impact on our business, financial condition and results of operations.

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Non-Controlling Interest in Subsidiaries

6 Months Ended

Mar. 31, 2014

Noncontrolling Interest [Abstract]

Note 10 - Non-Controlling Interest in Subsidiaries

At March 31, 2014, the Company owned 96% of Novalog’s common stock, 98% of MSI’s common stock, 81% of RedHawk’s common stock, and 95% of iNetWorks’ common stock.

 For the three and six months ended March 31, 2014 and 2013, Novalog, MSI, RedHawk, and iNetWorks did not have any operating activities.

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Common Stock Warrants and Stock Based Compensation (Details) (USD $)	6 Months Ended
	Mar. 31, 2014
Common Stock Warrants And Stock Based Compensation Details
Outstanding shares, Beginning of period	51,752,000
Options granted, shares	149,438,000
Options exercised
Options forfeited, shares	(48,958,000)
Outstanding shares, End of period	152,232,000
Vested and expected to vest, End of period	129,398,000
Exercisable, End of period	101,432,000
Outstanding weighted average exercise price, beginning	$ 0.20
Options granted, weighted average exercise price	$ 0.04
Options exercised, weighted average exercise price
Options forfeited, weighted average exercise price	$ 0.10
Outstanding weighted average exercise price, ending	$ 0.07
Vested and expected to vest, weighted average exercise price, End of period	$ 0.07
Exercisable, weighted average exercise price, End of period	$ 0.08
Outstanding at beginning of period	7 years 8 months 12 days
Options granted, shares	9 years 7 months 6 days
Options forfeited, shares	8 years 3 months 18 days
Outstanding shares, End of period	9 years 2 months 12 days
Vested and expected to vest, End of period	9 years 2 months 12 days
Exercisable, End of period	9 years

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Common Stock Warrants and Stock Based Compensation (Tables)

6 Months Ended

Mar. 31, 2014

Common Stock Warrants And Stock Based Compensation Tables

Summary of stock option transactions

	Number of Shares			Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Life (yrs)		Aggregate Intrinsic Value
Outstanding at September 30, 2013		51,752,000		$	0.20		7.7	$	-
Granted		149,438,000			0.04		9.6		-
Exercised		-			-		-		-
Forfeited/Cancelled		(48,958,000	)		0.10		8.3		-
Outstanding at March 31, 2014		152,232,000			0.07		9.2		-
Vested and expected to vest, March 31, 2014		129,398,000			0.07		9.2		-
Exercisable, March 31, 2014		101,432,000			0.08		9.0		-

Fair value of share-based compensation

	Six Months Ended March 31,
	2014		2013
Expected life	5.4 years		6.7 years
Expected volatility		169%		88.1% -99.3%
Expected dividend	None		None
Risk-free rate		1.6%		1.1%-1.3%

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General (Details Narrative) (USD $)	6 Months Ended
	Mar. 31, 2014	Sep. 30, 2013
Preferred stock designated as Series D Convertible, shares	1,000,000
Series D shares purchased by investors	477
Gross proceeds from purchase of Series D Preferred shares	$ 4,770,000
Senior note conversion amount	23,100,000
Senior note conversion, preferred share amount	2,300
Senior note conversion, common stock share amount	137,200,000
principal accrued interest exchange amount	14,500,000
Restricted common stock exchange amount, shares	101,400,000
Vesting price of restricted common stock	$ 0.143
Total number of authorized shares of capital stock, previous	801,000,000
Total number of authorized shares of capital stock, amended	2,001,000,000
Common stock, shares authorized	2,000,000,000	800,000,000
Amendment to increase the number of shares of Common Stock issuable under the 2011 Plan	446,500,000
Option Exchange Plan share purchase price	$ 0.042
outstanding stock options cancelled through Option Exchange Plan	28.6
Options granted, shares	149,438,000
Convertible 2014 Notes [Member]
Aggregate principal of debt authorized	3,500,000
Available for exchange for cancellation of debt	1,500,000
Maturity date	Jul. 31, 2014
Aggregate principal of debt issued	600,000
Notes matured	1,500,000
Convertible 2014 Notes 2 [Member]
Aggregate principal of debt authorized	6,000,000
Available for exchange for cancellation of debt	1,500,000
Maturity date	Jul. 31, 2014
Aggregate principal of debt issued	3,000,000
Notes matured	1,500,000
PCF LOC [Member]
Repayment of debt	2,000,000
Collateral amount	500,000
Maximum guarantee amount	$ 1,000,000
Series D Preferred Stock [Member]
Subscription agreements from certain accredited investors, price	$ 10,000
Warrant price per share	$ 0.084

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Commitments and Contingencies (Details) (USD $)	Mar. 31, 2014
FY 2014 [Member]
Capital Leases	$ 242,000
Operating Leases	135,000
FY 2015 [Member]
Capital Leases	128,000
Operating Leases	251,000
FY 2016 [Member]
Capital Leases	42,000
Operating Leases	238,000
FY 2017 [Member]
Capital Leases	25,000
Operating Leases	175,000
FY 2018 [Member]
Capital Leases
Operating Leases	149,000
FY 2019 [Member]
Capital Leases
Operating Leases
Interest [Member]
Capital Leases	(41,000)
Operating Leases
Future Min Lease Payments [Member]
Capital Leases	396,000
Operating Leases	$ 948,000

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Condensed Consolidated Statements of Comprehensive Loss (Unaudited) (USD $)	3 Months Ended		6 Months Ended
	Mar. 31, 2014	Mar. 31, 2013	Mar. 31, 2014	Mar. 31, 2013
Two Thousand and Ten Non Qualified Stock Option Plan [Member]
Net loss	$ (4,602,000)	$ (9,591,000)	$ (5,115,000)	$ (11,755,000)
Foreign currency translation adjustments	23,000		169,000
Comprehensive loss	$ (4,579,000)	$ (9,591,000)	$ (4,946,000)	$ (11,755,000)

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Convertible Preferred Stock

6 Months Ended

Mar. 31, 2014

Equity [Abstract]

Note 4 - Convertible Preferred Stock

Series B Preferred

 The Series B Preferred is non-voting, except to the extent required by law. With respect to distributions upon a deemed dissolution, liquidation or winding-up of the Company, the Series B Preferred ranks senior to the Common Stock and Series D Preferred. The liquidation preference per share of Series B Preferred equals its stated value, $1,000 per share. The Series B Preferred is not entitled to any preferential cash dividends; however, the Series B Preferred is entitled to receive, pari passu with the Company’s Common Stock, such dividends on the Common Stock as may be declared from time to time by the Company’s Board of Directors.   

Approximately 866 shares of Series B Preferred were outstanding at March 31, 2014, convertible into approximately 1,732,000 shares of the Company’s Common Stock.

Series D Preferred

 On October 30, 2013, we filed the Certificate of Designations with the Delaware Secretary of State to designate 4,000 shares of the Company's preferred stock as Series D Preferred. Each share of Series D Preferred has a Stated Value of $10,000 and votes alongside our Common Stock on an as-converted basis. The Series D Preferred ranks junior to our Series B Preferred, but is senior to all future classes of our preferred stock. The Series D Preferred is not redeemable at the election of the holder, but the Company may redeem the Series D Preferred, in whole or in part, in exchange for a cash payment equal to the Stated Value of the shared of Series D Preferred redeemed.  The holders of the Series D Preferred may elect, at any time, to convert the Series D Preferred into that number of shares of Common Stock equal to the Stated Value, divided by the current conversion price of $0.042 (the “Conversion Price”). The Series D Preferred also has a mandatory conversion provision that allows the Company to require conversion of all outstanding shares of Series D Preferred in the event the Company sells shares of Common Stock for at least $0.084 per share in a private financing or series of financings that result in aggregate gross proceeds of at least $10.0 million.

 As of March 31, 2014, there were 2,782 shares of Series D Preferred issued and outstanding.

 The following table summarizes equity activity for the quarter ended March 31, 2014 related to the sale of, and exchange of debt for, Series D Preferred and other equity activity.

	Series D Preferred Stock
	Shares		Amount		Paid-in Capital
Balance, September 30, 2013		-		-		181,443,000
Cash Proceeds from sale of Series D Preferred Stock and warrants, net of issuance costs of $234,000		477		5		4,531,000
Convertible debt exchanged for Series D Preferred stock		2,305		23		24,705,000
Total Series D activity		2,782		28		29,236,000
All other equity activity:
Convertible debt exchanged for restricted stock		-		-		13,111,000
Stock based compensation		-		-		2,539,000
Warrant derivatives reclassified to equity		-		-		2,834,000
Other equity activity, net		-		-		2,764,000
Balance, March 31, 2014		2,782		28		231,910,000

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Going Concern (Details Narrative) (USD $)	3 Months Ended		6 Months Ended
	Mar. 31, 2014	Mar. 31, 2013	Mar. 31, 2014	Mar. 31, 2013
Going Concern Details Narrative
Loss from continuing operations	$ (4,602,000)	$ (8,400,000)	$ (5,115,000)	$ (9,017,000)
Negative working capital	9,900,000		9,900,000
Stockholders deficit	9,500,000		9,500,000
Negative cash flows from operations			$ 4,400,000	$ 7,300,000

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Loss per Share (Details Narrative)	Mar. 31, 2014	Sep. 30, 2013
Loss Per Share Details Narrative
Options, warrants and convertible instruments outstanding	1,123,686,000	594,951,000

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Convertible Preferred Stock (Tables)

6 Months Ended

Mar. 31, 2014

Convertible Preferred Stock Tables

Equity activity related Series D Preferred

	Series D Preferred Stock
	Shares		Amount		Paid-in Capital
Balance, September 30, 2013		-		-		181,443,000
Cash Proceeds from sale of Series D Preferred Stock and warrants, net of issuance costs of $234,000		477		5		4,531,000
Convertible debt exchanged for Series D Preferred stock		2,305		23		24,705,000
Total Series D activity		2,782		28		29,236,000
All other equity activity:
Convertible debt exchanged for restricted stock		-		-		13,111,000
Stock based compensation		-		-		2,539,000
Warrant derivatives reclassified to equity		-		-		2,834,000
Other equity activity, net		-		-		2,764,000
Balance, March 31, 2014		2,782		28		231,910,000