U.S. SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





(Mark One)
 
 x     QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 For the quarterly period ended: March 31, 2010
 
 OR
 
 o   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 000-27023








TECHNEST HOLDINGS, INC.


(Exact name of registrant as specified in its charter)





Nevada
88-0357272(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)





10411 Motor City Drive, Suite 650, Bethesda, Maryland 20817


(Address of principal executive offices and zip code)





(301) 767-2810


(Registrant’s telephone number, including area code)





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 during the preceding 12 months (or for such shorter period that the registrant was required to filed such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes xNo o





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). Yes oNo o





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.





Large accelerated filer     o
Accelerated filer  oNon-accelerated filer       o
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 oNo x





As of May 14, 2010, there were 32,678,056 shares of common stock, $0.001 par value, of the registrant issued and outstanding.














FORM 10-Q


TABLE OF CONTENTS


MARCH 31, 2010





PagePART I.
FINANCIAL INFORMATION:Item 1.
Financial Statements (Unaudited)Consolidated Balance Sheets at March 31, 2010 and June 30, 2009
3-4Consolidated Statements of Operations for the Nine Months Ended March 31, 2010 and 2009
5Consolidated Statements of Operations for the Three Months Ended March 31, 2010 and 2009
6Consolidated Statement of Changes in Stockholders’ Equity for the Nine Months Ended March 31, 2010
7-8Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 2010 and 2009
9-10Notes to Condensed Consolidated Financial Statements
11Item 2.
Management’s Discussion and Analysis or Plan of Operation
18Item 4T.
Controls and Procedures
22PART II.
OTHER INFORMATION
23Item 1.
Legal Proceedings
23Item 1A.
Risk Factors
23Item 2.
Unregistered Sales of Equity Securities
29Item 6.
Exhibits
29Signatures

30





STATEMENTS CONTAINED IN THIS FORM 10-Q, WHICH ARE NOT HISTORICAL FACTS CONSTITUTE FORWARD-LOOKING STATEMENTS AND ARE MADE UNDER THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. FORWARD-LOOKING STATEMENTS INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. YOU CAN IDENTIFY THESE STATEMENTS BY FORWARD-LOOKING WORDS SUCH AS "MAY", "WILL", "EXPECT", "ANTICIPATE", "BELIEVE", "ESTIMATE", "CONTINUE", AND SIMILAR WORDS. YOU SHOULD READ STATEMENTS THAT CONTAIN THESE WORDS CAREFULLY. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS FORM 10-Q ARE BASED ON INFORMATION AVAILABLE TO US ON THE DATE HEREOF, AND WE ASSUME NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. EACH FORWARD-LOOKING STATEMENT SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND NOTES THERETO IN PART I, ITEM 1, OF THIS QUARTERLY REPORT AND WITH THE INFORMATION CONTAINED IN ITEM 2 TOGETHER WITH MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION CONTAINED IN OURANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED JUNE 30, 2009, INCLUDING, BUT NOT LIMITED TO, THE SECTION THEREIN ENTITLED "RISK FACTORS."





2





PART I. FINANCIAL INFORMATION





TECHNEST HOLDINGS, INC.


CONSOLIDATED BALANCE SHEETS


MARCH 31, 2010 AND JUNE 30, 2009











March 31, 2010


June 30, 2009(Unaudited)ASSETSCurrent AssetsCash and cash equivalents

$
177,420


$
5,567Accounts receivable


170,518



260,381Inventory and work in process


27,779



26,745Restricted cash


15,000



216,697Prepaid expenses and other current assets


130,197



750,013Assets related to discontinued operations


4,846,366



22,948,333Total Current Assets


5,367,280



24,207,736Property and Equipment– Net of accumulated depreciation $112,174 and $94,703


23,001



37,363Other AssetsDeposits


28,525



28,525Definite-lived intangible assets – Net of accumulated amortization $1,625,046 and $1,420,740


147,822



322,173Goodwill


4,876,038



4,876,038Total Other Assets


5,052,385



5,226,736Total Assets

$
10,442,666


$
29,471,835LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITYCurrent LiabilitiesAccounts payable

$
402,862


$
745,159Accrued expenses and other current liabilities


340,588



626,381Accrued state income taxes


293,091



293,091Liabilities related to discontinued operations


1,061,404



5,246,838Total Current Liabilities


2,097,945



6,911,469Total Liabilities


2,097,945



6,911,469








See notes to condensed consolidated financial statements.


3





TECHNEST HOLDINGS, INC.


CONSOLIDATED BALANCE SHEETS (concluded)





March 31, 2010


June 30, 2009(Unaudited)Series D Redeemable, Convertible Preferred Stock - $.0001 par value;3,000 shares authorized; -0- and 1,640 shares issued and outstanding at March 31,2010 and June 30, 2009, respectively


-



1,690,483Commitments and ContingenciesStockholders’ EquitySeries A Convertible Preferred Stock - $.001 par value; 150 shares authorized;-0- and 64.325 shares issued and outstanding at March 31, 2010 and June 30, 2009,respectively


-



-Series C Convertible Preferred Stock - $.001 par value; 1,149,425 shares authorized;-0- and 402,301 shares issued and outstanding at March 31, 2010 and June 30, 2009,respectively


-



402Common stock - par value $.001 per share; 495,000,000 shares authorized;32,272,091 and 20,676,739 shares issued and outstanding at March 31, 2010 andJune 30, 2009, respectively


32,271



20,675Additional paid-in capital


25,852,329



37,032,781Accumulated deficit


(17,320,728
)


(16,183,975
)Total Technest Holdings, Inc. Stockholders’ Equity


8,563,872



20,869,883Non controlling interest


(219,151
)


-Total Stockholders’ Equity


8,344,721



20,869,883Total Liabilities, Redeemable Preferred Stock and Stockholders’ Equity

$
10,442,666


$
29,471,835








See notes to condensed consolidated financial statements.


4





TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


FOR THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Unaudited)





2010


2009Revenues

$
1,701,847


$
1,854,263Cost of Revenues


856,725



1,039,431Gross Profit


845,122



814,832Operating ExpensesSelling, general and administrative


1,453,107



1,785,439Research and development


114,034



148,241Amortization of intangible assets


204,305



243,555Total Operating Expenses


1,771,446



2,177,235Operating Loss from Continuing Operations


(926,324
)


(1,362,403
)Other Income (Expense), NetOther income (expense)


6,921



(3,186
)Interest expense


(34,731
)


-Interest income


119,493



-Total Other Income (Expense), Net


91,683



(3,186
)Loss from Continuing Operations before Income Taxes


(834,641
)


(1,365,589
)Income tax benefit


-



334,212Net Loss from Continuing Operations


(834,641
)


(1,031,377
)Discontinued OperationsLoss on discontinued operations


(521,263
)


-Net Loss from Discontinued Operations


(521,263
)


-Net Loss


(1,355,904
)


(1,031,377
)Net Loss Attributable to Non-Controlling Interest


219,151



-Net Loss Attributable to Technest Holdings, Inc.


(1,136,753
)


(1,031,377
)Deemed Dividend to Preferred Stockholders - Series D


(291,306
)


(1,137,681
)Net Loss Applicable to Common Shareholders

$
(1,428,059
)

$
(2,169,058
)Basic and Diluted Loss Per Common shareFrom continuing operations attributable to Technest Holdings, Inc.

$
(0.04
)

$
(0.11
)From discontinued operations attributable to Technest Holdings, Inc.

$
(0.02
)

$
-Net Loss Per Share - Basic and Diluted

$
(0.06
)

$
(0.11
)Weighted Average Number of Common Shares OutstandingBasic and diluted


25,622,607



20,662,486Cash Dividends Per Common Share

$
0.407



-








See notes to condensed consolidated financial statements.


5





TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009


(Unaudited)





2010


2009Revenues

$
575,832


$
639,100Cost of Revenues


302,241



363,532Gross Profit


273,591



275,568Operating ExpensesSelling, general and administrative


473,758



628,372Research and development


43,190



36,305Amortization of intangible assets


41,935



81,185Total Operating Expenses


558,883



745,862Operating Loss from Continuing Operations


(285,292
)


(470,294
)Other Income (Expense), NetOther income (expense)


-



81Interest income


30,389



-Total Other Income (Expense), Net


30,389



81Loss from Continuing Operations before Income Taxes


(254,903
)


(470,213
)Income tax benefit


-



96,612Net Loss from Continuing Operations


(254,903
)


(373,601
)Discontinued OperationsLoss on discontinued operations


(207
)


-Net Loss from Discontinued Operations


(207
)


-Net Loss


(255,110
)


(373,601
)Net Loss Attributable to Non-Controlling Interest


79,130



-Net Loss Attributable to Technest Holdings, Inc.


(175,980
)


(373,601
)Deemed Dividend to Preferred Stockholders - Series D


-



(16,250
)Net Loss Applicable to Common Shareholders

$
(175,980
)

$
(389,851
)Basic and Diluted Loss Per Common shareFrom continuing operations attributable to Technest Holdings, Inc.

$
(0.01
)

$
(0.02
)From discontinued operations attributable to Technest Holdings, Inc.

$
-


$
-Net Loss Per Share - Basic and Diluted

$
(0.01
)

$
(0.02
)Weighted Average Number of Common Shares OutstandingBasic and diluted


32,272,091



20,676,211Cash Dividends Per Common Share

$
0.407



-








See notes to condensed consolidated financial statements.


6





TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY


FOR THE NINE MONTHS ENDED MARCH 31, 2010


(Unaudited)








Series A


Series CConvertible


ConvertibleCommon stock


Preferred stock


Preferred stockShares


Amount


Shares


Amount


Shares


AmountBalance - June 30, 2009


20,676,739


$
20,675



64


$
-



402,301


$
402Issuance of restricted stock aspayment for accrued expenses


754,535



755



-



-



-



-Accretion of Series D redeemableconvertible preferred stockto redemption value


-



-



-



-



-



-Beneficial conversion feature onSeries D redeemable convertiblepreferred stock


-



-



-



-



-



-Accretion of dividend on Series Dredeemable convertible preferredstock


-



-



-



-



-



-Issuance of restricted stock uponconversion of Series A convertiblepreferred stock


304,578



305



(64
)


-



-



-Issuance of restricted stock uponconversion of Series C convertiblepreferred stock


402,294



402



-



-



(402,301
)


(402
)Issuance of restricted stock uponconversion of Series D redeemableconvertible preferred stock


10,133,945



10,134



-



-



-



-Dividend payable


-



-



-



-



-



-Net Loss


-



-



-



-



-



-Balance - March 31, 2010


32,272,091


$
32,271



-


$
-



-


$
-











See notes to condensed consolidated financial statements.


7





TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY


FOR THE NINE MONTHS ENDED MARCH 31, 2010 (concluded)


(Unaudited)





Additional Paid-In


Accumulated


Non-Controlling


Total Stockholders'Capital


Deficit


Interest


EquityAmount


Amount


Amount


AmountBalance - June 30, 2009

$
37,032,781



(16,183,975
)

$
-


$
20,869,883Issuance of restricted stock aspayment for accrued expenses


124,245



-



-



125,000Accretion of Series D redeemableconvertible preferred stockto redemption value


(255,000
)


-



-



(255,000
)Beneficial conversion feature onSeries D redeemable convertiblepreferred stock


105,000



-



-



105,000Accretion of dividend on Series Dredeemable convertible preferredstock


(36,306
)


-



-



(36,306
)Issuance of restricted stock uponconversion of Series A convertiblepreferred stock


(305
)


-



-



-Issuance of restricted stock uponconversion of Series C convertiblepreferred stock


-



-



-



-Issuance of restricted stock uponconversion of Series D redeemableconvertible preferred stock


2,016,655



-



-



2,026,789Dividend payable


(13,134,741
)


-



-



(13,134,741
)Net Loss


-



(1,136,753
)


(219,151
)


(1,355,904
)Balance - March 31, 2010

$
25,852,329


$
(17,320,728
)

$
(219,151
)

$
8,344,721











See notes to condensed consolidated financial statements


8


TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


FOR THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Unaudited)








2010


2009Cash Flows From Operating Activities:Net loss

$
(1,355,904
)

$
(1,031,377
)Adjustment to reconcile net loss to net cash used in operating activities:Depreciation and amortization of property and equipment


17,471



25,422Amortization of intangible assets


204,305



243,555Stock based compensation to employees and directors


-



110,854Non-cash interest income related to discount accretion


(91,805
)


-Loss on sale of equipment


-



5,974Deferred income tax benefit


-



(334,212
)Changes in operating assets and liabilities:Accounts receivable


89,863



436,124Unbilled receivables


-



23,888Inventory and work in process


(1,034
)


8,098Restricted cash


201,697



18,606Deposits and prepaid expenses and other current assets


(37,957
)


53,371Accounts payable


(286,529
)


375,930Accrued expenses and other current liabilities


71,237



(531,723
)Net Cash Used In Operating Activities


(1,188,656
)


(595,490
)Cash Flows From Investing Activities:Purchase of equipment


(3,109
)


-Proceeds from sale of equipment


-



1,728Registration of new definite lived intangible assets


(29,954
)


(11,802
)Net Cash Used In Investing Activities


(33,063
)


(10,074
)Cash Flows From Financing Activities:Proceeds from short term note


150,000



-Repayment of short term note


(150,000
)


-Proceeds from issuance of Series D Redeemable, Convertible Preferred Stock


150,000



650,000Net Cash Provided by Financing Activities


150,000



650,000Net (Decrease)/Increase In Cash and Cash Equivalents from Continuing Operations


(1,071,719
)


44,436Cash Flows From Discontinued Operations:Operating activities - accounts payable and accrued expenses


(3,621,687
)


-Investing activities - proceeds from settlement on sale of EOIR


18,000,000



-Financing activities - return of capital dividend payment


(13,134,741
)Net Increase in Cash and Cash Equivalents from DiscontinuedOperations


1,243,572



-Net Increase in Cash and Cash Equivalents


171,853



44.436Cash and Cash Equivalents - Beginning of Period


5,567



76,761Cash and Cash Equivalents - End of Period

$
177,420


$
121,197









9










Supplemental Disclosures of Cash Flow Information:Cash paid during the periods for:Interest

$
30,000


$
-Taxes

$
-


$
-Non-Cash Investing and Financing Activities:Restricted stock issued as payment for accrued expenses

$
125,000


$
-Beneficial conversion on Series D Redeemable, Convertible Preferred Stock

$
105,000


$
455,000Accretion of Series D Redeemable, Convertible Preferred Stock to RedemptionValue

$
255,000


$
1,105,000Accrued dividend on Series D Redeemable, Convertible Preferred Stockconverted to Common Stock

$
36,306


$
32,681Series D Redeemable, Convertible Preferred Stock converted to Common Stock

$
2,026,789


$
-





See notes to condensed consolidated financial statements.

























10





TECHNEST HOLDINGS INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Unaudited)








1.
NATURE OF OPERATIONS





Business





Technest Holdings, Inc. (“Technest” or “the Company”) is engaged in the design, research and development, integration, analysis, modeling, system networking, sales and support of intelligent surveillance, three-dimensional facial recognition and three-dimensional imaging devices and systems primarily in the security and healthcare industries. Historically, the Company’s largest customers have been the Department of Defense and the National Institute of Health.





Litigation Related to the Sale of EOIR Technologies, Inc.





On October 26, 2009, Technest entered into a Settlement Agreement with EOIR Holdings, LLC (“LLC”) and EOIR Technologies, Inc. (“EOIR”), settling all claims related to the Stock Purchase Agreement, which the parties entered into in 2007 to effectuate the sale of EOIR, a subsidiary of Technest at the time (see Note 3 for additional information).





Under the terms of the Settlement Agreement, LLC agreed to pay Technest $18,000,000 no later than December 25, 2009 and an additional $5,000,000 within sixty days of EOIR being awarded a contract under the Warrior Enabling Broad Sensor Services (WEBSS) Indefinite Delivery Indefinite Quantity (ID/IQ) contract or any contract generally recognized to be a successor contract to its current STES contract. The additional $5,000,000 is also payable to Technest in the event that EOIR is awarded task orders under its current STES contract totaling $495,000,000.  EOIR has guaranteed the performance of the obligations of LLC under the Settlement Agreement. The Settlement Agreement was entered into after a binding arbitration decision awarded Technest $23 million for breach of the Stock Purchase Agreement between the parties.





On December 24, 2009, LLC paid Technest $18,000,000 and subsequently, the actions pending between the parties were dismissed in accordance with the Settlement Agreement.  The Company paid out of the proceeds received $3,621,687 of previously recorded liabilities related to the sale of EOIR and related litigation and $13,134,741 as a return of capital dividend to our shareholders. The Company recorded a $154,000 discount on the $5 million contingent receivable as management originally anticipated collection of this amount by September 2010. The release of the WEBSS contract has fallen slightly behind original expectations and the collection of the related receivable is now anticipated in the first quarter of 2011. During the three and nine months ended March 31, 2010, the Company accreted into interest income a total of $30,345 and $91,805, respectively, related to this discount.  Technest believes that the collectability of the contingent receivable is determinable beyond a reasonable doubt and as such does not believe any reserves are warranted at March 31, 2010.





2.
BASIS OF PRESENTATION





Basis of Presentation





The consolidated financial statements include the accounts of Technest and its wholly-owned subsidiary, Genex Technologies, Inc. Also included in the consolidation are the results of Technest’s 49% owned subsidiary Technest, Inc. (see Note 4).  Technest, Inc. conducts research and development in the field of computer vision technology and the Company has the right of first refusal to commercialize products resulting from this research and development.  The Company’s Chief Executive Officer beneficially owns 23% of Technest, Inc. and a former employee of the Company and current employee of Technest, Inc. owns an additional 23%.  The remaining 5% interest is held by an unrelated third party.  Technest, Inc. is considered a variable interest entity (VIE) for which the Company is the primary beneficiary.  As Technest, Inc.’s formation coincided with its consolidation with the Company, Technest, Inc. did not have any material assets, liabilities or non-controlling interests upon initial measurement.  The Company initially measured any assets transferred by the Company to Technest, Inc. at the same amounts at which the assets and liabilities would have been measured if they had not been transferred.  No gain or loss was recognized as a result of such transfers.





Effective July 1, 2009, the Company adopted newly effective accounting guidance related to the accounting and reporting for a non-controlling interest in a subsidiary. The guidance clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements.  Prior to implementation of this standard, the Company included the equity of the non-controlling interest separately on the liability side of the consolidated balance sheet, between liabilities and stockholders' equity.  Any non-controlling interest in prior periods presented has been reclassified to a separate component of equity. This non-controlling interest is adjusted for the non-controlling shareholders' proportionate share of Technest, Inc.’s net income and losses.  In accordance with the newly effective accounting guidance, losses attributable to the parent and the non-controlling interest in a subsidiary may exceed their interests in the subsidiary’s equity.  The excess, and any further losses attributable to the parent and the non-controlling interest, should be attributed to those interests.  That is, the non-controlling interest should continue to be attributed its share of losses even if that attribution results in a deficit non-controlling interest balance.  Implementation guidance provides for the recognition of the losses of Technest, Inc. on a prospective basis beginning in interim and annual periods subsequent to July 1, 2009.


11





All significant inter-company balances and transactions have been eliminated in consolidation.





On December 31, 2007, the Company divested the operations of its subsidiary, EOIR Technologies, Inc. (see Note 3). The assets, liabilities and results of operations (including costs related to the collection of the contingent consideration) of this subsidiary have been classified as a discontinued operation for all periods presented in the accompanying consolidated financial statements.





The accompanying unaudited condensed consolidated financial statements of Technest have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, without being audited, pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the financial statements not misleading have been included. Operating results for the three and nine months ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year ending June 30, 2010. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company's annual report on Form 10-K for the year ended June 30, 2009 filed with the Securities and Exchange Commission.





Recent Accounting Pronouncements





In June 2009, the FASB issued two related accounting pronouncements changing the accounting principles and disclosure requirements related to securitizations and special-purpose entities.  Specifically, these pronouncements eliminate the concept of a “qualifying special-purpose entity”, change the requirements for derecognizing financial assets and change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. These pronouncements also expand existing disclosure requirements to include more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets.  These pronouncements will be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter.  Earlier application is prohibited.  The recognition and measurement provisions regarding transfers of financial assets shall be applied to transfers that occur on or after the effective date.  The Company will adopt these new pronouncements on July 1, 2010, as required.  Management does not expect the adoption to have an impact on its financial position or results of operations.





In October 2009, the FASB issued two related accounting pronouncements, ASU 2009-13 and ASU 2009-14, relating to revenue recognition. One pronouncement provides guidance on allocating the consideration in a multiple-deliverable revenue arrangement and requires additional disclosure, while the other pronouncement provides guidance specific to revenue arrangements that include software elements.  For multiple-deliverable arrangements, the pronouncement eliminates the requirement that there be objective and reliable evidence of fair value of the undelivered item in order for the delivered item to be considered a separate unit of accounting.  Now, the delivered item shall be considered a separate unit of accounting if the delivered item has value to the customer on a standalone basis and, if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item or items is considered probable and substantially in the control of the vendor.  Arrangement consideration shall be allocated at the inception of the arrangement to all deliverables on the basis of their relative selling price.  When applying the relative selling price method, the selling price of each deliverable shall be determined using vendor-specific objective evidence, if it exists; third party evidence of selling price; or if neither of those exists, the vendor shall use its best estimate of the selling price for that deliverable.





The pronouncement specific to certain revenue arrangements that include software elements amends the scope of arrangements that are accounted for under software revenue recognition rules and provides guidance for allocating the arrangement consideration. The pronouncement clarifies that the following arrangements are outside the scope of accounting under software revenue recognition rules and must follow the general revenue recognition rules for multiple- deliverable arrangements: 1) non-software components of tangible products, 2) software components of tangible products that are sold, licensed or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality, and 3) undelivered elements that relate to software that is essential to the tangible product’s functionality in 2 above.  If an arrangement contains software and non-software deliverables, consideration must be allocated to the non-software deliverables individually and to the software deliverables as a group based on the relative selling price method.





Both of these pronouncements are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and both must be adopted together.  Early adoption is permitted.  If a vendor elects early adoption and the period of adoption is not the beginning of the vendor’s fiscal year, the vendor is required to apply the guidance in these pronouncements retrospectively from the beginning of the vendor’s fiscal year.  A vendor may also elect to adopt the guidance in these pronouncements retrospectively to prior periods.  The Company will adopt these new pronouncements on July 1, 2010, as required.  Management does not expect the adoption to have an impact on its financial position or results of operations.


12





In February 2010, the FASB issued Accounting Standards Update 2010-09 (ASU 2010-09) which provides that the Company is not required to disclose the date through which subsequent events have been evaluated but is required to evaluate subsequent events through the date that the financial statements are issued. These amendments in this Update were effective upon issuance and did not have a material impact on the Company’s consolidated financial statements.





3.           DISCONTINUED OPERATIONS





In May 2007, the Company’s Board of Directors approved a plan to divest the operations of EOIR Technologies, Inc. (“EOIR”). On September 10, 2007, Technest and its wholly owned subsidiary, EOIR entered into a Stock Purchase Agreement (“SPA”) with EOIR Holdings LLC (“LLC”), a Delaware limited liability company, pursuant to which Technest agreed to sell EOIR to LLC.  LLC is an entity formed on August 9, 2007 by The White Oak Guggenheim Aerospace and Defense Fund, L.P., for the purposes of facilitating this transaction.  The sale of EOIR to LLC was structured as a stock sale in which LLC acquired all of the outstanding stock of EOIR in exchange for approximately $34 million in cash, $11 million of which was paid at closing and $23 million of which was payable upon the successful re-award to EOIR of the contract with the U.S. Army's Night Vision and Electronics Sensors Directorate (“NVESD”). This transaction closed on December 31, 2007. On August 4, 2008, EOIR was one of three companies awarded the U.S. Army's NVESD contract with a funding ceiling of $495 million. The Contingent Purchase Price of $23 million was due as of August 21, 2008 in accordance with the SPA.





The Company recorded the $23 million of contingent consideration in the quarter ended March 31, 2008 as, at that time, the Company determined that the outcome of the contingency was determinable beyond a reasonable doubt based on having received notification of award of the NVESD contract pending review by the Small Business Administration.





On August 26, 2008, LLC notified Technest that, in their opinion, the conditions set forth in the Stock Purchase Agreement triggering payment of the Contingent Purchase Price had not been satisfied.  On August 21, 2009, an American Arbitration Association Panel of three arbitrators awarded Technest $23,778,403 following a seven-day hearing that ended on June 30, 2009.  The $23,778,403 includes $830,070 of interest through the date of the Award and is also subject to additional interest due Technest at 3.25% from the date of the Award through date of payment.  As a result of the Arbitration Agreement, the Company recorded a total of $722,070 of accrued interest income in the year ended June 30, 2009 related to this Arbitration Award.  This amount is included in prepaid expenses and other current assets in the June 30, 2009 Balance Sheet.





On October 26, 2009, Technest entered into a Settlement Agreement with EOIR Holdings, LLC and EOIR Technologies, Inc., settling all claims related to the Stock Purchase Agreement (see Note 1).





On December 24, 2009, LLC paid Technest $18,000,000 and subsequently, the actions pending between the parties were dismissed in accordance with the Settlement Agreement.  The Company paid out of the proceeds received $3,621,687 of previously recorded liabilities related to the sale of EOIR and related litigation and $13,134,741 as a return of capital dividend to our shareholders.





As a result of the Settlement Agreement, Technest adjusted the related assets and liabilities in the nine months ended March 31, 2010 to reflect the terms of the Settlement Agreement including netting the liability of $859,137 due to LLC as a working capital adjustment on the sale of EOIR and the interest receivable of $722,070 recorded previously in accordance with the arbitration ruling. The Company has recorded a $154,000 discount on the $5 million contingent receivable as management originally anticipated collection of this amount by September 2010. The release of the WEBSS contract has fallen slightly behind original expectations and the collection of the related receivable is now anticipated in the first calendar quarter of 2011.  During the three and nine months ended March 31, 2010, the Company accreted into interest income a total of $30,345 and $91,805, respectively, related to this discount.  Technest believes that the collectability of the contingent receivable is determinable beyond a reasonable doubt and as such does not believe any reserves are warranted at March 31, 2010.





The assets and liabilities related to the sale of EOIR and related legal and other costs incurred to collect the contingent consideration are presented as a discontinued operation in the consolidated financial statements.  The accretion of the discount is recorded in income from continuing operations as the interest income represents the consequences of management's subsequent decision to hold the related asset.





The loss on discontinued operations for the three and nine months ended March 31, 2010 was $207 and $521,263, respectively, which is primarily attributable to legal expenses incurred in connection with the arbitration and settlement process. The Company expects to incur only minor additional legal expenses associated with this matter and these expenses will be charged to discontinued operations as they are incurred.





4.
TECHNEST, INC.





On October 1, 2008, the Company formed and acquired a 49% interest in Technest, Inc. (represented by 490 shares of issued common stock) in exchange for the transfer of certain contracts and employees. Technest, Inc. conducts research and development in the field of computer vision technology. The Company has the right of first refusal to commercialize products resulting from this research and development. The Company’s Chief Executive Officer beneficially owns 23% of Technest, Inc. and a former employee of the Company and current employee of Technest, Inc. owns an additional 23%.  The remaining 5% interest is held by an unrelated third party. The Company has certain rights of first refusal and repurchase rights at Fair Market Value, as defined in certain restricted stock agreements, with respect to the shares of Technest, Inc. that it does not own.  The Company allocates certain general and administrative and overhead expenses to Technest, Inc. and in the three and nine months ended March 31, 2010, the Company allocated approximately $170,521 and $523,436, respectively, of such expenses to Technest, Inc.


13


Technest, Inc. is considered a variable interest entity (VIE) for which the Company is the primary beneficiary.   As Technest, Inc.’s formation coincided with its consolidation with the Company, Technest, Inc. did not have any material assets, liabilities or non-controlling interests upon initial measurement.  The Company initially measured any assets transferred by the Company to Technest, Inc. at the same amounts at which the assets and liabilities would have been measured if they had not been transferred.   No gain or loss was recognized as a result of such transfers.





On July 1, 2009, the Company adopted new guidance in accordance with the Accounting Standards Codification section 810-10 related to its non-controlling interest in Technest, Inc.  The non-controlling interest in the net loss for the three and nine months ended March 31, 2010 was $79,130 and $219,151, respectively.  In the three and nine months ended March 31, 2010, had the previous accounting guidance been applied, the Company’s net loss applicable to common stockholders would have been $255,110 (or $0.01 per share) and $1,647,210 (or $0.06 per share), respectively.





5.
DEFINITE-LIVED INTANGIBLE ASSETS





Definite-lived intangible assets consist of the following:





March 2010

Useful life (years)Patents - commercialized technology

$
440,000

5Patents - other


202,868

15Customer relationships and contracts


1,130,000

5Accumulated amortization


(1,625,046
)Net definite-lived intangible asset

$
147,822





Amortization expense was $204,305 and $243,555 for the nine months ended March 31, 2010 and 2009, respectively.





6.
AMERICAN ASSET FINANCING





On November 3, 2009, the Company received $150,000 from American Asset Finance LLC (“AAF”) for general working capital purposes. AAF was to be repaid immediately upon receipt of the EOIR settlement funds (see Note 3) in the amount of $180,000 if payment was made on or before February 2, 2010.





On December 24, 2009, the loan was repaid for $180,000.  The Company recorded $30,000 of interest expense related to this loan at the time of repayment.





7.
SERIES D REDEEMABLE, CONVERTIBLE PREFERRED STOCK





On October 1, 2008, the Company’s Board of Directors approved the designation of 3,000 shares of Series D Redeemable, Convertible Preferred Stock (“Series D Preferred”).  The Series D Preferred has a total face value of $3,000,000, a stated value of $1,000 per share and is convertible at any time at $0.20 per share. The Series D Preferred is redeemable upon receipt of the Contingent Purchase Price (see Note 3) at a price equal to the stated value plus dividends.  Due to its convertibility, the Company concluded that the Series D Preferred was not mandatorily redeemable.  However, since the redemption of the Series D Preferred is not solely within the control of the Company, it does not meet the requirements for classification as equity.  As a result, the Series D Preferred is classified in the mezzanine section of the consolidated balance sheet.





Dividends are accrued on the Series D Preferred quarterly at a rate of 5% per year and the Series D Preferred ranks pari passu with the holders of the Series A and Series C Preferred Stock (see Note 8).  Holders of the Series D Preferred have the right to one vote for each share of common stock into which the Series D Preferred could then convert.





On July 17, 2009, the Company sold 300 shares of its Series D Preferred to Southridge Capital Management LLC for a purchase price of $150,000 ($500 per share).





The Company has determined that as of the date of issuance there was a beneficial conversion feature of $105,000 for the fiscal 2010 issuance. Since the Series D Preferred is redeemable upon collection of the Contingent Purchase Price, the Company accreted the Series D Preferred to its redemption value immediately upon issuance. This resulted in a deemed dividend in the amount of $255,000 in fiscal 2010 prior to conversion.  The carrying value was further adjusted by additional dividends earned prior to conversion.  Total dividends accrued in 2010 on all outstanding Series D Preferred amounted to $36,305.  Cumulative accrued dividends on all outstanding Series D Preferred immediately prior to conversion amounted to $86,789.





On December 8, 2009, in accordance with the Series D 5% Convertible Preferred Stock Certificate of Designation, Southridge Partners LP and Southridge Capital Management LLC, the only holders of Series D Preferred, converted all of their shares of Series D Preferred into Technest Common Stock.  Upon conversion of the Series D Preferred, Southridge Partners LP acquired 6,859,306 shares of Technest Common Stock, which included 359,306 shares of Common Stock in payment of the accrued cumulative dividend of 5% per annum. Upon conversion of the Series D Preferred, Southridge Capital Management LLC acquired 3,274,639 shares of Technest Common Stock, which included 74,639 shares in payment of the accrued cumulative dividend of 5% per annum. After these conversions, there are no longer any shares of Technest Series D Preferred outstanding.


14





8.
STOCKHOLDERS' EQUITY





Series A Convertible Preferred Stock





On February 8, 2005, the Company's Board of Directors designated 150 shares of preferred stock as Series A Convertible Preferred Stock (“Series A Preferred Stock”). The Series A Preferred Stock is non-interest bearing, is not entitled to receive dividends and is not redeemable. The Series A Preferred Stock has a liquidation preference of $1,000 per share. The holders of Series A Preferred Stock have no voting rights except that they will be entitled to vote as a separate class on any amendment to the terms or authorized number of shares of Series A Preferred Stock, the issuance of any equity security ranking senior to the Series A Preferred Stock and the redemption of or the payment of a dividend in respect of any junior security. At any time, holders of Series A Preferred Stock may elect to convert their Series A Preferred Stock into common stock. Each share of Series A Preferred Stock is currently convertible into 4,735.3 shares of common stock provided that, following such conversion, the total number of shares of common stock then beneficially owned by such holder and its affiliates and any other persons whose beneficial ownership of Common Stock would be aggregated with the holder's for purposes of Section 13(d) of the Exchange Act, does not exceed 4.99% of the total number of issued and outstanding shares of common stock. The Series A Preferred Stock ranks pari passu with the Company's Series C and D Preferred Stock.





On December 10, 2009, all of the Board of Directors of Technest and all of the holders of the outstanding Series A Preferred Stock approved an amendment to the Series A Certificate of Designation to remove the 4.99% beneficial ownership restriction.





On December 14, 2009, in accordance with the Series A Certificate of Designation, as amended, Garth LLC, the only holder of the Series A Preferred Stock, converted all of its shares of Series A Preferred Stock into 304,578 shares of Technest Common Stock.  After this conversion, there are no longer any shares of Series A Preferred Stock outstanding.





Series C Convertible Preferred Stock





The Series C Convertible Preferred Stock (“Series C Preferred Stock”) is convertible into Technest common stock at any time at the option of the stockholder. The number of shares of Technest common stock into which each share of Series C Preferred Stock is convertible is determined by dividing $2.175 by the Series C Conversion Price of $2.175. Shares of the Series C Preferred Stock have a liquidation preference of approximately $2.175 per share, may only vote on changes to the rights, privileges and priority of the Series C Preferred Stock, receive dividends on an as converted basis whenever dividends are made to the Technest common stock holders, and are not redeemable. The Series C Preferred Stock ranks pari passu with the Company's Series A and Series D Preferred Stock.





On December 10, 2009, all of the Board of Directors of Technest and all of the holders of the outstanding Series C Preferred Stock approved an amendment to the Series C Certificate of Designation to remove the 9.99% beneficial ownership restriction.





On December 14, 2009, in accordance with the Series C Certificate of Designation, as amended, Southridge Partners LP and Southshore Capital Fund Ltd., the only holders of Series C Preferred Stock, converted all of their shares of Series C Preferred Stock into 344,827 shares of Technest Common Stock and 57,467 shares of Technest Common Stock, respectively. After these conversions, there are no longer any shares of Series C Preferred Stock outstanding.





Other Common Stock Issuances





During the nine months ended March 31, 2010, the Company issued the following amounts of common stock:





●
754,535 shares of its Common Stock with a fair value of $125,000 to five non-employee directors of the Company as compensation for service on the Company’s Board of Directors for the period July 1, 2008 to September 30, 2009.





The Company has established a reserve for the exercise of warrants of 275,000 shares for the future issuance of common stock.





9.
CAPITAL DISTRIBUTION





On December 23, 2009 the Board of Directors declared a special “return of capital” cash dividend of $0.407 per share of Common Stock amounting to $13,134,741. This distribution was in conjunction with the sale of EOIR Technologies, Inc. as previously announced. The cash dividend was paid on January 15, 2010 to shareholders of record as of January 4, 2010.





15





10.
OPTIONS, WARRANTS AND STOCK-BASED COMPENSATION





Options





No options were granted pursuant to the Plan during the periods ended March 31, 2010 and 2009 and there are currently no options outstanding under the Plan.





Warrants





No warrants were issued in the period ended March 31, 2010.  On February 14, 2010, 374,286 warrants expired without being exercised.  No warrants were issued, exercised or expired in the period ended March 31, 2009.





The following table summarizes the Company's warrants outstanding at March 31, 2010:





Exercise price


Number

Expiration Date$
5.85



75,000

08/03/2013$
1.89



200,000

07/17/2011275,000Weighted average remaining life

1.9 years





As of March 31, 2010 all warrants are exercisable.  There is no aggregate intrinsic value for warrants outstanding as of March 31, 2010.





Stock Award Plan





On March 13, 2006, Technest adopted the Technest Holdings, Inc. 2006 Stock Award Plan, pursuant to which Technest may award up to 1,000,000 shares of its common stock to employees, officers, directors, consultants and advisors to Technest and its subsidiaries. The purpose of this plan is to secure for Technest and its shareholders the benefits arising from capital stock ownership by employees, officers and directors of, and consultants or advisors to, Technest and its subsidiaries who are expected to contribute to the Company’s future growth and success.





Technest has broad discretion in making grants under the Plan and may make grants subject to such terms and conditions as determined by the board of directors or the committee appointed by the board of directors to administer the Plan. Stock awards under the Plan will be subject to the terms and conditions, including any applicable purchase price and any provisions pursuant to which the stock may be forfeited, set forth in the document making the award.





Total stock-based compensation related to shares that vested in the nine months ended March 31, 2010 and 2009 was $0 and $110,854, respectively.





On September 21, 2009, the Board of Directors of Technest increased the number of shares issuable under the 2006 Stock Award Plan to 2,000,000 shares from 1,000,000 shares





As of March 31, 2010, the Company had 621,115 shares available for future grant under the Plan.





11.
NET LOSS PER SHARE





Securities that could potentially dilute basic earnings per share ("EPS") and that were not included in the computation of diluted EPS because to do so would have been anti-dilutive for the three and nine months ended March 31, 2010 and 2009, consist of the following:





Shares Potentially Issuable2010


2009Series A Convertible Preferred Stock


-



306,047Series C Convertible Preferred Stock


-



402,301Series D Redeemable, Convertible, Preferred Stock


-



6,663,405Warrants


275,000



649,286Total


275,000



8,021,039





16





12.
COMMITMENTS AND CONTINGENCIES





Facility Rental





Technest currently leases offices with approximately 6,848 square feet in Bethesda, Maryland, pursuant to a five-year lease which expires March 31, 2011. Monthly lease amounts for this facility total approximately $16,053, increasing annually by 3%.





Rent expense for continuing operations in the three and nine months ended March 31, 2010 was $46,755 and $140,265, respectively. Rent expense for continuing operations in the three and nine months ended March 31, 2009 was $37,010 and $141,072, respectively.





Employment Agreements with Gino M. Pereira and  Nitin V. Kotak





The Company is obligated under employment agreements with certain members of senior management.





13.
INCOME TAXES





There was no provision for federal or state income taxes for the three and nine months ended March 31, 2010 due to the Company's operating losses and a full valuation reserve on deferred tax assets.





The Company's deferred tax assets consist primarily of the tax effects of its net operating loss carry forwards.  As of March 31, 2010, the Company had a valuation allowance of $3,045,000.  The Company has recorded a valuation allowance against deferred tax assets as management has determined certain net operating loss carryforwards will not be available due to Internal Revenue Code Section 382 ownership changes and the utilization of other net operating loss carryforwards is uncertain. In the nine months ended March 31, 2010, there was no change in the valuation allowance.   As of March 31, 2010, the Company has net operating loss carryforwards not subject to IRC Section 382 limitations of  $4,273,000 which begin to expire in 2024.





The benefit from federal and state income taxes related to continuing operations for the nine months ended March 31, 2009 was $334,212.





14.
EMPLOYEE BENEFIT PLANS





Technest has adopted a 401(k) plan for the benefit of employees. Essentially all Technest employees are eligible to participate. The Company also contributes to the plan under a safe harbor plan requiring a 3% contribution for all eligible participants. In addition, the Company may contribute a 3% elective match. The Company contributes 6%, excluding bonuses on an annual basis, to those who have been employed by Technest for more than one year and remain employed on the last day of the fiscal year.





Contributions and other costs of this plan in the three and nine months ended March 31, 2010 were $27,345 and $81,690, respectively. Contributions and other costs of this plan in the three and nine months ended March 31, 2009 were $25,620 and $75,043, respectively.





15.
LITIGATION





As discussed in Notes 1 and 3, litigation related to the sale of EOIR Technologies, Inc. was settled on October 26, 2009.





16.
SUBSEQUENT EVENTS





On May 10, 2010 the Company issued 405,965 shares of its Common Stock with an aggregate value of $50,000 to five non-employee directors of the company as compensation for service on the Company’s board of directors for the period October 1, 2009 to March 31, 2010.











17





Item 2.  Management’s Discussion and Analysis or Plan of Operation





The following discussion and analysis of our financial condition and results of operations for our financial nine months ending March  31, 2010 should be read together with our financial statements and related notes included elsewhere in this report.





FORWARD LOOKING STATEMENTS





The information in this discussion contains forward-looking statements. These forward-looking statements involve risks and uncertainties, including but not limited, to statements regarding Technest Holdings, Inc.’s capital needs, business strategy and expectations. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may”, “should”, “expect”, “plan”, “intend”, “anticipate”, “believe”, “estimate”, “predict”, “potential” or “continue”, the negative of such terms or other comparable terminology. Actual events or results may differ materially. In evaluating these statements, you should consider various factors, including the risks outlined in the Risk Factors section below, and, from time to time, in other reports we file with the Securities and Exchange Commission (the “SEC”). These factors may cause our actual results to differ materially from any forward-looking statement. Readers are cautioned not to place undue reliance on any forward looking statements contained in this report. We will not update these forward looking statements unless the securities laws and regulations require us to do so.





OVERVIEW





General





As a result of the sale of EOIR, the remaining business of Technest is the design, research and development, integration, sales and support of three-dimensional imaging devices and systems primarily in the healthcare industries and intelligent surveillance devices and systems, and three-dimensional facial recognition in the security industries. Historically, the Company’s largest customers have been the National Institutes of Health and the Department of Defense.





Our products leverage several core technology platforms, including:





●
3D Imaging Technology Platforms:-3D capture using patented Rainbow 3D technology-3D processing, data manipulation, and advanced modeling-3D display in volumetric space





●
Intelligent Surveillance Technology Platforms:-360 degree video acquisition using mirror, lens, and array configurations-2D video detection, tracking, recognition and enhancement software





●
3D Facial Recognition Technology Platforms:-3D facial image acquisition and recognition algorithms and software





●
General Technology Platforms:-High-speed imaging processing hardware and embedded algorithms





Defense and Security - 3D-ID





Our major products consist of our 3D SketchArtist, and 3D FaceCam, Portable MVR, OmniEyeTM Wellcam, OmniEyeTM Cerberus, Smart Optical Sensor (SOS), Smart SuiteTM, OmniEye Viewer, and Small Tactical Ubiquitous Detection System (STUDS).





3D SketchArtist is a three-dimensional composite sketch tool that uses our patented three-dimensional morphing technology. The tool allows you to transform ordinary two-dimensional sketches into rapidly evolving mock-ups that can be modified via facial features, poses, expressions, and lighting in seconds. In August 2008, the 3D SketchArtist was successfully introduced at the annual International Association of Identification (IAI) show. In fiscal 2009, the Company, through a distributor, sold 25 copies to the Los Angeles Police Department and several other copies to other law enforcement agencies. The Company is currently having this product evaluated for use by security forces overseas.





3D FaceCam changes the way we capture photographs. The 3D FaceCam uses three sensors to create precise, complete 3D face images at light speed. By capturing the very highly detailed geometric and texture information on a face, the 3D FaceCam overcomes a photo’s traditional limitations of pose, lighting, and expression. Capture speed is less than half a second, enabling rapid processing of large numbers of people. 3D FaceCam is also highly accurate, making 3D FaceCam ideal for facial recognition. 3D FaceCam is currently being evaluated by certain correctional facilities for use with inmates and visitors.





18





The Company has developed a new pocket size, highly portable multi-sensor video recording device designed to be used in outdoor environments-The Portable MVR. It features A/V recording with advanced MPEG4 compression, photo snapshot with JPEG format and motion detection.  A 2.5 inch LCD makes recording and playback simple using on-screen intuitive menus and embedded software.  The MVR also features power saving, pre and post triggers, and an external video output connector so that the MVR can be placed “in-line” with an external monitor. Recordings can also be played back on a separate computer. This product is being purchased by the US Army as an initial pilot program for use on unmanned robotic platforms.





OmniEyeTM Wellcam is an ultra light, portable 360 degree field of view camera which can be used in field applications, such as detection of underground weapon caches and search and rescue beneath building rubble, due to its durability.





OmniEyeTM Cerberus is a re-configurable multi-sensor system that is designed for long distance infrared and visible light detection. OmniEyeTM Cerberus delivers this flexibility while still maintaining seamless panoramic coverage up to 360 degrees.





SOS high speed image processing platform powers our Smart SuiteTM algorithms, enhancing both new and existing sensor systems with capabilities including: reliable target detection, motion tracking, and object classification and recognition. Smart SuiteTM algorithms are a portfolio of advanced video analysis and augmentation modules. The SOS is a powerful system that allows multiple cameras to be deployed easily in a distributed, scaleable network that provides autonomous surveillance.





OmniEye Viewer is a software platform for a wide range of security and surveillance camera products. A flexible user interface allows the user to remotely control OmniEye remote sensors and choose the best view desired for their specific application.  User's can choose from 360-degree "fish-eye" and/or panoramic views, multi-sensor stitched views, or perspective Pan-Tilt-Zoom views to move left-right, up-down to "see as a person would see".  Trip wires and regions of interest can also be set to customize alarm scenarios to the application.





STUDS are state-of-the-art, miniature, disposable, low-cost motion-tracking, positioning and imaging unattended ground sensors that permit long-range surveillance at high resolution. The system also includes rapidly deployable wireless networking and GPS mapping for integration with legacy sensors, among other advantages.





Medical Devices





3D Digitizer Systems provide turnkey three-dimensional (3D) imaging solutions. The Company continues to develop applications for custom fit ear pieces for MP3 players, iPods and cell phones as well as Ankle-Foot Orthoses (AFOs) in collaboration with Northeastern University and Spaulding Rehabilitation hospital in Boston, Massachusetts. Currently marketing and development efforts on these products have slowed as the Company is concentrating its limited resources on its defense and security products.





Technest Business Strategy





Our goal is to establish the Company as a leading innovator in the 3-D imaging products and solutions arena. The broad strategies that we have in place to achieve this goal are outlined below:





●
Focus on commercialization of pipeline products;





●
Utilize relationships with current and new industry partners to bring technology to market;





●
Develop recurring revenue models where possible;





●
Continue to explore the cutting edge of 3-D and 360° imaging through continued research and development;





●
Seek strategic acquisitions.








19





RESULTS OF OPERATIONS





Recent Developments





Litigation Related to the Sale of EOIR Technologies, Inc.





On October 26, 2009, Technest Holdings, Inc. (“Technest”) entered into a Settlement Agreement with EOIR Holdings, LLC (“LLC”) and EOIR Technologies, Inc. (“EOIR”), settling all claims related to the Stock Purchase Agreement, which the parties entered into in 2007 to effectuate the sale of EOIR, a subsidiary of Technest at the time (see Note 1 and Note 3 to the financial statements for additional information).





Under the terms of the Settlement Agreement, LLC agreed to pay Technest $18,000,000 no later than December 25, 2009 and an additional $5,000,000 within sixty days of EOIR being awarded a contract under the Warrior Enabling Broad Sensor Services Indefinite Delivery Indefinite Quantity (ID/IQ) contract or any contract generally recognized to be a successor contract to its current STES contract. The additional $5,000,000 is also payable to Technest in the event that EOIR is awarded task orders under its current STES contract totaling $495,000,000.  EOIR has guaranteed the performance of the obligations of LLC under the settlement agreement. The settlement agreement was entered into in the wake of a previously reported binding arbitration decision awarding Technest $23 million for breach of the Stock Purchase Agreement between the parties.  The details of the settlement agreement were filed as Exhibit 10.1 to a Current Report on Form 8-K on October 29, 2009.  Refer to Note 1 and Note 3 for additional information.





On December 24, 2009, Technest received $18,000,000 pursuant to the Settlement Agreement and subsequently, the actions pending between the parties were dismissed in accordance with the Settlement Agreement.





On December 23, 2009 the board of directors declared a special “return of capital” cash distribution of $0.407 per share of Common Stock amounting to $13,134,741. This distribution was in relation to the sale of EOIR Technologies, Inc. as previously announced. The cash dividend was paid on January 15, 2010 to shareholders of record as of January 4, 2010.





Three and nine months ended March 31, 2010 compared with the three and nine months ended March 31, 2009





Revenues





Technest had $575,832 in revenues during the three months ended March 31, 2010 compared with $639,100 during the three months ended March 31, 2009. These revenues were largely generated by Small Business Innovative Research grants (SBIR’s) in the field of 3-dimensional imaging and intelligent surveillance. We use the revenue from these grants to develop future potential products for our business. By their nature these revenues do not consistently accrue from quarter to quarter. At March 31, 2010, the Company’s backlog of funded contracts was approximately $1.9 million. The revenue for the three months ended March 31, 2009 included the sale of 21 WellCam units. There were no sales of these units in the three months ended March 31, 2010 which is the main reason for the decrease in revenue for the quarter.





Technest had $1,701,847 in revenues during the nine months ended March 31, 2010 compared with $1,854,263 during the nine months ended March 31, 2009. The primary reason for the reduction in revenues were non-recurring sales of  42 Wellcam units in the nine months ended March 31, 2009.





Gross profit





The gross profit for the three months ended March 31, 2010 was $273,591 or 48% of revenues. The gross profit for the three months ended March 31, 2009 was $275,568 or 43% of revenues.  Technest expects to expand its revenue base to include commercial product revenues and, accordingly, gross profit on future revenues may differ.





The gross profit for the nine months ended March 31, 2010 was $845,122 or 50% of revenues. The gross profit from continuing operations for the nine months ended March 31, 2009 was $814,832 or 44% of revenues. The nine months ended March 31, 2009 included certain firm fixed price contracts that had a lower than average gross profit.





Selling, general and administrative expenses





Selling, general and administrative expenses for the three months and nine months ended March 31, 2010 were $473,758 and $1,453,107, respectively, and consisted primarily of payroll related expenses, professional fees and rent.  Selling, general and administrative expenses for the three months and nine months ended March 31, 2009 were $628,372 and $1,785,439, respectively, and consisted primarily of payroll related expenses and professional fees. The Company continues to reduce operating costs where appropriate.





20





Research and Development





In the three months and nine months ended March 31, 2010 the Company incurred $43,190 and $114,034, respectively, in development expenses associated with its three dimensional camera products.





In the three months and nine months ended March 31, 2009 the Company incurred $36,305 and $148,241, respectively, in development expenses associated with its EARCAD, 3D scanner and SketchArtist products.





Amortization of intangible assets





Amortization of intangible assets for the three months and nine months ended March 31, 2010 was $41,935 and $204,305, respectively.  Amortization of intangible assets for the three months and nine months ended March 31, 2009 was $81,185 and $243,555 respectively.  The amortization for the three and nine months ended March 31, 2010 is lower because some of the intangible assets have become fully amortized in February, 2010.  The majority of amortization expense relates to the definite-lived intangible assets acquired in conjunction with Genex Technologies.





Operating loss





The operating loss before taxes from continuing operations for the three months ended March 31, 2010 was $285,292 compared with $470,294 for the three months ended March 31, 2009.





The operating loss before taxes from continuing operations for the nine months ended March 31, 2010 was $926,324 compared with $1,362,403 for the nine months ended March 31, 2009.





Discontinued Operations





The net loss from discontinued operations for the three months and nine months ended March 31, 2010 was $207 and $521,263. This was entirely attributable to costs incurred with the arbitration against, and the subsequent settlement with, EOIR Holdings LLC.





Net Loss applicable to common shareholders





The net loss applicable to common stockholders for the three months and nine months ended March 31, 2010 was $175,980 and $1,428,059, respectively.  Included in the net loss for three months and nine months ended March 31, 2010 are non-cash deemed dividends of $-0- and $291,306, respectively, related to Series D Redeemable, Convertible Preferred Stock.





The net loss attributable to common shareholders for the three months and nine months ended March 31, 2009 was $389,851 and $2,169,058, respectively. Included in the net loss for three months and nine months ended March 31, 2009 are non-cash deemed dividends of $16,250 and $1,137,681, respectively, related to Series D Redeemable, Convertible Preferred Stock.





Liquidity and Capital Resources





Cash and Working Capital





On March 31, 2010, Technest had a positive working capital balance of $3,269,335 due primarily to the remaining amount due under the Settlement Agreement related to the sale of EOIR. Our primary source of operating cash flows was payments from our customers. Payments from customers are based on the amount and timing of work performed by us or the number of units delivered.  Our primary ongoing uses of operating cash relate to payments to subcontractors and vendors, salaries and related expenses and professional fees. The timing of such payments is generally even throughout the year.  Our vendors and subcontractors generally provide us with normal trade payment terms.  Net cash used in operating activities for the nine months ended March 31, 2010 was $1,188,656 compared with net cash used in operating activities of $595,490 for the nine months ended March 31, 2009 as the Company incurred $521,263 of non recurring litigation related expenditures against EOIR Holdings and also reduced its accounts payable and accruals relating to operating activities by $215,292. This was partially off set by the release of restricted cash of $201,697 and a reduction in accounts receivable of $89,863.





Cash Used in Investing Activities





In the nine months ended March 31, 2010, Technest used cash of $29,954 for the acquisition of new definite lived intangible assets representing costs associated with filing for new patents.  Technest also used $3,109 for purchase of new equipment.





Cash Provided by Financing Activities





In the nine months ended March 31, 2010, the Company received $150,000 related to the issuance of its Series D Preferred Stock. These proceeds were used primarily for legal expenses as well as for working capital purposes. The Company also received and repaid a short term loan of $150,000 which was used for the payment of past due professional fees.





21





Cash Provided from Discontinued Operations





On December 24, 2009, the Company received $18,000,000 from the sale of EOIR and related settlement agreement. From that amount, the Company paid $3,621,687 directly relating to contractual obligations from the sale of EOIR and costs associated with the subsequent arbitration and settlement agreement.  On January 15, 2010, the Company paid $13,134,741 towards a return of capital dividend.





Sources of Liquidity





During the nine months ended March 31, 2010, we satisfied our operating and investing cash requirements from cash reserves and from the sale of Series D Redeemable Convertible Preferred Stock, a short term loan and the receipt of $18,000,000 from the settlement agreement with EOIR Holdings, Inc.





Subsequent to the capital distribution, on January 15, 2010, which accounted for the majority of the proceeds received from the settlement agreement, the Company continues to expand its efforts in commercial sales and believes that these activities will contribute positively in fiscal 2010. In addition, the Company is aggressively cutting costs and the Company’s Chief Executive Officer has voluntarily reduced his compensation by approximately 27%. As a result of the forgoing, management believes that Technest has sufficient sources of liquidity to satisfy its obligations for at least the next 12 months.





Off Balance Sheet Arrangements





We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders. As of March 31, 2010, Technest had warrants outstanding for the purchase of 275,000 shares of common stock. However, due to the net share settlement provisions of these warrants, Technest does not expect any material cash proceeds upon exercise.





Effect of inflation and changes in prices





Management does not believe that inflation and changes in price will have a material effect on operations.





Critical Accounting Policies and Estimates





The preparation of Technest's financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities as of the date of the financial statements and the amounts of revenues and expenses recorded during the reporting periods. We base our estimates on historical experience, where applicable, and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions.





Our critical accounting policies and use of estimates are discussed in and should be read in conjunction with the annual consolidated financial statements and notes included in the latest Form 10-K, as filed with the SEC, which includes audited consolidated financial statements for our fiscal years ended June 30, 2009 and 2008.





Item 4T. Controls and Procedures





Evaluation of Disclosure Controls and Procedures.





Based on our management's evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the "Exchange Act")) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.





Changes in Internal Control Over Financial Reporting.





There was no change in our internal control over financial reporting during the quarter ended March 31, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.





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PART II. OTHER INFORMATION








ITEM 1. Legal Proceedings.





Litigation Related to the Sale of EOIR Technologies, Inc.





On October 26, 2009, Technest Holdings, Inc.(“Technest”)entered into a Settlement Agreement with EOIR Holdings, LLC (“LLC”) and EOIR Technologies, Inc. (“EOIR”), settling all claims related to the Stock Purchase Agreement, which the parties entered into in 2007 to effectuate the sale of EOIR, a subsidiary of Technest at the time.





Under the Agreement, LLC agreed to pay Technest $18,000,000 no later than December 25, 2009 and an additional $5,000,000 within sixty days of EOIR being awarded a contract under the Warrior Enabling Broad Sensor Services Indefinite Delivery Indefinite Quantity (ID/IQ) contract or any contract generally recognized to be a successor contract to its current STES contract. The additional $5,000,000 is also payable to Technest in the event that EOIR is awarded task orders under its current STES contract totaling $495,000,000.  EOIR has guaranteed the performance of the obligations of LLC under the Settlement Agreement. The Settlement Agreement was entered into in the wake of a previously reported binding arbitration decision awarding Technest $23 million for breach of the Stock Purchase Agreement between the parties.  The details of the Settlement Agreement were filed as Exhibit 10.1 to a Current Report on Form 8-K on October 29, 2009. On December 24, 2009, LLC paid Technest $18,000,000 and subsequently, the actions pending between the parties were dismissed in accordance with the Settlement Agreement.





ITEM 1A. Risk Factors.





Any investment in our common stock involves a high degree of risk. You should consider carefully the risks described below and elsewhere in this report and the information under “Note Regarding Forward-Looking Statements,” before you decide to buy our common stock. If any of the following risks, or other risks not presently known to us or that we currently believe are not material, develop into an actual event, then our business, financial condition and results of operations could be adversely affected. In that case, the trading price of our common stock could decline due to any of these risks and uncertainties, and you may lose part or all of your investment.





Risks Related To Our Business, Results of Operations and Financial Condition





We have a history of operating losses and cannot give assurance of future revenues or operating profits; investors may lose their entire investment.





Technest has had net operating losses each year since its inception. As of March 31, 2010, our accumulated deficit was approximately $17.3 million. If Technest continues to suffer losses as it has in the past, investors may not receive any return on their investment and may lose their entire investment.





If we cannot obtain additional capital required to fund our operations and finance the growth our business, operating results and financial condition may suffer and the price of our stock may decline.





The development of our technologies will require additional capital, and our business plan is to acquire additional revenue-producing assets. Although we believe that we have sufficient sources of liquidity to satisfy our obligations for at least the next 12 months, we may be unable to obtain additional funds, if needed, in a timely manner or on acceptable terms, which may render us unable to fund our operations or expand our business. If we are unable to obtain capital when needed, we may have to restructure our business or delay or abandon our development and expansion plans. If this occurs, the price of our common stock may decline and you may lose part or all of your investment.





We will have ongoing capital needs as we expand our business.  If we raise additional funds through the sale of equity or convertible securities, your ownership percentage of our common stock will be reduced. In addition, these transactions may dilute the value of our common stock.  We may have to issue securities that have rights, preferences and privileges senior to our common stock.  The terms of any additional indebtedness may include restrictive financial and operating covenants that would limit our ability to compete and expand. Although we have been successful in the past in obtaining financing for working capital and acquisitions, there can be no assurance that we will be able to obtain the additional financing we may need to fund our business, or that such financing will be available on acceptable terms.





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If Technest is not successful in its businesses after the sale of EOIR, the anticipated benefits of the sale may not be realized.





Historically, EOIR had been the majority of Technest’s business operations.  After the sale of EOIR, Technest operates independent of EOIR and EOIR’s resources.  Achieving the anticipated benefits of the sale will depend, in part, on the Company’s success in leveraging opportunities and success in applying the proceeds of the sale. The challenges involved include the following:




·
shifting management’s primary focus to technologies in the fields of intelligent surveillance, three-dimensional facial recognition and three-dimensional imaging;





·
establishing new sales and vendor partner relationships in these fields;





·
demonstrating to customers that the sale will not result in adverse changes to the ability of the Company to address the needs of customers; and





·
retaining key employees.








It is not certain that Technest can be successful in a timely manner or at all or that any of the anticipated benefits of the sale will be realized. If the benefits of the sale do not meet the market expectations, the market price of Technest common stock may decline.





Our business may suffer if we cannot protect our proprietary technology.





Our ability to compete depends significantly upon our patents, our trade secrets, our source code and our other proprietary technology. Any misappropriation of our technology or the development of competing technology could seriously harm our competitive position, which could lead to a substantial reduction in revenue.





The steps we have taken to protect our technology may be inadequate to prevent others from using what we regard as our technology to compete with us. Our patents could be challenged, invalidated or circumvented, in which case the rights we have under our patents could provide no competitive advantages. Existing trade secrets, copyright and trademark laws offer only limited protection. In addition, the laws of some foreign countries do not protect our proprietary technology to the same extent as the laws of the United States, which could increase the likelihood of misappropriation.  Furthermore, other companies could independently develop similar or superior technology without violating our intellectual property rights.





If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome, disruptive and expensive, distract the attention of management, and there can be no assurance that we would prevail.





Claims by others that we infringe their intellectual property rights could increase our expenses and delay the development of our business. As a result, our business and financial condition could be harmed.





Our industries are characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. We cannot be certain that our products do not and will not infringe issued patents, patents that may be issued in the future, or other intellectual property rights of others.





We do not conduct exhaustive patent searches to determine whether the technology used in our products infringes patents held by third parties. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies.





We may face claims by third parties that our products or technology infringe their patents or other intellectual property rights. Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract the attention of our management. If any of our products are found to violate third-party proprietary rights, we may be required to pay substantial damages. In addition, we may be required to re-engineer our products or obtain licenses from third parties to continue to offer our products. Any efforts to re-engineer our products or obtain licenses on commercially reasonable terms may not be successful, which would prevent us from selling our products, and, in any case, could substantially increase our costs and have a material adverse effect on our business, financial condition and results of operations.





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Fluctuations in our quarterly revenue and results of operations could depress the market price of our common stock.





Our future net sales and results of operations are likely to vary significantly from quarter to quarter due to a number of factors, many of which are outside our control. Accordingly, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. It is possible that our revenue or results of operations in a quarter will fall below the expectations of securities analysts or investors. If this occurs, the market price of our common stock could fall significantly. Our results of operations in any quarter can fluctuate for many reasons, including:





●
our ability to perform under contracts and manufacture, test and deliver products in a timely and cost-effective manner;





●
our success in winning competitions for orders;





●
the timing of new product introductions by us or our competitors;





●
the mix of products we sell;





●
competitive pricing pressures; and





●
general economic climate.





A large portion of our expenses, including expenses for facilities, equipment, and personnel, are relatively fixed. Accordingly, if our revenues decline or do not grow as much as we anticipate, we might be unable to maintain or improve our operating margins. Any failure to achieve anticipated revenues could therefore significantly harm our operating results for a particular fiscal period.





Risks Related to Contracting with the United States Government





Our current revenues are derived from a small number of contracts within the U.S. government set aside for small businesses.





We currently derive substantially all of our revenue from Small Business Innovation Research contracts with the U.S. Governmentsuch that the loss of any one contract could materially reduce our revenues. As a result, our financial condition and our stock price would be adversely affected.





In order to receive these Small Business Innovation Research contracts, we must satisfy certain eligibility criteria established by the Small Business Administration. If we do not satisfy these criteria, we would not be eligible for these contracts and thus, our primary source of revenue would no longer be available to us.  As a result, our financial condition would be adversely affected.





Our business could be adversely affected by changes in budgetary priorities of the Government.





Because we derive a substantial majority of our revenue from contracts with the Government, we believe that the success and development of our business will continue to depend on our successful participation in Government contract programs. Changes in Government budgetary priorities could directly affect our financial performance. A significant decline in government expenditures, or a shift of expenditures away from programs that we support, or a change in Government contracting policies, could cause Government agencies to reduce their purchases under contracts, to exercise their right to terminate contracts at any time without penalty or not to exercise options to renew contracts. Any such actions could cause our actual results to differ materially from those anticipated. Among the factors that could seriously affect our Government contracting business are:





·
changes in Government programs or requirements;





·
budgetary priorities limiting or delaying Government spending generally, or specific departments or agencies in particular, and changes in fiscal policies or available funding, including potential Governmental shutdowns (as occurred during the Government’s 1996 fiscal year);





·
curtailment of the Government’s use of technology solutions firms.


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Our contracts and administrative processes and systems are subject to audits and cost adjustments by the Government, which could reduce our revenue, disrupt our business or otherwise adversely affect our results of operations.





Government agencies, including the Defense Contract Audit Agency, or DCAA, routinely audit and investigate Government contracts and Government contractors’ administrative processes and systems. These agencies review our performance on contracts, pricing practices, cost structure and compliance with applicable laws, regulations and standards. They also review our compliance with regulations and policies and the adequacy of our internal control systems and policies, including our purchasing, property, estimating, compensation and management information systems. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and any such costs already reimbursed must be refunded. Moreover, if any of the administrative processes and systems is found not to comply with requirements, we may be subjected to increased government oversight and approval that could delay or otherwise adversely affect our ability to compete for or perform contracts. Therefore, an unfavorable outcome to an audit by the DCAA or another agency could cause actual results to differ materially from those anticipated. If an investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeitures of profits, suspension of payments, fines and suspension or debarment from doing business with the Government. In addition, we could suffer serious reputational harm if allegations of impropriety were made against us. Each of these results could cause actual results to differ materially from those anticipated.





Unfavorable government audit results could force us to adjust previously reported operating results and could subject us to a variety of penalties and sanctions.





The federal government audits and reviews our performance on awards, pricing practices, cost structure, and compliance with applicable laws, regulations, and standards. Like most large government vendors, our awards are audited and reviewed on a continual basis by federal agencies, including the Defense Contract Management Agency and the Defense Contract Audit Agency. An audit of our work, including an audit of work performed by companies we have acquired or may acquire or subcontractors we have hired or may hire, could result in a substantial adjustment in our operating results for the applicable period. For example, any costs which were originally reimbursed could subsequently be disallowed. In this case, cash we have already collected may need to be refunded and our operating margins may be reduced. To date, we have not experienced any significant adverse consequences as a result of government audits.





If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or debarment from doing business with U.S. Government agencies.





Risks Related To “Controlled Companies”





Technest’s controlling stockholder has significant influence over the Company.





As of May 14, 2010, Southridge Partners LP owns 41.86% of the shares of Technest Common Stock, with a total of 13,679,166 shares of Technest Common Stock. Aberdeen Avenue LLC beneficially owns 15.57% of the shares of Technest Common Stock, with a total of 5,089,421 shares of Technest Common Stock. Southshore Capital Fund Ltd. beneficially owns 3.28% of the shares of Technest Common Stock, with a total of 1,072,257 shares of Technest Common Stock. Stephen Hicks, one of our directors, is deemed to beneficially own the shares of Technest Common Stock beneficially owned by Southridge Partners LP, Aberdeen Avenue LLC, Southshore Capital Fund Ltd. and Garth LLC. Including the shares of Technest Common Stock beneficially owned by these entities, along with those shares directly owned by Mr. Hicks and the shares owned by Trillium Partners, LP, Mr. Hicks is deemed to beneficially own 63.82% of the shares of Technest Common Stock, with a total of 20,854,658 shares of Technest Common Stock. Mr. Hicks disclaims beneficial ownership of such shares other than those issued to Mr. Hicks as a director of Technest.





In 2008, Southridge appointed three members to Technest’s board of directors (currently, there are a total of six directors on Technest’s board of directors).  As a result, Southridge possesses significant influence over our affairs.  Southridge’s stock ownership and relationships with members of Technest’s board of directors may have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of Technest, which in turn could materially and adversely affect the market price of Technest’s common stock.





A very small number of investors hold a controlling interest in our stock. As a result, the ability of minority shareholders to influence our affairs is extremely limited.





A very small number of investors collectively owned approximately 63.82% of Technest’s outstanding common stock on a primary basis.  As a result, those investors have the ability to control all matters submitted to the stockholders of Technest for approval (including the election and removal of directors).  A significant change to the composition of our board could lead to a change in management and our business plan. Any such transition could lead to, among other things, a decline in service levels, disruption in our operations and departures of key personnel, which could in turn harm our business.





Moreover, this concentration of ownership may have the effect of delaying, deferring or preventing a change in control, impeding a merger, consolidation, takeover or other business combination involving us, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control, which in turn could materially and adversely affect the market price of the common stock.


26





Minority shareholders of Technest will be unable to affect the outcome of stockholder voting as these investors or any other party retains a controlling interest.





Risks Related To Capital Structure





Shares eligible for future sale, if sold into the public market, may adversely affect the market price of our common stock.





Currently, we have a significant number of shares that are eligible for public resale. Our common stock is thinly traded. The public resale of these shares may result in a greater number of shares being available for trading than the market can absorb. This may cause the market price of our common stock to decrease.





The sale of material amounts of common stock could encourage short sales by third parties and further depress the price of our common stock.  As a result, you may lose all or part of your investment.





The significant downward pressure on our stock price caused by the sale of a significant number of shares could cause our stock price to decline, thus allowing short sellers of our stock an opportunity to take advantage of any decrease in the value of our stock. The presence of short sellers in our common stock may further depress the price of our common stock.





Risks Related To Investing In Low- Priced Stock





It may be difficult for you to resell shares of our common stock if an active market for our common stock does not develop.





Our common stock is not actively traded on a securities exchange and we do not meet the initial listing criteria for any registered securities exchange or the Nasdaq National Market System. It is quoted on the less recognized OTC Bulletin Board. This factor may further impair your ability to sell your shares when you want and/or could depress our stock price. As a result, you may find it difficult to dispose of, or to obtain accurate quotations of the price of, our securities because smaller quantities of shares could be bought and sold, transactions could be delayed and security analyst and news coverage of our company may be limited. These factors could result in lower prices and larger spreads in the bid and ask prices for our shares.





Technest’s common stock is “penny stock,” with the result that trading of our common stock in any secondary market may be impeded.





Due to the current price of our common stock, many brokerage firms may not be willing to effect transactions in our securities, particularly because low-priced securities are subject to SEC rules imposing additional sales requirements on broker-dealers who sell low-priced securities (generally defined as those having a per share price below $5.00). These disclosure requirements may have the effect of reducing the trading activity in the secondary market for our stock as it is subject to these penny stock rules. Therefore, stockholders may have difficulty selling those securities.  These factors severely limit the liquidity, if any, of our common stock, and will likely continue to have a material adverse effect on its market price and on our ability to raise additional capital.





The penny stock rules require a broker-dealer, prior to a transaction in a penny stock, to deliver a standardized risk disclosure document prepared by the SEC, that:





(a)
contains a description of the nature and level of risk in the market for penny stocks in both public offerings and secondary trading;





(b)
contains a description of the broker’s or dealer’s duties to the customer and of the rights and remedies available to the customer with respect to a violation to such duties or other requirements of securities laws;





(c)
contains a brief, clear, narrative description of a dealer market, including bid and ask prices for penny stocks and the significance of the spread between the bid and ask price;





(d)
contains a toll-free telephone number for inquiries on disciplinary actions;





(e)
defines significant terms in the disclosure document or in the conduct of trading in penny stocks; and





(f)
contains such other information and is in such form, including language, type, size and format, as the SEC may require by rule or regulation.





In addition, the broker-dealer also must provide, prior to effecting any transaction in a penny stock, the customer with:





(a)
bid and ask quotations for the penny stock;





(b)
the compensation of the broker-dealer and its salesperson in the transaction;





27





(c)
the number of shares to which such bid and ask prices apply, or other comparable information relating to the depth and liquidity of the market for such stock; and





(d)
monthly account statements showing the market value of each penny stock held in the customer’s account.





Also, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from those rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written acknowledgment of the receipt of a risk disclosure statement, a written agreement to transactions involving penny stocks, and a signed and dated copy of a written suitability statement.





We cannot predict the extent to which investor interest in our stock or a business combination, if any, will lead to an increase in our market price or the development of an active trading market or how liquid that market, if any, might become.





The market price of our common stock may be volatile. As a result, you may not be able to sell our common stock in short time periods, or possibly at all.





Our stock price has been volatile. From January 2006 to March 2010, the trading price of our common stock ranged from a low price of $0.05 per share to a high price of $11.35 per share. Many factors may cause the market price of our common stock to fluctuate, including:





●
variations in our quarterly results of operations;





●
the introduction of new products by us or our competitors;





●
acquisitions or strategic alliances involving us or our competitors;





●
future sales of shares of common stock in the public market; and





●
market conditions in our industries and the economy as a whole.





In addition, the stock market has recently experienced extreme price and volume fluctuations. These fluctuations are often unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our common stock. When the market price of a company's stock drops significantly, stockholders often institute securities class action litigation against that company. Any litigation against us could cause us to incur substantial costs, divert the time and attention of our management and other resources or otherwise harm our business.





Risks Relating to New Corporate Governance Standards





We expect our administrative costs and expenses resulting from certain regulations to increase, adversely affecting our financial condition and results of operations.





We face new corporate governance requirements under the Sarbanes-Oxley Act of 2002, the NASDAQ Capital Market requirements and SEC rules adopted thereunder. These regulations when we become subject to them will increase our legal and financial compliance and make some activities more difficult, time-consuming and costly.





New corporate governance requirements have made it more difficult to attract qualified directors. As a result, our business may be harmed and the price of our stock may be adversely affected.





New corporate governance requirements have increased the role and responsibilities of directors and executive officers of public companies. These new requirements have made it more expensive for us to maintain director and officer liability insurance. We may be required to accept reduced coverage or incur significantly higher costs to maintain coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve as members of our board of directors.





If we fail to maintain effective internal controls over financial reporting, the price of our common stock may be adversely affected.





We are required to establish and maintain appropriate internal controls over financial reporting. Our internal controls over financial reporting may have weaknesses and conditions that need to be addressed, the disclosure of which may have an adverse impact on the price of our common stock.





Failure to establish those controls, or any failure of those controls once established, could adversely impact our public disclosures regarding our business, financial condition or results of operations. In addition, management's assessment of internal controls over financial reporting may identify weaknesses and conditions that need to be addressed in our internal controls over financial reporting or other matters that may raise concerns for investors. Any actual or perceived weaknesses and conditions that need to be addressed, disclosure of management's assessment of our internal controls over financial reporting or disclosure of our independent registered public accounting firm's attestation to or report on management's assessment of our internal controls over financial reporting may have an adverse impact on the price of our common stock.


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ITEM 2. Unregistered Sales of Equity Securities





Director Fees





On May 10, 2010, Technest issued 81,193 shares of its Common Stock (authorized by the Board on April 30, 2010)  to each of its non-employee directors for a total of 405,965 shares under  its 2006 Stock Award Plan as compensation for their services as directors during the quarters ended December 31, 2009 and March 31, 2010.  The issuance and sale of the securities were not registered under the Securities Act, but were made in reliance upon the exemptions from the registration requirements of the Securities Act set forth in Section 4(2) thereof.





The form of Non-Employee Director Restricted Stock Agreement entered into between Technest and each non-employee director is filed herewith as Exhibit 10.1 and is incorporated by reference herein.











ITEM 6.  Exhibits





Exhibit

No.
Description
Filed with this Quarterly

Report
Incorporated by referenceForm
Filing Date
Exhibit No.10.1
Form of Non-Employee Director Restricted Stock Grant Agreement entered into by each non-employee director and Technest Holdings, Inc. dated May 2010.
X31.1
Certification by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).
X31.2
Certification by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).
X32.1
Certification by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section 1350.
X


























29





SIGNATURES





In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.





TECHNEST HOLDINGS, INC.Date: May 14, 2010
By:
/s/ Gino M. PereiraGino M. PereiraChief Executive Officer and PresidentDate: May 14, 2010
By:
/s/ Nitin V. KotakNitin V. KotakChief Financial Officer

















30


Exhibit Index





Exhibit

No.
Description
Filed with this Quarterly

Report
Incorporated by referenceForm
Filing Date
Exhibit No.10.1
Form of Non-Employee Director Restricted Stock Grant Agreement entered into by each non-employee director and Technest Holdings, Inc. dated May 2010.
X31.1
Certification by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).
X31.2
Certification by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).
X32.1
Certification by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section 1350.
X




























31