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: December 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 February 12, 2011, 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


DECEMBER 31, 2010





PagePART I.
FINANCIAL INFORMATION:
3Item 1.
Financial Statements (Unaudited)
3Consolidated Balance Sheets at December 31, 2010 and June 30, 2010
3Consolidated Statements of Operations for the Six Months Ended December 31, 2010 and 2009
4Consolidated Statements of Operations for the Three Months Ended December 31, 2010 and 2009
5Consolidated Statement of Changes in Stockholders’ Equity for the Six Months Ended December 31, 2010
6Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2010 and 2009
7-8Notes to Condensed Consolidated Financial Statements
9Item 2.
Management’s Discussion and Analysis or Plan of Operation
15Item 4.
Controls and Procedures
21PART II.
OTHER INFORMATION
21Item 1A.
Risk Factors
21Item 6.
Exhibits
28Signatures

29





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, 2010, INCLUDING, BUT NOT LIMITED TO, THE SECTION THEREIN ENTITLED "RISK FACTORS."





2





PART I. FINANCIAL INFORMATION





TECHNEST HOLDINGS, INC.


CONSOLIDATED BALANCE SHEETS


DECEMBER 31, 2010 AND JUNE 30, 2010


(Unaudited)





December 31, 2010


June 30, 2010ASSETSCurrent AssetsCash and cash equivalents

$
331,326


$
285,644Accounts receivable


81,887



163,068Unbilled receivable


-



104,569Inventory and work in process


20,734



26,896Restricted cash


15,000



15,000Prepaid expenses and other current assets


169,206



145,480Assets related to discontinued operations


4,846,367



4,846,367Total Current Assets


5,464,520



5,587,024Property and Equipment– Net of accumulated depreciation of $129,538 and $118,013


7,128



17,162Other AssetsDeposits


28,525



28,525Definite-lived intangible assets – Net of accumulated amortization of $1,633,207 and $1,627,731


141,084



143,597Goodwill


3,050,000



4,876,038Total Other Assets


3,219,609



5,048,160Total Assets

$
8,691,257


$
10,652,346LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent LiabilitiesAccounts payable

$
415,097


$
417,268Accrued expenses and other current liabilities


225,101



320,781Accrued income taxes


369,816



369,816Liabilities related to discontinued operations


1,045,374



1,061,404Total Current Liabilities


2,055,388



2,169,269Total Liabilities


2,055,388



2,169,269Commitments and ContingenciesStockholders’ EquityCommon stock - par value $.001 per share; 495,000,000 shares authorized;32,678,056 shares

issued and outstanding at December 31, 2010 and at June, 30, 2010


32,676



32,676Additional paid-in capital


25,901,925



25,901,925Accumulated deficit


(19,116,445
)


(17,283,187
)Total Technest Holdings, Inc. Stockholders’ Equity


6,818,156



8,651,414Non controlling interest


(182,287
)


(168,337
)Total Stockholders’ Equity


6,635,869



8,483,077Total Liabilities and Stockholders’ Equity

$
8,691,257


$
10,652,346








See notes to condensed consolidated financial statements.




3




TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


FOR THE SIX MONTHS ENDED DECEMBER 31, 2010 AND 2009


(Unaudited)





2010


2009Revenues

$
1,237,303


$
1,126,015Cost of Revenues


487,786



554,484Gross Profit


749,517



571,531Operating ExpensesSelling, general and administrative


798,039



979,349Research and development


25,638



70,844Amortization of intangible assets


5,476



162,370Total Operating Expenses


829,153



1,212,563Operating Loss from Continuing Operations


(79,636
)


(641,032
)Other (Expense) Income, NetGoodwill impairment loss


(1,826,038
)


-Interest income


31,444



89,104Interest expense


-



(34,731
)Other income


27,022



6,921Total Other (Expense) Income, Net


(1,767,572
)


61,294Loss from Continuing Operations before Income Taxes


(1,847,208
)


(579,738
)Income tax benefit


-



-Net Loss from Continuing Operations


(1,847,208
)


(579,738
)Discontinued OperationsLoss on discontinued operations


-



(521,056
)Net Loss from Discontinued Operations


-



(521,056
)Net Loss


(1,847,208
)


(1,100,794
)Net Loss Attributable to Non-Controlling Interest


13,950



140,021Net Loss Attributable to Technest Holdings, Inc.


(1,833,258
)


(960,773
)Deemed Dividend to Preferred Stockholders - Series D


-



(291,306
)Net Loss Applicable to Common Shareholders

$
(1,833,258
)

$
(1,252,079
)Basic and Diluted Loss Per Common shareFrom continuing operations attributable to Technest Holdings, Inc.

$
(0.06
)

$
(0.03
)From discontinued operations attributable to Technest Holdings, Inc.

$
-


$
(0.02
)Net Loss Per Share - Basic and Diluted

$
(0.06
)

$
(0.05
)Weighted Average Number of Common Shares OutstandingBasic and diluted


32,678,056



22,370,400










4





TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


FOR THE THREE MONTHS ENDED DECEMBER 31, 2010 AND 2009


(Unaudited)





2010


2009Revenues

$
597,591


$
540,076Cost of Revenues


247,495



274,658Gross Profit


350,096



265,418Operating ExpensesSelling, general and administrative


385,618



490,846Research and development


12,206



40,594Amortization of intangible assets


2,791



81,185Total Operating Expenses


400,615



612,625Operating Loss from Continuing Operations


(50,519
)


(347,207
)Other (Expense) Income, NetGoodwill impairment loss


(1,826,038
)


-Interest income


15,768



30,881Interest expense


-



(34,731
)Other income


6,788



6,921Total Other (Expense) Income, Net


(1,803,482
)


3,071Loss from Continuing Operations before Income Taxes


(1,854,001
)


(344,136
)Income tax benefit


-



-Net Loss from Continuing Operations


(1,854,001
)


(344,136
)Discontinued OperationsLoss on discontinued operations


-



(81,510
)Net Loss from Discontinued Operations


-



(81,510
)Net Loss


(1,854,001
)


(425,646
)Net Loss Attributable to Non-Controlling Interest


22,642



87,491Net Loss Attributable to Technest Holdings, Inc.


(1,831,359
)


(338,155
)Deemed Dividend to Preferred Stockholders - Series D


-



(12,184
)Net Loss Applicable to Common Shareholders

$
(1,831,359
)

$
(350,339
)Basic and Diluted Loss Per Common shareFrom continuing operations attributable to Technest Holdings, Inc.

$
(0.06
)

$
(0.01
)From discontinued operations attributable to Technest Holdings, Inc.

$
-


$
(0.00
)Net Loss Per Share - Basic and Diluted

$
(0.06
)

$
(0.01
)Weighted Average Number of Common Shares OutstandingBasic and diluted


32,678,056



24,000,881








See notes to condensed consolidated financial statements.




5





TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY


FOR THE SIX MONTHS ENDED DECEMBER 31, 2010


(Unaudited)




Common stock


Additional

Paid-In

Capital


Accumulated

Deficit


Non-Controlling

Interest


Total

Stockholders'

EquityShares


Amount


Amount


Amount


Amount


AmountBalance - June 30, 2010


32,678,056


$
32,676


$
25,901,925


$
(17,283,187
)

$
(168,337
)

$
8,483,077Net Loss


-



-



-



(1,833,258
)


(13,950
)


(1,847,208
)Balance - December 31,2010


32,678,056


$
32,676


$
25,901,925


$
(19,116,445
)

$
(182,287
)

$
6,635,869








See notes to condensed consolidated financial statements.




6





TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


FOR THE SIX MONTHS ENDED DECEMBER 31, 2010 AND 2009


(Unaudited)





2010


2009Cash Flows From Operating Activities:Net loss

$
(1,847,208
)

$
(1,100,794
)Adjustment to reconcile net loss to net cash provided (used) in operating activities:Depreciation and amortization of property and equipment


11,525



11,826Amortization of intangible assets


5,476



162,370Goodwill impairment loss


1,826,038



-Non-cash interest income related to discount accretion


(31,312
)


(61,460
)Changes in operating assets and liabilities:Accounts receivable


81,181



125,681Unbilled receivable


104,569



-Inventory and work in process


6,162



(14,416
)Restricted cash


-



201,697Deposits and prepaid expenses and other current assets


7,586



(30,213
)Accounts payable


(2,171
)


(210,901
)Accrued expenses and other current liabilities


(95,680
)


56,621Net Cash Provided (Used) In Operating Activities


66,166



(859,589
)Cash Flows From Investing Activities:Purchase of equipment


(1,491
)


(777
)Registration of new definite lived intangible assets


(2,963
)


(29,954
)Net Cash Used In Investing Activities


(4,454
)


(30,731
)Cash Flows From Financing Activities:Proceeds from short term note


-



150,000Repayment of short term note


-



(150,000
)Proceeds from issuance of Series D Redeemable, Convertible Preferred Stock


-



150,000Net Cash Provided by Financing Activities


-



150,000Net Increase (Decrease) In Cash and Cash Equivalents from Continuing Operations


61,712



(740,320
)Cash Flows From Discontinued Operations:Operating activities - accounts payable and accrued expenses


(16,030
)


(3,621,687
)Investing activities - proceeds from settlement on sale of EOIR


-



18,000,000Net (Decrease) Increase in Cash and Cash Equivalents from Discontinued Operations


(16,030
)


14,378,313Net Increase in Cash and Cash Equivalents


45,682



13,637,993Cash and Cash Equivalents - Beginning of Period


285,644



5,567Cash and Cash Equivalents - End of Period

$
331,326


$
13,643,560












7





TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


FOR THE SIX MONTHS ENDED DECEMBER 31, 2010 AND 2009 (concluded)


(Unaudited)




2010


2009Supplemental Disclosures Of Cash Flow Information:Cash paid during the periods for:Interest

$
-


$
30,000Taxes

$
-


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

$
-


$
125,000Beneficial conversion on Series D Redeemable, Convertible Preferred Stock

$
-


$
105,000Accretion of Series D Redeemable, Convertible Preferred Stock to redemption value

$
-


$
255,000Accrued dividend on Series D Redeemable, Convertible Preferred Stockconverted to Common Stock

$
-


$
36,306Series D Redeemable, Convertible Preferred Stock converted to Common Stock

$
-


$
2,026,789








See notes to condensed consolidated financial statements.




8





TECHNEST HOLDINGS INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR THE SIX MONTHS ENDED DECEMBER 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.





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 second calendar quarter of 2011. During the six months ended December 31, 2010 and 2009, the Company accreted into interest income an amount of $31,312 and $61,460 respectively, related to this discount.  Technest believes that the collectability of the contingent receivable is determinable beyond a reasonable doubt and probable of collection and as such does not believe any reserves are warranted at December 31, 2010.





Acquisition of AccelPath LLC





As discussed more fully in Note 14, subsequent to period end the Company entered into a Unit Purchase Agreement (the “Agreement”) with AccelPath LLC (“AccelPath”), a Massachusetts limited liability company, and all of the members of AccelPath.  Pursuant to the Agreement, Technest agreed to acquire all of the outstanding membership interests of AccelPath in consideration for 86,151,240 shares of Technest’s common stock.  Immediately following the transaction, the sellers will beneficially own 72.5% of Technest’s issued and outstanding common stock and AccelPath shall continue to operate as a wholly owned subsidiary of Technest.





No adjustments have been made to these financial statements related to this transaction due to the timing of the transaction being subsequent to period end.




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 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.




9




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 considered necessary to make the financial statements not misleading have been included. Operating results for the three and six months ended December 31, 2010 are not necessarily indicative of the results that may be expected for the year ending June 30, 2011. 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, 2010 filed with the Securities and Exchange Commission.





Recent Accounting Pronouncements





There have been no recently issued accounting pronouncements that have had or are expected to 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.





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).





The assets and liabilities related to the sale of EOIR and related legal and other costs incurred to collect the contingent consideration as further discussed in Note 1 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.





There was no loss from discontinued operations for the three and six months ended December 31, 2010.  The net loss from discontinued operations for the three and six months ended December 31, 2009 was $81,510 and $521,056, respectively, which is primarily attributable to legal expenses incurred in connection with the arbitration and settlement process.





10





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 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 six months ended December 31, 2010, the Company allocated a net amount of approximately $155,113 and $296,873, respectively, of such expenses to Technest, Inc.  In the three and six months ended December 31, 2009, the Company allocated a net amount of approximately $174,212 and $352,916 respectively, of such expenses to Technest, Inc.





5.
GOODWILL AND DEFINITE-LIVED INTANGIBLE ASSETS





Goodwill and Impairment





The Company performs a formal impairment analysis in the fourth quarter of each fiscal year.  However, goodwill is tested for impairment between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount.





As a result of the pending transaction with AccelPath (see Note 14), the Company undertook an impairment analysis of its goodwill and intangible assets.  Fair value of the Company was estimated using a number of factors including the Company’s market capitalization, the fair value implied in the AccelPath transaction, previously prepared discounted cash flow analyses and consultation with an independent valuation expert.  As a result of this analysis, the Company determined that the carrying value of Company exceeded its fair value.  To date, the Company has not finalized its analysis of the implied fair value of the Company’s goodwill; however an impairment loss is probable and reasonably estimable.  The preliminary fair value assessment was performed by the Company taking into consideration a number of factors including the preliminary results of a purchase price allocation performed by an independent valuation expert, as it relates to the AccelPath transaction.   As a result of this preliminary analysis, the Company recorded an estimated goodwill impairment loss of $1,826,038 during the quarter ended December 31, 2010.  Any adjustment in the estimated impairment loss will be recognized in subsequent reporting periods.  The Company expects to finalize the impairment loss analysis in the quarter ending March 31, 2011.





A rollforward of the goodwill balance follows:




December 2010Balance at June 30, 2010

$
$4,876,038Accumulated impairment losses


(1,826,038
)Goodwill recognized during the period


-Recognition of deferred tax asset


-Derecognition of goodwill


-Balance at December 31, 2010

$
3,050,000




There have been no impairment losses on the goodwill balance prior to July 1, 2010.





Definite-Lived Intangible Assets





Definite-lived intangible assets consist of the following:





December 2010


June 2010


Useful life (years)Patents - commercialized technology

$
440,000


$
440,000



5Patents - other


204,291



201,328



15Customer relationships and contracts


1,130,000



1,130,000



5Accumulated amortization


(1,633,207
)


(1,627,731
)Net definite-lived intangible asset

$
141,084


$
143,597





11




Amortization expense was $5,476 and $162,370 for the six months ended December 31, 2010 and 2009, respectively.





6.
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 had a total face value of $3,000,000, a stated value of $1,000 per share and was convertible at any time at $0.20 per share. The Series D Preferred was redeemable upon receipt of the EOIR contingent purchase price 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 was not solely within the control of the Company, it did not meet the requirements for classification as equity.  As a result, the Series D Preferred was classified in the mezzanine section of the consolidated balance sheet prior to conversion.





Dividends accrued on the Series D Preferred quarterly at a rate of 5% per year.





During fiscal 2010 the Company sold 300 shares of its Series D Preferred stock for total proceeds of $150,000.





The Company 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 was 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 $291,306, which includes $36,306 of accretion of dividends, for the first six months of fiscal 2010.   The carrying value was further adjusted by additional dividends earned prior to conversion.





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 (total of 1,940 shares) 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 were no longer any shares of Technest Series D Preferred outstanding.


7.
STOCKHOLDERS' EQUITY


Series A and Series C Convertible Preferred Stock





On December 14, 2009, all outstanding shares of the Company’s Series A and Series C Preferred Stock were converted into shares of Technest Common Stock.  After these conversions there were no longer any shares of Series A and Series C Preferred Stock outstanding.





Common Stock Issuances





During the six months ended December 31, 2010, the Company did not issue any common stock.





8.
OPTIONS, WARRANTS AND STOCK-BASED COMPENSATION





Options





No options were granted pursuant to the Company's 2001 Stock Option Plan during the six months ended December 31, 2010 and 2009 and there are currently no options outstanding under the Plan.





Warrants





No warrants were issued, exercised or expired in the periods ended December 31, 2010 and 2009.  The Company has established a reserve for the exercise of warrants of 275,000 shares for the future issuance of common stock.





The following table summarizes the Company's warrants outstanding at December 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

1.1 years




12




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





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 December 31, 2010, the Company has 111,845 shares available for future grant under the Plan.


9.
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 six months ended December 31, 2010 and 2009, consist of the following:





Shares Potentially Issuable2010


2009Warrants


275,000



649,286Total


275,000



649,286





10.
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. On February 8, 2011, the Company amended its lease term to extend through December 31, 2011 on the same terms as under its current lease.




Rent expense for continuing operations in the six months ended December 31, 2010 and 2009 was $96,315 and $93,510, respectively.





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





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





11.
INCOME TAXES





There was no provision for federal or state income taxes for the six months ended December 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 December 31, 2010, the Company had a valuation allowance of $3,500,000.  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 six months ended December 31, 2010, there was no change in the valuation allowance.   As of December 31, 2010, the Company has net operating loss carryforwards not subject to IRC Section 382 limitations of $3,150,000 which begin to expire in 2024.




13




12.
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.





Contributions and other costs of the plan in the three and six months ended December 31, 2010 were $18,321 and $42,002, respectively.  Contributions and other costs of the plan in the three and six months ended December 31, 2009 were $30,183 and $54,345, respectively.





13.
LITIGATION





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




14.
SUBSEQUENT EVENTS




Acquisition of AccelPath LLC




On January 11, 2011, Technest, AccelPath LLC, a Massachusetts limited liability company (“AccelPath”) and all of the members of AccelPath (collectively, the “Sellers”), entered into a Unit Purchase Agreement pursuant to which Technest agreed to acquire all of the outstanding membership interests of AccelPath from the Sellers, in consideration for 86,151,240 shares of Technest’s common stock in the aggregate (the “Transaction”).  Immediately following the Transaction, the Sellers will beneficially own approximately 72.5% of Technest’s issued and outstanding common stock.  Following the closing of the Transaction (the “Closing”), AccelPath shall continue to operate as a wholly owned subsidiary of Technest. Please see the “Recent Developments” section of the Management’s Discussion and Analysis for a more detailed discussion of the Transaction.





Bridge Financing




On January 11, 2011, Technest entered into a Securities Purchase Agreement (the “Bridge Financing Agreement”) with Southridge Partners II, LP (“Southridge”) to issue 300 shares of its Series E 5% Convertible Preferred Stock, with a stated value of $1,000 per share, to Southridge for a purchase price of $300,000 (the “Bridge Financing”).  The shares of Series E 5% Convertible Preferred Stock shall be issued in three tranches over a 90-day period beginning on the Closing.  Prior to the Closing of the Transaction, Southridge Partners, LP and its affiliates are the holders of a majority of Technest’s shares of common stock. Please see the “Recent Developments” section of the Management’s Discussion and Analysis for a more detailed discussion of the Bridge Financing.





Contingent Value Rights




On January 13, 2011, Technest entered into a Contingent Value Rights Agreement (the “CVR Agreement”) pursuant to which each of Technest’s common stockholders of record as of January 25, 2011 shall receive one contingent value right (a “CVR”) for each share of Technest common stock held by them.  Each CVR shall entitle the holder thereof to its pro rata portion of a payment to be received by Technest pursuant to a Settlement Agreement and Mutual Release with EOIR Holdings LLC and EOIR Technologies, Inc. (the “Settlement Agreement”), less certain expenses that will be deducted from such payment.  The CVR was distributed on February 2, 2011. Please see the “Recent Developments” section of the Management’s Discussion and Analysis for a more detailed discussion of the CVRs.





14





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 six  months ending December 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.These statements include, but are not limited to, statements about Technest’s expected benefits of, and the ability to consummate, the Transaction with AccelPath and the Sellers, the receipt of the payment under the Settlement Agreement, the final amount of the payments under the CVR Agreement and all other statements regarding future performance.  All such information and statements are subject to certain risks and uncertainties, the effects of which are difficult to predict and generally beyond the control of Technest, that could cause actual results to differ materially from those expressed in, or implied or projected by, the forward-looking information and statements contained herein.  These risks and uncertainties include, but are not limited to, whether Technest and AccelPath will be able to satisfy all closing conditions to the Transaction, including the completion of the Bridge Financing; whether Technest will realize the improvements in its operations that it expects from the Transaction; whether the conditions triggering the payment to Technest under the Settlement Agreement will be achieved; the amount of expenses that will be deducted from, and reduce the amount of, payments pursuant to the CVR Agreement; general economic conditions; and those risks identified and discussed by Technest in its filings with the U.S. Securities and Exchange Commission.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, 3D FaceCam, Portable MVR, OmniEyeTM Wellcam, 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.





15




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.





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.





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.





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.





Technest Business Strategy





The Company is currently reviewing its strategic options.





RECENT DEVELOPMENTS





Acquisition of AccelPath LLC




On January 11, 2011, Technest, AccelPath LLC, a Massachusetts limited liability company (“AccelPath”) and all of the members of AccelPath (collectively, the “Sellers”), entered into a Unit Purchase Agreement (the “Purchase Agreement”) pursuant to which Technest agreed to acquire all of the outstanding membership interests of AccelPath from the Sellers, in consideration for 86,151,240 shares of Technest’s common stock in the aggregate(the “Transaction”).  Immediately following the Transaction, the Sellers will beneficially own approximately 72.5% of Technest’s issued and outstanding common stock.  Following the closing of the Transaction (the “Closing”), AccelPath shall continue to operate as a wholly owned subsidiary of Technest.




A total of 86,151,240 shares of Technest’s common stock will be issued in the Transaction, including 23,171,713 shares to Shekhar Wadekar, a Manager of AccelPath.  Immediately following the Transaction and not including the shares issued in the Bridge Financing (described below), Shekhar Wadekar will be deemed to beneficially own 19.5% of the shares of Technest’s common stock.  Following the Transaction, Shekhar Wadekar will serve as a director of Technest and will be its Chief Executive Officer.




Prior to the Transaction, Stephen Hicks, one of Technest’s directors, was deemed to beneficially own shares of Technest’s common stock beneficially owned by Southridge Partners LP, Aberdeen Avenue LLC, Southridge Capital Management LLC, Southshore Capital Fund Ltd. and Garth LLC.  Including the shares of Technest common stock beneficially owned by these entities, along with shares directly owned by Mr. Hicks and shares owned by Trillium Partners, LP (for which Mr. Hicks is the President of the general partner), Mr. Hicks was deemed to beneficially own 65.1% of the shares of Technest common stock, or a total of 21,258,562 shares of Technest’s common stock as of February 15, 2011.  Mr. Hicks disclaims beneficial ownership of such shares other than those issued to Mr. Hicks as a director of Technest.  Immediately following the Transaction and not including shares issued in the Bridge Financing (described below), Mr. Hicks will be deemed to beneficially own 17.89% of the shares of Technest’s common stock (including the shares owned by Southridge Partners LP, Aberdeen Avenue LLC, Southridge Capital Management LLC, Southshore Capital Fund Ltd., Garth LLC, and Trillium Partners LP).




Each of the parties to the Purchase Agreement has made customary representations, warranties and covenants.  The Closing is subject to, among other things, the continued accuracy of the representations and warranties of the parties contained in the Purchase Agreement, the performance of certain covenants and obligations of the parties, the satisfaction of certain matters relating to certain creditors and certain employees of Technest, and Technest executing the CVR Agreement (as described below) and definitive agreements relating to the Bridge Financing (as described below).  The Purchase Agreement may be terminated at any time prior to the Closing with the written consent of AccelPath and Technest, upon the issuance of a final governmental order or action that restrains, enjoins or otherwise prohibits the Transaction or by either party, or upon a breach of a representation, warranty or covenant in the Purchase Agreement that is not cured prior to the Closing.




16




Pursuant to the terms of the Purchase Agreement, the parties have agreed to enter into certain other agreements at the Closing, including a Lock-Up Agreement that prohibits the Sellers and certain of Technest’s existing stockholders from transferring shares of common stock held by them for a period of up to ten months following the Closing.




Effective immediately prior to the Closing, Gino M. Pereira will resign from his position as Technest’s President and Chief Executive Officer and his employment agreement dated January 14, 2008 will be terminated.  In connection with the Transaction, each of Gino M. Pereira, Robert A. Curtis, Laurence J. Ditkoff, David R. Gust and Stephen M. Hicks will resign from the Board of Directors of Technest effective immediately prior to the Closing; Henry Sargent will remain on the Board; and each of Shekhar G. Wadekar, Suren G. Dutia and F. Howard Schneider, Ph.D. will be appointed to the Board of Directors of Technest to fill three of the vacancies caused by such resignations.  Following the Closing, the Board will consist of four directors, three of whom will have been appointed in connection with the Transaction.




The issuance of Technest’s common stock in the Transaction will not be registered under the Securities Act of 1933, and will be made in reliance upon the exemptions from the registration requirements of the Securities Act set forth in Section 4(2) thereof.




The foregoing summary of the Purchase Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the Purchase Agreement, a copy of which is filed as Exhibit 2.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on January 14, 2011 and is incorporated herein by reference.




The Purchase Agreement has been filed to provide investors and stockholders with information regarding its terms.  It is not intended to provide any other factual information about Technest.  The Purchase Agreement contains representations and warranties that the parties to the Purchase Agreement made to and solely for the benefit of each other, and the assertions embodied in such representations and warranties are qualified by information contained in confidential disclosure schedules that the parties exchanged in connection with signing the Purchase Agreement. Accordingly, investors and stockholders should not rely on such representations and warranties as characterizations of the actual state of facts or circumstances, since they were only made as of the date of the Purchase Agreement and are modified in important part by the underlying disclosure schedules.  Moreover, information concerning the subject matter of the representations and warranties may change after the date of the Purchase Agreement, which subsequent information may not be fully reflected in the Technest’s public disclosures.




Bridge Financing




On January 11, 2011, Technest entered into a Securities Purchase Agreement (the “Bridge Financing Agreement”) with Southridge Partners II, LP (“Southridge”) to issue 300 shares of its Series E 5% Convertible Preferred Stock, with a stated value of $1,000 per share, to Southridge for a purchase price of $300,000 (the “Bridge Financing”).  The shares of Series E 5% Convertible Preferred Stock shall be issued in three tranches over a 90-day period beginning on the Closing.  Prior to the Closing of the Transaction, Southridge Partners, LP and its affiliates are the holders of a majority of Technest’s shares of common stock.




As set forth in the Series E 5% Convertible Preferred Stock Certificate of Designation to be filed with the Secretary of State of Nevada (the “Certificate of Designation”), the Series E 5% Convertible Preferred Stock to be issued in the Bridge Financing will be convertible into Technest common stock at the option of Southridge at any time.  The number of shares of Technest common stock into which each share of Series E 5% is convertible is determined by dividing $1,000 (the stated value) by $0.0444 per share.  The 300 shares of Series E 5% Preferred Stock issuable to Southridge will be convertible into 6,754,173 shares of Technest common stock.  The holders of Series E 5% Convertible Preferred Stock are entitled to receive cumulative dividends on the preferred stock at the rate per share (as a percentage of the stated value per share) equal to five percent (5%) per annum payable in cash.




The issuance and sale of the securities in the Bridge Financing will not be registered under the Securities Act of 1933, and will be made in reliance upon the exemptions from the registration requirements of the Securities Act set forth in Section 4(2) thereof.




The foregoing summary of the Bridge Financing does not purport to be complete and is qualified in its entirety by reference to the full text of the Bridge Financing Agreement, a copy of which is filed as Exhibit 10.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on January 14, 2011 and the Certificate of Designation, a copy of which is filed as Exhibit 4.1 to the same Current Report on Form 8-K, each of which are incorporated herein by reference.




17




Contingent Value Rights




On January 13, 2011, Technest entered into a Contingent Value Rights Agreement (the “CVR Agreement”) with Mellon Investor Services LLC (the “Exchange Agent”) pursuant to which each of Technest’s common stockholders of record as of January 25, 2011 shall receive one contingent value right (a “CVR”) for each share of Technest common stock held by them.  Each CVR shall entitle the holder thereof to its pro rata portion of a payment to be received by Technest pursuant to a Settlement Agreement and Mutual Release with EOIR Holdings LLC and EOIR Technologies, Inc. (the “Settlement Agreement”), less certain expenses that will be deducted from such payment.  The CVR was distributed on February 2, 2011. Pursuant to the Settlement Agreement, EOIR Holdings LLC agreed to, among other things, pay Technest $5,000,000 within sixty days of EOIR Technologies, Inc. being awarded a contract under the Warrior Enabling Broad Sensor Services Indefinite Delivery Indefinite Quantity contract or any contract generally recognized to be a successor contract to U.S. Army contract no. WI5P7T-08-D-P417 (the “STES Contract”).  The $5,000,000 is also payable to Technest in the event that EOIR Technologies, Inc. is awarded task orders under its current STES Contract totaling $495,000,000.   If the $5,000,000 payment is received under the Settlement Agreement, the holders of the CVRs will receive their pro rata portion of the net proceeds from such payment as certain expenses will be deducted from that payment prior to the distribution to the CVR holders.  Following deduction of such expenses, Technest estimates that the cash payment will be approximately $0.09 per CVR.




As of February 1, 2011, Continental Stock Transfer & Trust Company has been appointed as the successor agent, replacing Mellon Investor Services LLC for the CVRs pursuant to the CVR Agreement.




The foregoing summary of the CVR Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the CVR Agreement, a copy of which is filed as Exhibit 10.2 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on January 14, 2011 and is incorporated herein by reference.  The foregoing summary of the Settlement Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the Settlement Agreement, a copy of which is filed as Exhibit 10.1 to our Current Report on Form 8-K filed on October 29, 2009 and is incorporated herein by reference.




RESULTS OF OPERATIONS





Three and six months ended December 31, 2010 compared with the three and six months ended December 31, 2009





Revenues





Technest had $597,591 in revenues from continuing operations during the three months ended December 31, 2010 compared with $540,076 during the three months ended December 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 December 31, 2010, the Company’s backlog of funded contracts was approximately $429,000.




Technest had $1,237,303 in revenues from continuing operations during the six months ended December 31, 2010 compared with $1,126,015 during the six months ended December 31, 2009.





Gross profit





The gross profit from continuing operations for the three months ended December 31, 2010 was $350,096 or 59% of revenues. The gross profit from continuing operations for the three months ended December 31, 2009 was $265,418 or 49% of revenues.




The gross profit from continuing operations for the six months ended December 31, 2010 was $749,517 or 61% of revenues.  The gross profit from continuing operations for the six months ended December 31, 2009 was $571,531 or 51% of revenues.  The increase in profitability in fiscal 2011 is due to the Company billing at the increased provisional indirect rates approved by the DCAA in May 2010.




Selling, general and administrative expenses





Selling, general and administrative expenses for the three and six months ended December 31, 2010 were $385,618 and $798,039, respectively, and consisted primarily of payroll related expenses, professional fees and rent.





Selling, general and administrative expenses for the three and six months ended December 31, 2009 were $490,846 and $979,349, respectively, and consisted primarily of payroll related expenses, professional fees and rent.





18




Research and development





In the three and six months ended December 31, 2010 the Company incurred $12,206 and $25,638, respectively, in development expenses associated with its three dimensional camera products.





In the three and six months ended December 31, 2009 the Company incurred $40,594 and $70,844, respectively, in development expenses associated with its three dimensional camera products.





Amortization of intangible assets





Amortization of intangible assets for the three and six months ended December 31, 2010 was $2,791 and $5,476, respectively compared with $81,185 and $162,370, respectively for the three and six months ended December 31, 2009.   The amortization for the three and six months ended December 31, 2010 is lower because some of the intangible assets became 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 from continuing operations for the three months ended December 31, 2010 was $50,519 compared with $347,207 for the three months ended December 30, 2009.





The operating loss from continuing operations for the six months ended December 31, 2010 was $79,636 compared with $641,032 for the six months ended December 30, 2009.





Other (expense) income





Net other (expense) income for the three months ended December 31, 2010 was ($1,803,482) and consisted primarily of the impairment loss on goodwill of $1,826,038 offset by interest accreted on the remaining amount due under the Settlement Agreement related to the sale of EOIR Technologies, Inc.  Net other income for the three months ended December 31, 2009 was $3,071 and consisted primarily of interest income on the Arbitration Award and the Settlement Agreement relating to the sale of EOIR Technologies, Inc. and interest expense on short term note.





Net other (expense) income for the six months ended December 31, 2010 was ($1,767,572) and consisted primarily of the impairment loss on goodwill of $1,826,038 offset by interest accreted on the remaining amount due under the Settlement Agreement related to the sale of EOIR Technologies, Inc. and two insurance claims received on products lost in transit or stolen prior to shipment.  Net other income for the six months ended December 31, 2009 was $61,294 and consisted primarily of interest income on the Arbitration Award and the Settlement Agreement relating to the sale of EOIR Technologies, Inc. and interest expense on short term note.





Discontinued operations





There was no net loss from discontinued operations for the three and six months ended December 31, 2010.





The net loss from discontinued operations for the three and six months ended December 31, 2009 was $81,510 and $521,056, respectively.  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 and six months ended December 31, 2010 was $1,831,359 and $1,833,258, respectively.





The net loss attributable to common shareholders for the three and six months ended December 31, 2009 was $350,339 and $1,252,079, respectively. Included in the net loss for three and six months ended December 31, 2009 are  non-cash deemed dividends of $12,184 and $291,306, respectively, related to Series D Redeemable, Convertible Preferred Stock.





Liquidity and Capital Resources





Cash and Working Capital





On December 31, 2010, Technest had a positive working capital balance of $3,409,132 due primarily to the remaining amount due under the Settlement Agreement related to the sale of EOIR. The working capital balance relating solely to continuing operations was a negative balance of ($391,861). 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, rent 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 provided by operating activities for the six months ended December 31, 2010 was $66,166 compared with net cash of ($859,589) used in operating activities for the six months ended December 31, 2009.  The main drivers of working capital changes were: improvements in the collection of receivables in the amount of $81,181 and a reduction in unbilled receivables in the amount of $104,569 offset by a reduction in accrued expenses of $95,680.





19




Cash Used in Investing Activities





In the six months ended December 31, 2010, Technest used cash of $2,963 for the acquisition of new definite lived intangible assets representing costs associated with filing for new patents.  Technest also used $1,491 for purchase of new equipment.





Cash Provided by Financing Activities





In the six months ended December 31, 2010, the Company did not engage in any financing activities.





Cash Used in Discontinued Operations





In the six months ended December 31, 2010, the Company used $16,030 to pay down an account payable relating to discontinued operations.





Sources of Liquidity





During the six months ended December 31, 2010, we satisfied our operating and investing cash requirements from the cash provided by our operations.





On January 11, 2011, Technest and AccelPath entered into a Purchase Agreement pursuant to which Technest agreed to acquire all of the outstanding membership interests of AccelPath from the Sellers, in consideration for 86,151,240 shares of Technest’s common stock in the aggregate.  In conjunction with this on January 11, 2011, Technest entered into a Securities Purchase Agreement with Southridge Partners II, LP to issue 300 shares of its Series E 5% Convertible Preferred Stock, with a stated value of $1,000 per share, to Southridge for a purchase price of $300,000 The shares of Series E 5% Convertible Preferred Stock shall be issued in three tranches over a 90-day period beginning on the Closing.  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 December 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, 2010 and 2009.




20




Item 4.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 December 31, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.








PART II. OTHER INFORMATION





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 the AccelPath Transaction and the Combined Company




Satisfying closing conditions may delay completion of the Transaction.




On January 11, 2011, Technest entered into a Unit Purchase Agreement pursuant to which Technest agreed to acquire all of the outstanding membership interests of AccelPath LLC from AccelPath’s members  in consideration for 86,151,240 shares of Technest’s common stock in the aggregate (the “Transaction”).  There are many conditions to AccelPath and Technest’s obligations to close the Transaction.  The closing is subject to, among other things, the continued accuracy of the representations and warranties of the parties contained in the Purchase Agreement, the performance of certain covenants and obligations of the parties, the satisfaction of certain matters relating to certain creditors and certain employees of Technest.  If the closing conditions are not satisfied or waived and the Transaction does not close, it could adversely affect the prospects of the Company.




If the proposed Transaction with AccelPath is consummated, the combined business of both Technest and AccelPath (the “Combined Company”) may be exposed to additional risks which may result in a decline in the share price.




If the proposed Transaction is consummated, the Combined Company may be subject to a number of material risks, and its business could be adversely affected, including the following:




●
some of Technest’s or AccelPath’s suppliers, distributors and other business partners may seek to adversely change or terminate their relationships with the Combined Company as a result of the consummation of the Transaction;


●
as a result of the consummation of the Transaction, current and prospective employees could experience uncertainty about their future roles within the Combined Company, and this uncertainty may adversely affect the Combined Company’s ability to retain its key employees, who may seek other employment opportunities; and we can give no assurance that we will be able to successfully complete and integrate AccelPath and Technest.





In addition, the market price of Technest’s common stock after the Transaction may decline for a number of other reasons, including if:




●
the Combined Company does not achieve the perceived benefits of the Transaction as rapidly or to the extent anticipated, if at all;


●
the dilution of Technest’s outstanding stock as a result of the issuance of shares of stock in the Transaction and the Bridge Financing may negatively affect the trading price of Technest’s stock; or


●
the effect of the Transaction on the Combined Company’s business and prospects is not consistent with the expectations of financial or industry analysts.





21




Ownership of Technest’s common stock may be highly concentrated after consummation of the Transaction and the Bridge Financing.




After consummation of the Transaction and the Bridge Financing, certain stockholders will have beneficial ownership of significant portions of Technest’s outstanding stock.  Such stockholders, acting individually or as a group, will have substantial influence over the outcome of a corporate action of Technest requiring stockholder approval, including the election of directors, any approval of a merger, consolidation or sale of all or substantially all of Technest’s assets or any other significant corporate transaction, even if the outcome sought by such stockholders is not in the interest of Technest’s other stockholders.  These stockholders, acting as a group, may also delay or prevent a change in control of Technest, even if such change in control would benefit the other stockholders of Technest.  In addition, the significant concentration of stock ownership may adversely affect the value of Technest’s common stock due to investors’ perception that conflicts of interest may exist or arise.




If the Combined Company is unable to develop new and enhanced products that achieve widespread market acceptance, it may be unable to recoup product development costs, and its earnings and revenue may decline.




The Combined Company’s future success depends on its ability to broadly market existing technologies, products, and services, and to develop and introduce new product and service offerings and grow its business, particularly in the healthcare and security industries.  The Combined Company expects to commit substantial resources to developing new products and services, as well as to continue marketing the existing products and services of AccelPath and Technest.  If the market for these products and services does not develop as anticipated, or demand for the Combined Company’s current product and service offerings does not grow or grows more slowly than the Combined Company expects, the Combined Company will have expended substantial resources and capital without realizing sufficient revenue, and the Combined Company’s business and operating results could be adversely affected.




The Combined Company will operate in a very competitive environment.




The Combined Company expects to encounter intense competition from a number of companies that offer products in the Combined Company’s targeted application areas.  It is anticipated that the Combined Company’s competitors in these areas will include:




●
healthcare and other companies that manufacture tests and analytics for use in the healthcare industry;


●
diagnostic companies and companies developing technologies for pathology;


●
digital imaging companies;


●
companies developing technologies for the surveillance and security industries; and


●
companies developing point-of-care diagnostic tests.




The Combined Company’s current and future products and services will face competition from established companies and numerous development-stage companies that continually enter these markets.  In many instances, competitors have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than the Combined Company. Moreover, these competitors may offer broader product lines and have greater name recognition than the Combined Company and may offer discounts as a competitive tactic.




In addition, several development-stage companies are currently making or developing products and services that compete with or will compete with the Combined Company’s current and future products and services.  Competitors may succeed in marketing technologies or products that are more effective or commercially attractive than the Combined Company’s current or future products and services that render the Combined Company’s technologies and current or future products obsolete.  Competitors may also develop proprietary positions that may prevent the Combined Company from successfully commercializing its products.




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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 December 31, 2010, our accumulated deficit was approximately $19.1 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 complete the Bridge Financing or additional financing, our operating results and financial condition may suffer and the price of our stock may decline.





The development of our technologies will require additional capital. Although we believe with the completion of the Bridge Financing we will have sufficient sources of liquidity to satisfy our obligations for at least the next 12 months, we may be unable to complete the financing or 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.





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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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.





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.




24




Risks Related To “Controlled Companies”





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





As of February 15, 2011, Southridge Partners LP owns 40.3% of the shares of Technest Common Stock, with a total of 13,170,173 shares of Technest Common Stock. Aberdeen Avenue LLC beneficially owns 5.6% of the shares of Technest Common Stock, with a total of 1,814,782 shares of Technest Common Stock. Southridge Capital Management LLC beneficially owns 10.0% of the shares of Technest Common Stock, with a total of 3,274,639 shares of Technest Common Stock. Southshore Capital Fund Ltd. beneficially owns 1,035,208 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, Southridge Capital Management 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 65.1% of the shares of Technest Common Stock, with a total of 21,258,562 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 65.1% 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.





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.





25




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;





(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 July 2007 to January 2011, the trading price of our common stock ranged from a low price of $0.05 per share to a high price of $0.64 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.





26




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.





27





Item 6.Exhibits





Exhibit

No.
Description
Filed with this

QuarterlyReport
Incorporated by referenceForm
FilingDate
Exhibit No.2.1
Unit Purchase Agreement, dated as of January 11, 2011, by and among Technest Holdings, Inc., AccelPath LLC and the members of AccelPath LLC

8-K
January 14, 2011
2.14.1
Series E 5% Convertible Preferred Stock Certificate of Designation to be filed with the Secretary of State of Nevada

8-K
January 14, 2011
4.110.1
Securities Purchase Agreement, dated as of January 11, 2011, by and between Technest and Southridge Partners II, LP

8-K
January 14, 2011
10.110.2
Contingent Value Rights Agreement, dated as of January 13, 2011, by and between Technest Holdings, Inc. and Mellon Investor Services LLC

8-K
January 14, 2011
10.210.3
Amendment to Motor City Lease dated February 8, 2011 between Technest Holdings, Inc. and Motor City Drive, LLC
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.
X99.1
Press Release dated as of January 14, 2011

8-K
January 14, 2011
99.1








28





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: February 17, 2011
By:
/s/ Gino M. PereiraGino M. PereiraChief Executive Officer and PresidentDate: February 17, 2011
By:
/s/ Nitin V. KotakNitin V. KotakChief Financial Officer








29





Exhibit Index




Exhibit

No.
Description
Filed with this

QuarterlyReport
Incorporated by referenceForm
FilingDate
Exhibit No.2.1
Unit Purchase Agreement, dated as of January 11, 2011, by and among Technest Holdings, Inc., AccelPath LLC and the members of AccelPath LLC

8-K
January 14, 2011
2.14.1
Series E 5% Convertible Preferred Stock Certificate of Designation to be filed with the Secretary of State of Nevada

8-K
January 14, 2011
4.110.1
Securities Purchase Agreement, dated as of January 11, 2011, by and between Technest and Southridge Partners II, LP

8-K
January 14, 2011
10.110.2
Contingent Value Rights Agreement, dated as of January 13, 2011, by and between Technest Holdings, Inc. and Mellon Investor Services LLC

8-K
January 14, 2011
10.210.3
Amendment to Motor City Lease dated February 8, 2011 between Technest Holdings, Inc. and Motor City Drive, LLC
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.
X99.1
Press Release dated as of January 14, 2011

8-K
January 14, 2011
99.1