UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-K





x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the Fiscal Year Ended June 30, 2010.o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





Commission File Number 000-27023





Technest Holdings, Inc.


(Exact name of Registrant as specified in its Charter)





Nevada

(State or other jurisdictionof incorporation or organization)
88-0357272

(I.R.S. Employer Identification No.)10411 Motor City Drive, Suite 650, Bethesda, MD

(Address of principal executive offices)
20817

(Zip Code)10411 Motor City Drive, Suite 650, Bethesda, MD

(Mailing Address)





Issuer’s Telephone Number: (301) 767-2810





Securities registered pursuant to Section 12(b) of the Act:





Title of Class

Name of each exchange on which registeredNone

Not Applicable





Securities registered pursuant to Section 12(g) of the Exchange Act:





Common Stock, par value $0.001 per share


(Title or Class)





Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  o Yes   x No





Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  o Yes   x No





Indicate by check mark whether the registrant  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding twelve (12) months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety (90) days.  x Yes   o No





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




Indicate by check mark if  disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.  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).  o Yes   x No





The aggregate market value of the voting and non-voting common equity held by non-affiliates* computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity, as of December 31, 2009 (See definition of affiliate in Rule 12b-2 of the Exchange Act.) was: $3,013,720




*
Affiliates for the purpose of this item refers to the issuer’s officers and directors and/or any persons or firms (excluding those brokerage firms and/or clearing houses and/or depository companies holding issuer’s securities as record holders only for their respective clienteles’ beneficial interest) owning 5% or more of the issuer’s Common Stock, both of record and beneficially.





APPLICABLE ONLY TO CORPORATE REGISTRANTS





State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:




32,678,056 shares as of September 20, 2010, all of one class of common stock, $0.001 par value.





DOCUMENTS INCORPORATED BY REFERENCE





Documents Incorporated by reference:  None










TECHNEST HOLDINGS, INC.


FORM 10-K


TABLE OF CONTENTS


June 30, 2010





Part IItem 1.
Business
4Item 2.
Property
8Part IIItem 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
9Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
9Item 8.
Financial Statements
F-1Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
23Item 9A(T).
Controls and Procedures
23Item 9B.
Other Information
24Part IIIItem 10.
Directors, Executive Officers and Corporate Governance
25Item 11.
Executive Compensation
27Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
31Item 13.
Certain Relationships and Related Transactions and Director Independence.
33Item 14.
Principal Accounting Fees and Services
34Part IVItem 15.
Exhibits
34Signatures
48





2




NOTE REGARDING FORWARD-LOOKING STATEMENTS





This annual report on Form 10-K contains forward-looking statements, which involve risks and uncertainties, such as our plans, objectives, expectations and intentions. You can identify these statements by our use of words such as “may,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” “continue,” “plans,” or their negatives or cognates. Some of these statements include discussions regarding our future business strategy and our ability to generate revenue, income and cash flow. We wish to caution the reader that all forward-looking statements contained in this Form 10-K are only estimates and predictions. Our actual results could differ materially from those anticipated as a result of risks facing us or actual events differing from the assumptions underlying such forward-looking statements. Readers are cautioned not to place undue reliance on any forward-looking statements contained in this Annual Report on Form 10-K. We will not update these forward-looking statements unless the securities laws and regulations require us to do so.





In this annual report on Form 10-K, and unless the context otherwise requires “Technest,” the “Company,” “we,” “us” and “our” refer to Technest Holdings, Inc. and its subsidiaries, taken as a whole.





All dollar amounts in this Annual Report are in U.S. dollars, unless otherwise stated.




3




PART I




Item 1. Description of Business





Recent Developments





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 to the consolidated financial statements for additional information).





Under the terms of the Settlement Agreement, LLC agreed to pay Technest $18,000,000 no later than December 25, 2009 and an additional $5,000,000 within sixty days of EOIR being awarded a contract under the Warrior Enabling Broad Sensor Services (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 year ended June 30, 2010, the Company accreted into interest income a total of $107,219 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 June 30, 2010.





General





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





Our products leverage several core technology platforms, including:





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





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





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





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





Defense and Security - 3D-ID





Our major products consist of our 3D SketchArtist, and 3D FaceCam, Portable MVR, OmniEyeTM Wellcam, 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





4




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





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





Technest Business Strategy





The Company is currently reviewing its strategic options and focusing on 3D access control and facial recognition for law enforcement and detention centers.





Technest History





Technest Holdings, Inc. is the successor of a variety of businesses dating back to 1993. We were incorporated in 1993 as Alexis and Co. in the State of Nevada, and subsequently changed our name to Wee Wees Inc. Prior to December 17, 1996, we had no operations. Between December 1996 and May 2002, we were involved in a number of different businesses.





Between October 10, 2003 and February 14, 2005, we had no operations, nominal assets, accrued liabilities totaling $184,468 and 139,620 (post-reverse stock split) shares of common stock issued and outstanding.





Acquisition of Genex. On February 14, 2005, Technest became a majority owned subsidiary of Markland Technologies, Inc., a homeland defense, armed services and intelligence contractor. Technest issued to Markland 1,954,023 shares of its common stock in exchange for 10,168,764 shares of Markland common stock which were used as partial consideration for the concurrent acquisition of Genex Technologies, Inc. The acquisition of Genex Technologies, Inc. was effected pursuant to an Agreement Plan of Merger, dated February 14, 2005, by and among Markland, Technest, Mtech Acquisition, Inc. (a wholly-owned subsidiary of Technest), Genex and Jason Geng (the then sole stockholder of Genex). Technest paid $3,000,000 in cash and transferred the 10,168,764 shares of Markland common stock to Jason Geng, the sole stockholder of Genex, for all of the capital stock of Genex. As a result of this transaction, Genex Technologies, Inc. became a wholly-owned subsidiary of Technest. Technest financed the acquisition of Genex with the sale of 1,149,425 shares of Technest Series B preferred stock (which were convertible into Markland common stock), five-year warrants to purchase up to 1,149,425 shares of Technest common stock for an exercise price of $6.50 per share (after giving effect to the Reverse Stock Split), and 1,149,425 shares of Technest Series C preferred stock convertible into 1,149,425 shares of Technest's common stock (after giving effect to the Reverse Stock Split). Technest received gross proceeds of $5,000,000 in this offering. The issuance of these securities was not registered under the Securities Act, but was made in reliance upon the exemptions from the registration requirements of the Securities Act set forth in Section 4(2) thereof.





Reverse Stock Split. On June 2, 2005, our Board of Directors and the holders of a majority of our outstanding shares of common stock approved a recapitalization in the form of a one (1) for two hundred eleven and eighteen one hundredths (211.18) reverse stock split of our shares of common stock, par value $.001 per share, outstanding (the “Reverse Stock Split”) after considering and concluding that the Reverse Stock Split was in our best interests and the best interests of our stockholders, with all fractional shares rounded up to the nearest whole number. The Reverse Stock Split was effective as of the close of business on July 19, 2005. The Reverse Stock Split did not reduce the amount of authorized shares of our common stock, which remains at 495,000,000.




5




Acquisition of EOIR. On August 17, 2005, pursuant to a Stock Purchase Agreement with Markland, our majority stockholder, we purchased all of the outstanding stock of EOIR, formerly one of Markland’s wholly-owned subsidiaries. As consideration for the stock of EOIR, we issued 12 million shares of our common stock to Markland, and, as a result, Markland’s ownership of Technest increased at the time of the transaction from 85% to approximately 98% on a primary basis and from 39% to approximately 82% on a fully diluted basis (assuming the conversion of all of our convertible securities and the exercise of all warrants to purchase Technest common stock). This reorganization did not result in a change of control of EOIR. We did not need stockholder consent in order to complete this reorganization.  Markland acquired EOIR on June 29, 2004.





Sale of EOIR Technologies, Inc.On September 10, 2007, Technest Holdings, Inc. (the “Company” or “Technest”) and its wholly owned subsidiary, EOIR Technologies, Inc. (“EOIR”), entered into a Stock Purchase Agreement with EOIR Holdings LLC, a Delaware limited liability company (“LLC”), pursuant to which Technest agreed to sell EOIR to LLC.  LLC is an entity formed on August 9, 2007 by The White Oak Guggenheim Defense and Aerospace Funds 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 is 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 awarded the 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 Stock Purchase Agreement. LLC alleged that the amount was not due because the award of the contract to EOIR did not meet the requirements for payment under the SPA.  However, following a seven-day Arbitration hearing that ended on June 30, 2009, the arbitration panel unanimously agreed with Technest and on August 21, 2009 ruled that LLC breached the SPA and must pay the remainder of the purchase price, including interest of $830,070, of  $23,778,403 plus interest from the date of the Award through date of payment at 3.25%.  LLC filed a petition to vacate the arbitration award in the U.S. District Court for the District of Columbia.  On September 21, 2009, Technest filed its opposition to  LLC's motion to vacate the award. As detailed in Technest's opposition, the bases for vacating an arbitration award are extremely limited.  On October 5, 2009, Technest filed its opposition to  LLC's superseding petition to vacate the arbitration award.





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 to the consolidated financial statements for additional information). Under the terms of the Settlement Agreement, LLC agreed to pay Technest $18,000,000 no later than December 25, 2009 and an additional $5,000,000 within sixty days of EOIR being awarded a contract under the Warrior Enabling Broad Sensor Services (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 quarter of calendar 2011. During the year ended June 30, 2010, the Company accreted into interest income a total of $107,219 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 June 30, 2010.





Technest Inc. On October 1, 2008, the Company formed and acquired a 49% interest in Technest, Inc. in exchange for the transfer of certain contracts and employees. Technest, Inc. conducts research and development in the field of computer vision technology. Technest Holdings has the right of first refusal to commercialize products resulting from this research and development. The Company’s Chief Executive Officer beneficially owns 23% of Technest, Inc. and a former employee of the Company and current employee of Technest, Inc. owns an additional 23%.  The remaining 5% interest is held by an unrelated third party. The Company has certain rights of first refusal and repurchase rights at Fair Market Value, as defined in certain restricted stock agreements, with respect to the shares of Technest, Inc. that it does not own.





Competition





The markets for our products and solutions are extremely competitive and are characterized by rapid technological change as a result of technical developments exploited by our competitors, changing technical needs of customers, and frequent introductions of new features. We expect competition to increase as other companies introduce products that are competitively priced, that may have increased performance or functionality, or that incorporate technological advances not yet developed or implemented by us. Some of our present and potential competitors may have financial, marketing, and research resources substantially greater than ours. In order to compete effectively in this environment, we must continually develop and market new and enhanced products at competitive prices, and have the resources to invest in significant research and development activities. There is a risk that we may not be able to make the technological advances necessary to compete successfully. Existing and new competitors may enter or expand their efforts in our markets, or develop new products to compete against ours. Our competitors may develop new technologies or enhancements to existing products or introduce new products that will offer superior price or performance features. New products or technologies may render our products obsolete. Many of our primary competitors are well-established companies that have substantially greater financial, managerial, technical, marketing, personnel and other resources than we do.




6




We have particular proprietary technologies, some that have been developed and others that are in development. We will focus on our proprietary technologies, or leverage our management experience, in order to differentiate ourselves from these organizations. There are other technologies being presented to our customers that directly compete with our technologies.





Intellectual Property





Our ability to compete effectively depends to a significant extent on our ability to protect our proprietary information. We rely primarily on patents and trade secret laws and confidentiality procedures to protect our intellectual property rights. We own 21 U.S. patents and have 10 patents pending. We enter into confidentiality agreements with our consultants and key employees, and maintain controls over access to and distribution of our technology, software and other proprietary information. 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.





We do not generally 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 in the future. 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 seek to 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.





Dependence on U.S. Government Contracts





Almost all of our range of services and products are sold to agencies of the U.S. Government. Although we are continuously working to diversify our client base, we will continue to aggressively seek additional work from the U.S. Government.





Much of our business is won through submission of formal competitive bids. Commercial bids are frequently negotiated as to terms and conditions for schedule, specifications, delivery and payment.





Essentially all contracts with the United States Government, and many contracts with other government entities, permit the government client to terminate the contract at any time for the convenience of the government or for default by the contractor. We operate under the risk that such terminations may occur and have a material impact on operations.





Government Regulation





Most of our U.S. Government business is subject to unique procurement and administrative rules based on both laws and regulations, including the U.S. Federal Acquisition Regulation, that provide various profit and cost controls, rules for allocations of costs, both direct and indirect, to contracts and non-reimbursement of unallowable costs such as interest expenses and some costs related to business acquisitions, including for example the incremental depreciation and amortization expenses arising from fair value increases to the historical carrying values of acquired assets.





Companies supplying defense-related equipment to the U.S. Government are subject to some additional business risks specific to the U.S. defense industry. Among these risks are the ability of the U.S. Government to unilaterally suspend a company from new contracts pending resolution of alleged violations of procurement laws or regulations. In addition, U.S. Government contracts are conditioned upon the continuing availability of Congressional appropriations. Congress usually appropriates funds for a given program on a September 30 fiscal year basis, even though contract performance may take several years. Consequently, at the outset of a major program, the contract is usually partially funded, and additional monies are normally committed to the contract by the procuring agency only as appropriations are made by Congress for future fiscal years.




7




U.S. Government contracts are, by their terms, subject to unilateral termination by the U.S. Government either for its convenience or default by the contractor if the contractor fails to perform the contracts' scope of work. Upon termination other than for a contractor's default, the contractor will normally be entitled to reimbursement for allowable costs and an allowance for profit. Foreign defense contracts generally contain comparable provisions permitting termination at the convenience of the government. To date, none of our significant contracts have been terminated.





As is common in the U.S. defense industry, we are subject to business risks, including changes in the U.S. Government's procurement policies, governmental appropriations, national defense policies or regulations, service modernization plans, and availability of funds. A reduction in expenditures by the U.S. Government for products and services of the type we manufacture and provide, lower margins resulting from increasingly competitive procurement policies, a reduction in the volume of contracts or subcontracts awarded to us or the incurrence of substantial contract cost overruns could materially adversely affect our business.





Sales and Marketing





Our current marketing efforts are focused on: (1) federal government agencies; and (2) commercial security applications. These marketing duties are divided among senior management.





Manufacturing





Our primary manufacturing facilities are located in Bethesda, Maryland.





Employees





As of September 15, 2010, Technest had a total of 14 employees. We believe our future success will depend upon the continued service of our key technical and senior management personnel and upon our continued ability to attract and retain highly qualified technical and managerial personnel. None of our employees is represented by a labor union. We have never experienced a work stoppage and consider our relationship with our employees to be good.





Item 2. Description of Property





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.





We believe that our present facilities are adequate to meet our current needs. If new or additional space is required, we believe that adequate facilities are available at competitive prices.





8




PART II





Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities





Until March 30, 2001 our common stock was traded on the OTC Bulletin Board under the symbol FNTN. On April 2, 2001, our trading symbol was changed to FNIT and in July 2001, it was changed to THNS. Prior to our initial public offering on December 16, 1996, there was no public trading market for such shares. On July 19, 2005, as a result of our reverse stock split, we began trading under the symbol TCNH. In June 2005, we changed our fiscal year end from December 31 to June 30; however, the following table sets forth the high and low closing bid quotations for our common stock as set forth on Nasdaq.com for the calendar years listed below:





Calendar Year

High


Low2008First Quarter

$
0.62


$
0.31Second Quarter

$
0.51


$
0.31Third Quarter

$
0.45


$
0.24Fourth Quarter

$
0.25


$
0.052009First Quarter

$
0.30


$
0.05Second Quarter

$
0.20


$
0.10Third Quarter

$
0.40


$
0.15Fourth Quarter

$
0.62


$
0.252010First Quarter

$
0.51


$
0.06Second Quarter

$
0.14


$
0.05





The above quotations reflect inter-dealer prices, without retail mark-up, markdown or commission. These quotes are not necessarily representative of actual transactions or of the value of our common stock, and are in all likelihood not based upon any recognized criteria of securities valuation as used in the investment banking community. As of September 23, 2010, there were approximately 315 record holders of our common stock.





Following the settlement agreement with EOIR Holdings entered into in connection with the sale of EOIR Technologies, Inc., on December 23, 2009, Technest’s board of directors declared a special “return of capital” cash distribution of $0.407 per share of common stock. The cash dividend was paid on January 15, 2010 to shareholders of record as of January 4, 2010. Other than this special “return of capital” cash distribution, we have not paid any cash dividends on our common stock in the past. The payment of any cash dividends will be at the discretion of the board of directors and will be dependent upon our results of operations, financial condition, capital requirements, contractual restrictions and other factors deemed relevant by the board.





Issuer Purchases of Equity Securities





We did not make any purchases of our common stock during the three months ended June 30, 2010, which is the fourth quarter of our fiscal year.





Item 7.  Management’s Discussion and Analysis





The following discussion and analysis of our financial condition and results of operations for the years ending June 30, 2010 and 2009 should be read together with our financial statements and related notes included elsewhere in this annual report on Form 10-K.





9




When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that characterize our business. In particular, we encourage you to review the risks and uncertainties described in the section entitled "Risk Factors” beginning on page 17 of this annual report on Form 10-K. These risks and uncertainties could cause actual results to differ materially from those forecasted in forward-looking statements or implied by past results and trends. Forward-looking statements are statements that attempt to project or anticipate future developments in our business; we encourage you to review the examples of forward-looking statements under "Note Regarding Forward-Looking Statements." These statements, like all statements in this annual report on Form 10-K, speak only as of June 30, 2010 and we undertake no obligation to update or revise the statements in light of future developments.





Year ended June 30, 2010 compared with the year ended June 30, 2009





Revenues





Technest had $2,699,532 in revenues from continuing operations during the year ended June 30, 2010 compared with $2,482,726 during the year ended June 30, 2009. These revenues were largely generated by Small Business Innovation Research Grants in the field of 3-dimensional imaging. At June 30, 2010, the Company’s backlog of funded contracts was approximately $1.0 million. However, since then, the Company has been awarded a further funded contract for $0.8 million.





Gross profit





The gross profit from continuing operations for the year ended June 30, 2010 was $1,448,273 or 54% of revenues. The gross profit from continuing operations for the year ended June 30, 2009 was $1,148,830 or 46% of revenues. Technest expects to expand its revenue base to include commercial product revenues and, accordingly, gross profit on future revenues may differ. In the year ended June 30, 2010, the Company billed approximately $84,000 representing the difference between provisional indirect cost rates for the fiscal year 2009 and final rates resulting from the submission to the Defense Contract Audit Agency (DCAA) of the annual Incurred Cost report for the year ended June 30, 2009.   During the year ended June 30, 2010, the Company also started billing at the increased provisional indirect cost rates for fiscal 2010 approved by the DCAA in May 2010.  These actions accounted for the increased profitability in fiscal 2010.




Selling, general and administrative expenses





Selling, general and administrative expenses for the year ended June 30, 2010 were $1,871,033 compared $2,142,630 for the year ended June 30, 2009.  These consisted primarily of payroll related expenses, professional fees and rent.  The Company continues to reduce operating costs where appropriate.





Certain general and administrative expenses of the Company that are associated with EOIR totaling approximately $521, 263 and $2,723,747 in the years ended June 30, 2010 and 2009, respectively, have been included in the net loss from discontinued operations.  These expenses included legal and other costs associated with the EOIR arbitration hearing.




10





Research and development





In the year ended June 30, 2010, the Company incurred $146,952 in development expenses associated with its three dimensional camera products.





In the year ended June 30, 2009, the Company incurred $192,349 in development expenses associated with its EARCAD, 3D scanner and SketchArtist products.





Amortization of intangible assets





Amortization of intangible assets for the year ended June 30, 2010 was $206,990 compared with $324,741 for the year ended June 30, 2009.  Certain intangible assets were fully amortized in February, 2010.  The majority of amortization expense relates to the definite-lived intangible assets acquired in conjunction with Genex Technologies.





Operating loss





The operating loss before taxes from continuing operations for the year ended June 30, 2010 was $776,702 compared with $1,510,890 for the year ended June 30, 2009.





Other (expenses) income





In the year ended June 30, 2010, the Company accreted $107,219 as interest income related to the discount on the $5 million receivable on the sale of EOIR and recorded approximately $27,590 as interest income as a result of the final settlement of the receivable on the sale of EOIR.  During the year the Company paid $30,000 towards interest to American Asset Finance, LLC, upon repayment of the short term note issued to them.





In the year ended June 30, 2009, the Company recorded $722,071 as interest income as a result of the unanimous arbitration award that the Company received over EOIR Holdings LLC.





Discontinued Operations





The net loss from discontinued operations in the year ended June 30, 2010 was $597,988 compared with a net loss of $2,209,506 in the year ended June 30, 2009. The loss in the year ended June 30, 2010 was attributable to costs incurred with the arbitration against, and the subsequent settlement with, EOIR Holdings LLC and a provision for taxes of $76,725 related to state taxes which were not able to be offset by state net operating losses as a result of the Company’s use of the installment method related to the gain on the sale of EOIR.  The loss in the year ended June 30, 2009 was attributable to costs incurred with the arbitration against EOIR Holdings LLC offset by a tax benefit of $565,909 resulting from the Company incurring additional expenses in the year related to the EOIR arbitration hearing that are expected to reduce the taxable gain from the sale of EOIR.





Net loss applicable to common shareholders





The net loss applicable to common stockholders for the year ended June 20, 2010 was $1,390,517 in comparison with a net loss of $4,389,466 applicable to common shareholders for the year ended June 30, 2009. Included in the net loss for the years ended June 30, 2010 and 2009 are non-cash deemed dividends of $291,305 and $1,386,484, respectively, related to Series D Redeemable, Convertible Preferred Stock.




11


Liquidity and Capital Resources





Cash and Working Capital





On June 30, 2010, Technest had a positive working capital balance of $3,417,755 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 ($367,208).  Our primary source of operating cash flows was payments from our customers.  Payments from customers are based on the amount and timing of work performed by us or the number of units delivered.  Our primary ongoing uses of operating cash relate to payments to subcontractors and vendors, salaries and related expenses and professional fees.  The timing of such payments is generally even throughout the year.  Our vendors and subcontractors generally provide us with normal trade payment terms.  Net cash used in operating activities for the year ended June 30, 2010 was $1,081,972 compared with net cash of $881,118 used in operating activities for the year ended June 30, 2009. The main drivers of working capital changes were: release of restricted cash in the amount of $201,697, improvements in the collection of receivables in the amount of $97,313 together with a reduction in the amounts due to vendors and accruals of $170,693, an increase of unbilled receivables in the amount of $104,569, an increase in prepaid expenses and other current assets of $37,826 and an increase in accrued income taxes of $76,725. Net cash used in operating activities for the year ended June 30, 2009 includes a legal settlement of $600,000 related to the litigation with Deer Creek.





Cash Used in Investing Activities





In the year ended June 30, 2010, Technest used cash of $28,414 for the acquisition of new definite-lived intangible assets representing costs associated with filing for new patents.  Technest also used $3,109 for the purchase of new equipment.





Cash Provided by Financing Activities





In the year ended June 30, 2010, the Company received $150,000 related to the issuance of its Series D Preferred Stock. These proceeds were used primarily for legal expenses. The Company also received and repaid a short term loan of $150,000 which was used for the payment of past due professional fees.





Cash Provided from Discontinued Operations





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





Sources of Liquidity





During the year ended June 30, 2010, we satisfied our operating and investing cash requirements from cash reserves and from the sale of Series D Redeemable Convertible Preferred Stock, a short term loan and the receipt of $18,000,000 from the settlement agreement with EOIR Holdings, Inc.





The Company continues to expand its efforts in commercial sales and believes that these activities will contribute positively in fiscal 2011. In addition, the Company is aggressively cutting costs and the Company’s Chief Executive Officer has voluntarily reduced his compensation by approximately 27%. As a result of the forgoing, management believes that Technest has sufficient sources of liquidity to satisfy its obligations for at least the next 12 months.





Commitments and Contingencies





Facilities





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.





Legal










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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 June 30, 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 has had or 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.





The sections below present information about the nature of and rationale for our critical accounting policies.





Principles of Consolidation and Discontinued Operation





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





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




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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.  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.





Concentrations





We are subject to concentrations of credit risk because the majority of our revenues and accounts receivable are derived from the U.S. government, including the Department of Defense, who is not required to provide collateral for amounts owed to us. Substantially all of Technest revenues are currently generated from individual customers within the Department of Defense and the National Institute for Health under Small Business Innovative Research contracts. Consequently, substantially all of our accounts receivable are due from Federal government agencies either directly or through other government contractors. We do not believe that we are subject to any unusual credit risks, other than the normal level of risk attendant to operating our business.





From time to time we have cash balances in banks in excess of the maximum amount insured by the FDIC.





Technest is subject to risks common to companies in the homeland defense technology industry, including, but not limited to, development by its competitors of new technological innovations, dependence on key personnel, protection of proprietary technology and loss of significant customers.





Impairment of Goodwill





Goodwill consists of the excess of the purchase price over the fair value of tangible and identifiable intangible net assets acquired in business combinations. Accounting guidance requires us to test goodwill for impairment at least annually at the reporting unit level in lieu of being amortized and requires a two-step impairment test for goodwill and intangible assets with indefinite lives. The first step is to compare the carrying amount of the reporting unit's net assets to the fair value of the reporting unit. If the fair value exceeds the carrying value, no further work is required and no impairment loss is recognized. If the carrying amount exceeds the fair value, then the second step is required to be completed, which involves allocating the fair value of the reporting unit to each asset and liability, with the excess being implied goodwill. An impairment loss occurs if the amount of the recorded goodwill exceeds the implied goodwill.




To estimate the fair value of its reporting unit containing the goodwill, the Company utilizes a discounted cash flow model. Other valuation methods, such as a comparable company analysis, are used to corroborate the discounted cash flow analysis performed at the reporting unit.  In estimating fair value, management relies on and considers a number of factors, including but not limited to, future revenue growth by product/service line, operating profit margins, overhead expenses, perpetual growth rates, discount rate, and market data and analysis, including market capitalization.




The Company estimated a growth rate for its government contract business based on historical growth rates, current contract backlog and anticipated future contracts.  As this work generally has low operating profit margins, the Company’s fair value estimate is not sensitive to changes in the estimated growth rate of the government contract business.  To estimate the growth in the Company’s 3D Access Control product, the Company prepared a bottom up revenue forecast including estimates of the number of customers acquired, quantities purchased per customer and sales price per unit.  The Company’s revenue forecast assumes five years of customer acquisitions with the number of customers remaining level after that. The Company’s fair value estimate is very sensitive to changes in the number of customers, especially in the last year of the forecast (Year 5).  A decrease of more than 10% in the Year 5 forecast would cause the estimated fair value of the reporting unit to no longer exceed the carrying value of the net assets.  The later years in a forecast are inherently more difficult to accurately predict.  However, the Company believes that its current estimates of sales and number of customers are conservative and includes all information reasonably available to the Company.  The fair value estimate is also very sensitive to changes in the discount rate used to discount estimated future cash flows.  The Company determined its discount rate using discount rate information originally calculated in outside valuations obtained in prior years updated by the Company for current market conditions, risk-free interest rates and the specific risk profile of the Company.  An increase in the discount rate would cause the estimated fair value of the reporting unit to no longer exceed the carrying value of the net assets.  However, the Company believes that its discount rate is conservative and includes all information reasonably available to the Company.




Technest tests its goodwill for impairment annually in its fourth quarter. Accounting principles generally accepted in the U.S. require additional testing if events or circumstances indicate that impairment may exist. As a result of the very light trading volume in the Company’s common stock, inefficiencies in investor research of small capitalization companies and the relatively small amount of shares in the public float, the Company’s book value exceeds its market capitalization. Technest performed an impairment test of the goodwill as of June 30, 2010. Based upon the impairment test performed, there was no impairment indicated for Technest’s goodwill as of June 30, 2010.  The fair value of the reporting unit containing the goodwill was determined utilizing a discounted cash flow valuation approach.





Estimated Useful Lives of Amortizable Intangible Assets





Definite-lived intangible assets acquired with Genex represent costs of outside legal counsel related to obtaining new patents.  Patent costs are amortized over the legal life of the patents, generally fifteen years, starting on the patent issue date.  The costs of unsuccessful and abandoned patent applications are expensed when abandoned.  The cost to maintain existing patents are expensed as incurred.  The nature of the technology underlying these patents relates to 3D imaging, intelligent surveillance and 3D facial recognition technologies.





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Technest also acquired commercialized technology relating to 3D facial recognition cameras and contracts and customer relationships from the application of 3D imaging technologies to breast cancer research for the National Institute of Health and disposable sensors and 3D face mapping for the Department of Defense. The amounts assigned to definite-lived intangible assets were determined by management based on a number of factors including an independent purchase price allocation analysis. These assets have an estimated useful life of five years.





Contracts and customer relationships acquired as a result of business combinations have been valued by management considering various factors including independent appraisals done by valuation and financial advisory firms. These assets are being amortized over the contractual terms of the existing contracts plus anticipated contract renewals.





Impairment of Long-Lived Assets





We continually monitor events and changes in circumstances that could indicate carrying amounts of long-lived assets, including amortizable intangible assets, may not be recoverable. We recognize an impairment loss when the carrying value of an asset exceeds expected cash flows. Accordingly, when indicators or impairment of assets are present, we evaluate the carrying value of such assets in relation to the operating performance and future undiscounted cash flows of the underlying business. Our policy is to record an impairment loss when we determine that the carrying amount of the asset may not be recoverable. No impairment charges were recorded in any of the periods presented.





Revenue Recognition





Revenues from products are recognized when the following criteria are met: (1) there is persuasive evidence of an arrangement, such as contracts, purchase orders or written requests; (2) delivery has been completed and no significant obligations remain; (3) price to the customer is fixed or determinable; and (4) collection is probable.





Revenues from time and materials contracts are recognized as costs are incurred and billed. Revenues from firm fixed price contracts are recognized on the percentage-of-completion method, either measured based on the proportion of costs recorded to date on the contract to total estimated contract costs or measured based on the proportion of labor hours expended to date on the contract to total estimated contract labor hours, as specified in the contract. Revenues from firm fixed price contracts with payments tied to milestones are recognized when all milestone requirements have been achieved and all other revenue recognition criteria have been met.   Costs incurred on firm fixed price contracts with milestone payments are recorded as work in process until all milestone requirements have been achieved. During the year ended June 30, 2010, approximately 2% of our revenue has come from firm fixed price contracts.





Provisions for estimated losses on all contracts are made in the period in which such losses become known. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined.







15


Impact of Recently Issued Accounting Standards





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





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





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





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





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RISK FACTORS





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





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





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





Technest has had net operating losses each year since its inception. As of June 30, 2010, our accumulated deficit was approximately $ 17.2 million. If Technest continues to suffer losses as it has in the past, investors may not receive any return on their investment and may lose their entire investment.





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





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





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





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.





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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.





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





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




●
our ability to perform under contracts and manufacture, test and deliver products in a timely and cost-effective manner;●
our success in winning competitions for orders;●
the timing of new product introductions by us or our competitors;●
the mix of products we sell;●
competitive pricing pressures; and●
general economic climate.





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





Risks Related to Contracting with the United States Government





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





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





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





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





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




●
changes in Government programs or requirements;●
budgetary priorities limiting or delaying Government spending generally, or specific departments or agencies in particular, and changes in fiscal policies or available funding, including potential Governmental shutdowns (as occurred during the Government’s 1996 fiscal year);●
curtailment of the Government’s use of technology solutions firms.
 
 18
 
 Our contracts and administrative processes and systems are subject to audits and cost adjustments by the Government, which could reduce our revenue, disrupt our business or otherwise adversely affect our results of operations.





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





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





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





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





Risks Related To “Controlled Companies”





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





As of September 23, 2010, 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 5.5% 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 10.02% of the shares of Technest Common Stock, with a total of 3,274,639 shares of Technest Common Stock. Southridge Capital Fund Ltd. Beneficially owns 1,072,257 shares of Technest Common Stock. Stephen Hicks, one of our directors, is deemed to beneficially own the shares of Technest Common Stock beneficially owned by Southridge Partners LP, Aberdeen Avenue LLC, 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 62.23% of the shares of Technest Common Stock, with a total of 20,345,665 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 62.23% 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.





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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.





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;





20




(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 January 2006 to August 2010, the trading price of our common stock ranged from a low price of $0.05 per share to a high price of $11.35 per share. Many factors may cause the market price of our common stock to fluctuate, including:




●
variations in our quarterly results of operations;●
the introduction of new products by us or our competitors;●
acquisitions or strategic alliances involving us or our competitors;●
future sales of shares of common stock in the public market; and●
market conditions in our industries and the economy as a whole.


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





Risks Relating to New Corporate Governance Standards





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





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





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





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





21




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.




22





Item 8.  Financial Statements





TECHNEST HOLDINGS, INC.


CONSOLIDATED FINANCIAL STATEMENTS





INDEX





Page NumberTechnest Holdings, Inc. and SubsidiariesYears ended June 30, 2010 and 2009Report of Independent Registered Public Accounting Firm
F-2Consolidated Balance Sheets
F-3Consolidated Statements of Operations
F-5Consolidated Statements of Changes in Stockholders’ Equity
F-6Consolidated Statements of Cash Flows
F-8Notes to Consolidated Financial Statements
F-10











F-1





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the Board of Directors


Technest Holdings, Inc. and Subsidiaries


Bethesda, Maryland





We have audited the accompanying consolidated balance sheets of Technest Holdings, Inc. and subsidiaries as of June 30, 2010 and 2009 and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.





We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.





In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Technest Holdings, Inc. and subsidiaries as of June 30, 2010 and 2009, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.











/s/ Wolf & Company, P.C.





Boston, Massachusetts


September 27, 2010





F-2




TECHNEST HOLDINGS, INC.CONSOLIDATED BALANCE SHEETSJUNE 30, 2010 AND 2009June 30, 2010


June 30, 2009ASSETSCurrent AssetsCash and cash equivalents

$
285,644


$
5,567Accounts receivable


163,068



260,381Unbilled receivable


104,569



-Inventory and work in process


26,896



26,745Restricted cash


15,000



216,697Prepaid expenses and other current assets


145,480



750,013Assets related to discontinued operations


4,846,367



22,948,333Total Current Assets


5,587,024



24,207,736Property and Equipment– Net of accumulated depreciation $118,013 and $94,703


17,162



37,363Other AssetsDeposits


28,525



28,525Definite-lived intangible assets – Net of accumulated amortization $1,627,731and $1,420,740


143,597



322,173Goodwill


4,876,038



4,876,038Total Other Assets


5,048,160



5,226,736Total Assets

$
10,652,346


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

$
417,268


$
745,159Accrued expenses and other current liabilities


320,781



626,381Accrued state income taxes


369,816



293,091Liabilities related to discontinued operations


1,061,404



5,246,838Total Current Liabilities


2,169,269



6,911,469Total Liabilities


2,169,269



6,911,469





See notes to consolidated financial statements.




(continued)




F-3




TECHNEST HOLDINGS, INC.CONSOLIDATED BALANCE SHEETSJUNE 30, 2010 AND 2009June 30, 2010


June 30, 2009Series D Redeemable, Convertible Preferred Stock - $.0001 par value;3,000 shares authorized; -0- and 1,640 shares issued and outstanding at June 30,2010 and June 30, 2009, respectively (preference in liquidation of $1,690,483)at June 30, 2009)


-



1,690,483Commitments and ContingenciesStockholders’ EquitySeries A Convertible Preferred Stock - $.001 par value; 150 shares authorized;-0- and 64.325 shares issued and outstanding at June 30, 2010 and 2009, respectively(preference in liquidation of $64,325 at June 30, 2009)


-



-Series C Convertible Preferred Stock - $.001 par value; 1,149,425 shares authorized;-0- and 402,301 shares issued and outstanding at June 30, 2010 and 2009, respectively(preference in liquidation of $875,005 at June 30, 2009)


-



402Common stock - par value $.001 per share; 495,000,000 shares authorized;32,678,056 and 20,676,739 shares issued and outstanding at June 30, 2010 and 2009,respectively


32,676



20,675Additional paid-in capital


25,901,925



37,032,781Accumulated deficit


(17,283,187
)


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


8,651,414



20,869,883Non controlling interest


(168,337
)


-Total Stockholders’ Equity


8,483,077



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

$
10,652,346


$
29,471,835





See notes to consolidated financial statements.




F-4





TECHNEST HOLDINGS, INC.CONSOLIDATED STATEMENTS OF OPERATIONSFOR THE YEARS ENDED JUNE 30, 2010 AND 20092010


2009Revenues

$
2,699,532


$
2,482,726Cost of Revenues


1,251,259



1,333,896Gross Profit


1,448,273



1,148,830Operating ExpensesSelling, general and administrative


1,871,033



2,142,630Research and development


146,952



192,349Amortization of intangible assets


206,990



324,741Total Operating Expenses


2,224,975



2,659,720Operating Loss from Continuing Operations


(776,702
)


(1,510,890
)Other Income, NetOther income (expense)


6,921



(4,657
)Interest expense


(34,731
)


-Interest income


134,951



722,071Total Other Income, Net


107,141



717,414Loss from Continuing Operations before Income Taxes


(669,561
)


(793,476
)Income tax benefit


-



-Net Loss from Continuing Operations


(669,561
)


(793,476
)Discontinued OperationsLoss from discontinued operations (including loss on disposal of$-0- and $2,775,415 during the years ended June 30, 2010 and 2009, respectively)


(521,263
)


(2,775,415
)Income tax (expense) benefit


(76,725
)


565,909Net Loss from Discontinued Operations


(597,988
)


(2,209,506
)Net Loss


(1,267,549
)


(3,002,982
)Net Loss Attributable to Non-Controlling Interest


168,337



-Net Loss Attributable to Technest Holdings, Inc.


(1,099,212
)


(3,002,982
)Deemed Dividend to Preferred Stockholders - Series D


(291,305
)


(1,386,484
)Net Loss Applicable to Common Shareholders

$
(1,390,517
)

$
(4,389,466
)Basic and Diluted Loss Applicable to Common Shareholders Per Common ShareFrom continuing operations attributable to Technest Holdings, Inc.

$
(0.03
)

$
(0.10
)From discontinued operations attributable to Technest Holdings, Inc.

$
(0.02
)

$
(0.11
)Net Loss Applicable to Common Shareholder Per Share - Basic and Diluted

$
(0.05
)

$
(0.21
)Weighted Average Number of Common Shares OutstandingBasic and diluted


27,337,016



20,662,486Cash Dividends Per Common Share

$
0.407


$
-





See notes to consolidated financial statements.




F-5




TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY


FOR THE YEARS ENDED JUNE 30, 2010 AND 2009





Common stock


Series A

Convertible

Preferred stock


Series C

Convertible

Preferred stockShares


Amount


Shares


Amount


Shares


AmountBalance - July 1, 2008


20,505,863


$
20,504



64


$
-



402,301


$
402Issuance and amortization of stock-basedcompensation related to restricted stock grants


170,876



171



-



-



-



-Accretion of Series D redeemableconvertible preferred stock to redemptionvalue


-



-



-



-



-



-Beneficial conversion feature on  Series Dredeemable convertible preferred stock


-



-



-



-



-



-Accretion of dividend on Series Dredeemable convertible preferred stock


-



-



-



-



-



-Net Loss


-



-



-



-



-



-Balance - June 30, 2009


20,676,739



20,675



64



-



402,301



402Issuance of restricted stock as payment foraccrued expenses


1,160,500



1,160



-



-



-



-Accretion of Series D redeemableconvertible preferred stock to redemptionvalue


-



-



-



-



-



-Beneficial conversion feature on  Series Dredeemable convertible preferred stock


-



-



-



-



-



-Accretion of dividend on Series Dredeemable convertible preferred stock


-



-



-



-



-



-Issuance of restricted stock upon conversion ofSeries A convertible preferred stock


304,578



305



(64
)


-



-



-Issuance of restricted stock upon conversion ofSeries C convertible preferred stock


402,294



402



-



-



(402,301
)


(402
)Issuance of restricted stock upon conversion ofSeries D redeemable convertible preferredstock


10,133,945



10,134Dividend paid ($0.407 per share)


-



-



-



-



-



-Net Loss


-



-



-



-



-



-Balance - June 30, 2010


32,678,056


$
32,676



-


$
-



-


$
-





See notes to consolidated financial statements.




(continued)




F-6


TECHNEST HOLDINGS, INC.


CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY


FOR THE YEARS ENDED JUNE 30, 2010 AND 2009 (concluded)





Additional

Paid-In


Accumulated


Non-Controlling


Total Stockholders'Capital


Deficit


Interest


EquityAmount


Amount


Amount


AmountBalance - July 1, 2008

$
37,792,582


$
(13,180,993
)

$
-


$
24,632,495Issuance and amortization of stock-basedcompensation related to restricted stock grants


110,683



-



-



110,854Accretion of Series D redeemableconvertible preferred stock to redemptionvalue


(1,336,000
)


-



-



(1,336,000
)Beneficial conversion feature on  Series Dredeemable convertible preferred stock


516,000



-



-



516,000Accretion of dividend on Series Dredeemable convertible preferred stock


(50,484
)


-



-



(50,484
)Net Loss


-



(3,002,982
)


-



(3,002,982
)Balance - June 30, 2009


37,032,781



(16,183,975
)


-



20,869,883Issuance of restricted stock as payment foraccrued expenses


173,840



-



-



175,000Accretion of Series D redeemableconvertible preferred stock to redemptionvalue


(255,000
)


-



-



(255,000
)Beneficial conversion feature on  Series Dredeemable convertible preferred stock


105,000



-



-



105,000Accretion of dividend on Series Dredeemable convertible preferred stock


(36,305
)


-



-



(36,305
)Issuance of restricted stock upon conversion ofSeries A convertible preferred stock


(305
)


-



-



-Issuance of restricted stock upon conversion ofSeries C convertible preferred stock


-



-



-



-Issuance of restricted stock upon conversion ofSeries D redeemable convertible preferredstock


2,016,655



-



-



2,026,789Dividend paid ($0.407 per share)


(13,134,741
)


-



-



(13,134,741
)Net Loss


-



(1,099,212
)


(168,337
)


(1,267,549
)Balance - June 30, 2010

$
25,901,925


$
(17,283,187
)

$
(168,337
)

$
8,483,077





See notes to consolidated financial statements.




F-7




TECHNEST HOLDINGS, INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 FOR THE YEARS ENDED JUNE 30, 2010 AND 2009


2010


2009Cash Flows From Operating Activities:Net loss

$
(1,267,549
)

$
(3,002,982
)Adjustment to reconcile net loss to net cash used in operating activities:Depreciation and amortization of property and equipment


23,310



31,791Amortization of intangible assets


206,990



324,741Stock-based compensation to employees and directors


-



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


(107,219
)


-Loss on disposal of equipment


-



7,531Loss on disposal of discontinued operations


-



2,775,415Deferred income tax benefit


-



(732,000
)Changes in operating assets and liabilities:Accounts receivable


97,313



340,527Unbilled receivable


(104,569
)


23,888Inventory and work in process


(151
)


9,797Restricted cash


201,697



20,591Deposits and prepaid expenses and other current assets


(37,826
)


(624,113
)Accounts payable


(40,093
)


365,449Accrued expenses and other current liabilities


(130,600
)


(698,698
)Accrued income taxes


76,725



166,091Net Cash Used In Operating Activities


(1,081,972
)


(881,118
)Cash Flows From Investing Activities:Purchase of equipment


(3,109
)


-Proceeds from sale of equipment


-



1,727Registration of new definite lived intangible assets


(28,414
)


(11,803
)Net Cash Used In Investing Activities


(31,523
)


(10,076
)Cash Flows From Financing Activities:Proceeds from short term note


150,000



-Repayment of short term note


(150,000
)


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


150,000



820,000Net Cash Provided by Financing Activities


150,000



820,000









(continued)




F-8




TECHNEST HOLDINGS, INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 FOR THE YEARS ENDED JUNE 30, 2010 AND 2009 (concluded)


2010


2009Net Decrease In Cash and Cash Equivalents from Continuing Operations


(963,495
)


(71,194
)Cash Flows From Discontinued Operations:Operating activities - accounts payable and accrued expenses


(3,621,687
)


-Investing activities - proceeds from settlement on sale of EOIR


18,000,000



-Financing activities - return of capital dividend payment


(13,134,741
)


-Net Increase in Cash and Cash Equivalents from DiscontinuedOperations


1,243,572



-Net Increase (Decrease) in Cash and Cash Equivalents


280,077



(71,194
)Cash and Cash Equivalents - Beginning of Period


5,567



76,761Cash and Cash Equivalents - End of Period

$
285,644


$
5,567Supplemental Disclosures Of Cash Flow Information:Cash paid during the periods for:Interest

$
30,000


$
-Taxes

$
-


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

$
175,000


$
-Beneficial conversion on Series D Redeemable, Convertible PreferredStock

$
105,000


$
516,000Accretion of Series D Redeemable, Convertible Preferred Stock toredemption value

$
255,000


$
1,336,000Accrued dividend on Series D Redeemable, Convertible Preferred Stock

$
36,305


$
50,484Series D Redeemable, Convertible Preferred Stock converted to CommonStock

$
2,026,789


$
-








F-9




TECHNEST HOLDINGS INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2010 AND 2009





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 quarter of calendar 2011. During the year ended June 30, 2010, the Company accreted into interest income a total of $107,219 related to this discount.  Technest believes that the collectability of the contingent receivable is determinable beyond a reasonable doubt and as such does not believe any reserves are warranted at June 30, 2010.





2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Basis of Presentation





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





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




F-10




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.





Use of Estimates





The preparation of the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.





Reclassification





Certain amounts in the 2009 financial statements have been reclassified to conform with the 2010 presentation.





Concentrations and Risks





Technest, from time to time, has cash balances in excess of the maximum amount insured by the FDIC.





Substantially all of Technest’s revenues are currently generated from individual customers within the Department of Defense and the National Institute for Health under Small Business Innovative Research contracts.





Technest is subject to risks common to companies in the homeland defense technology industry, including, but not limited to, development by its competitors of new technological innovations, dependence on key personnel, protection of proprietary technology and loss of significant customers.





Cash and Cash Equivalents





The Company considers all highly liquid investments with maturities of ninety days or less to be cash equivalents. The company had no cash equivalents as of June 30, 2010.





Restricted cash represents a certificate of deposit securing a Company credit card.  The certificate of deposit is recorded at cost plus accumulated interest earned at 1.19%.





Accounts Receivable





Accounts receivable represent the amounts invoiced by the Company under contracts. An allowance for doubtful accounts is determined based on management's best estimate of probable losses inherent in the accounts receivable balance. Management assesses the allowance based on known troubled accounts, historical experience and other currently available evidence.





A significant portion of the Company's receivables are due from government contracts, either directly or as a subcontractor. The Company has not experienced any material losses in accounts receivable related to these contracts and has provided no allowance at June 30, 2010 and 2009. If management determines amounts to be uncollectible, they will be charged to operations when that determination is made.





Unbilled receivables represent amounts earned related to allowable costs incurred under contracts but not billed.





Inventory and Work in Process





Inventories are stated at the lower of cost or market.  Cost is determined by the first-in, first-out method and market represents the lower of replacement costs or estimated net realizable value. Work in process represents allowable costs incurred but not billed related to time and material contracts.  Costs incurred on firm fixed price contracts with milestone payments are recorded as work in process until all milestone requirements have been achieved.





F-11




Property and Equipment





Property and equipment are valued at cost and are being depreciated over their useful lives using the straight-line method for financial reporting purposes. Routine maintenance and repairs are charged to expense as incurred. Expenditures which materially increase the value or extend useful lives are capitalized.





Property and equipment are depreciated over the estimated useful lives of assets as follows:





Software


3 yearsComputer equipment


3 yearsFurniture and fixtures


5 years





Property and equipment consisted of the following at June 30, 2010 and 2009:





2010


2009Software

$
11,242


$
11,242Computer equipment


29,764



26,655Furniture and fixtures


94,169



94,169135,175



132,066Less accumulated depreciation


(118,013
)


(94,703
)$
17,162


$
37,363





Depreciation expense from continuing operations for the years ended June 30, 2010 and 2009 was $23,310 and $31,791, respectively.





Definite-lived Intangible Assets





With the acquisition of Genex, Technest acquired commercialized technology (patents) relating to 3D facial recognition cameras and contracts and customer relationships from the application of 3D imaging technologies to breast cancer research for the National Institute of Health and disposable sensors and 3D face mapping for the Department of Defense. The amounts assigned to definite-lived intangible assets were determined by management based on a number of factors including an independent purchase price allocation analysis. These assets have an estimated useful life of five years.





Also included are certain costs of outside legal counsel related to obtaining new patents.  Patent costs are amortized over the legal life of the patents, generally fifteen years, starting on the patent issue date.  The costs of unsuccessful and abandoned patent applications are expensed when abandoned.  The cost to maintain existing patents are expensed as incurred.  The nature of the technology underlying these patents relates to 3-D imaging, intelligent surveillance and 3-D facial recognition technologies.





Redeemable Preferred Stock





The Company excludes from stockholders’ equity all preferred stock with redemption provisions that are outside the Company’s control. Dividends on the Series D Convertible, Redeemable Preferred Stock, prior to conversion (see Note 7), are accreted as earned and are recorded as a charge to additional paid-in capital in the absence of retained earnings and as deemed dividends in determining net income (loss) applicable to common stockholders.





Fair Value of Financial Instruments





The financial statements include various estimated fair value information.  Financial instruments are initially recorded at historical cost. If subsequent circumstances indicate that a decline in the fair value of a financial asset is other than temporary, the financial asset is written down to its fair value.





Unless otherwise indicated, the fair values of financial instruments approximate their carrying amounts. By their nature, all financial instruments involve risk, including credit risk for non-performance by counterparties.





The fair value of cash, accounts receivable and accounts payable approximate their recorded amounts because of their relatively short settlement terms.





Operating Segments





The Company operates in one operating segment. This is the business of research and development, design and fabrication of 3D imaging and of intelligent surveillance products.





Revenue Recognition





Revenues from products are recognized when the following criteria are met: (1) there is persuasive evidence of an arrangement, such as contracts, purchase orders or written requests; (2) delivery has been completed and no significant obligations remain; (3) price to the customer is fixed or determinable; and (4) collection is probable.





F-12




Revenues from time and materials contracts are recognized as costs are incurred and billed. Allowable costs incurred but not billed as of a period end are recorded as work in process.




Revenues from time and materials contracts are recognized as costs are incurred and billed. Revenues from firm fixed price contracts are recognized on the percentage-of-completion method, either measured based on the proportion of costs recorded to date on the contract to total estimated contract costs or measured based on the proportion of labor hours expended to date on the contract to total estimated contract labor hours, as specified in the contract. Revenues from firm fixed price contracts with payments tied to milestones are recognized when all milestone requirements have been achieved and all other revenue recognition criteria have been met.   Costs incurred on firm fixed price contracts with milestone payments are recorded as work in process until all milestone requirements have been achieved. During the year ended June 30, 2010, approximately 2% of our revenue has come from firm fixed price contracts.




Provisions for estimated losses on all contracts are made in the period in which such losses become known. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined.





Shipping Costs





Delivery and shipping charges billed to customers are included in contract revenue and direct costs in the accompanying statements of operations.





Research and Development





The Company charges unfunded research and development costs to expense as incurred. Funded research and development is part of the Company’s revenue base and the associated costs are included in cost of revenues. The Company capitalizes costs related to acquired technologies that have achieved technological feasibility and have alternative uses. Acquired technologies which do not meet these criteria are expensed as in-process research and development costs.





Income Taxes





The Company allocates current and deferred taxes to its subsidiaries as if each were a separate tax payer.  The Company has no unrecognized tax benefits or uncertainties requiring additional disclosures.





Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. A deferred tax asset is recorded for net operating loss and tax credit carry forwards to the extent that their realization is more likely than not. The deferred tax benefit or expense for the period represents the change in the deferred tax asset or liability from the beginning to the end of the period.





When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained.  The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions taken are not offset or aggregated with other positions.  Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority.  The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.





The Company is primarily subject to U.S. federal and Maryland state income tax.





The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense.





Loss Per Share





Basic and diluted net loss available to common shareholders per common share has been computed based on the weighted average number of shares of common stock outstanding during the periods presented. Basic net loss per share is computed by dividing net loss by weighted-average common shares outstanding during the year. Diluted net loss per share is computed by dividing net loss by the weighted-average number of common and dilutive option and warrant shares outstanding based on the average market price of Technest’s common stock (under the treasury stock method).





F-13




Common stock equivalents, consisting of Series A and C Preferred Stock, Series D Redeemable, Convertible Preferred Stock and warrants were not included in the calculation of the diluted loss per share for the years ended June 30, 2010 and 2009 because their inclusion would have had the effect of decreasing the net loss from continuing operations per share otherwise computed (see Note 11).





Goodwill and Impairment





Goodwill consists of the excess of the purchase price over the fair value of tangible and identifiable intangible net assets acquired in business combinations. The Company is required to test goodwill for impairment at least annually at the reporting unit level in lieu of being amortized. A two-step impairment test for goodwill and intangible assets with indefinite lives is required. The first step is to compare the carrying amount of the reporting unit's net assets to the fair value of the reporting unit. If the fair value exceeds the carrying value, no further work is required and no impairment loss is recognized. If the carrying amount exceeds the fair value, then the second step is required to be completed, which involves allocating the fair value of the reporting unit to each asset and liability, with the excess being implied goodwill. An impairment loss occurs if the amount of the recorded goodwill exceeds the implied goodwill.





To estimate the fair value of its reporting unit containing the goodwill, the Company utilizes a discounted cash flow model. Other valuation methods, such as a comparable company analysis, are used to corroborate the discounted cash flow analysis performed at the reporting unit.  In estimating fair value, management relies on and considers a number of factors, including but not limited to, future revenue growth by product/service line, operating profit margins, overhead expenses, perpetual growth rates, discount rate, and market data and analysis, including market capitalization.





During the years ended June 30, 2010 and 2009 and subsequent to year-end, the Company's stock price and its market capitalization continued to be volatile due to the limited trading volume in the stock, the current economic environment and overall volatility in the stock market, especially for micro capitalization stocks.  At June 30, 2010, the Company's market capitalization was less than its book value. As described above, the Company utilizes a discounted cash flow analysis for the reporting unit containing the goodwill as its principal valuation method, but also considers market transactions and market capitalization in its evaluation of recoverability of goodwill. The Company considered and evaluated the fluctuation in market capitalization as well as the other factors described above, and concluded that its goodwill balance of approximately $4.9 million at June 30, 2010 continues to be recoverable. The Company will continue to monitor the need to test our intangibles for impairment as required, including considering the uncertainty surrounding the current economic environment, changes in estimates of future cash flows, volatility in the stock market, as well as in the Company's own stock price in assessing goodwill recoverability.





Impairment of Long-Lived Assets





The Company amortizes intangible assets over the shorter of the contractual/legal life or the estimated economic life.





The Company continually monitors events and changes in circumstances that could indicate carrying amounts of long-lived assets may not be recoverable. An impairment loss is recognized when expected cash flows are less than the asset's carrying value. Accordingly, when indicators of impairment are present, the Company evaluates the carrying value of such assets in relation to the operating performance and future undiscounted cash flows of the underlying assets. Technest’s policy is to record an impairment loss when it is determined that the carrying amount of the asset may not be recoverable. The Company tested its long-lived assets for impairment and no impairment charges were recorded in the years ended June 30, 2010 and 2009.





Stock-Based Compensation





The Company recognizes compensation costs resulting from the issuance of stock-based awards to employees and directors as an expense in the statement of operations over the requisite service period based on the fair value for each stock award on the grant date.








F-14




Recent Accounting Pronouncements





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





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





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





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





3.  DISCONTINUED OPERATIONS





In May 2007, the Company’s Board of Directors approved a plan to divest the operations of EOIR Technologies, Inc. (“EOIR”). On September 10, 2007, Technest and its wholly owned subsidiary, EOIR entered into a Stock Purchase Agreement (“SPA”) with EOIR Holdings LLC (“LLC”), a Delaware limited liability company, pursuant to which Technest agreed to sell EOIR to LLC.  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 and probable of collection based on having received notification of award of the NVESD contract pending review by the Small Business Administration.





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





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




F-15






As a result of the Settlement Agreement, Technest adjusted the related assets and liabilities in the year ended June 30, 2010 to reflect the terms of the Settlement Agreement including netting the liability of $859,137 due to LLC as a working capital adjustment on the sale of EOIR and the interest receivable of $722,070 recorded previously in accordance with the arbitration ruling. The Company has recorded a $154,000 discount on the $5 million contingent receivable as management originally anticipated collection of this amount by September 2010. The release of the WEBSS contract has fallen slightly behind original expectations and the collection of the related receivable is now anticipated in the second calendar quarter of 2011.  During the year ended June 30, 2010, the Company accreted into interest income a total of $107,219 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 June 30, 2010.





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





The net loss from discontinued operations in the year ended June 30, 2010 was $521,263 compared with a net loss of $2,209,506 in the year ended June 30, 2009. The loss in the year ended June 30, 2010 was entirely attributable to costs incurred with the arbitration against, and the subsequent settlement with, EOIR Holdings LLC.  The loss in the year ended June 30, 2009 was attributable to costs incurred with the arbitration against EOIR Holdings LLC offset by a tax benefit of $565,909 resulting from the Company incurring additional expenses in the year related to the EOIR arbitration hearing that are expected to reduce the taxable gain from the sale of EOIR.





4. TECHNEST, INC.





On October 1, 2008, the Company formed and acquired a 49% interest in Technest, Inc. (represented by 490 shares of issued common stock) in exchange for the transfer of certain contracts and employees. Technest, Inc. conducts research and development in the field of computer vision technology. The Company has the right of first refusal to commercialize products resulting from this research and development. The Company’s Chief Executive Officer beneficially owns 23% of Technest, Inc. and a former employee of the Company and current employee of Technest, Inc. owns an additional 23%.  The remaining 5% interest is held by an unrelated third party. The Company has certain rights of first refusal and repurchase rights at fair market value, as defined in certain restricted stock agreements, with respect to the shares of Technest, Inc. that it does not own.  The Company allocates certain general and administrative and overhead expenses to Technest, Inc. and in the years ended June 30, 2010 and June 30, 2009, the Company allocated a net amount of approximately $791,000 and $413,000, respectively, of such expenses to Technest, Inc.





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





On July 1, 2009, the Company adopted new guidance in accordance with the Accounting Standards Codification section 810-10 related to its non-controlling interest in Technest, Inc.  The non-controlling interest in the net loss for the year ended June 30, 2010 was $168,337.  In the year ended June 30, 2010, had the previous accounting guidance been applied, the Company’s net loss applicable to common stockholders would have been $1,482,130 (or $0.05 per share).





5.  DEFINITE-LIVED INTANGIBLE ASSETS





Definite-lived intangible assets consist of the following at June 30:





Useful

life2010


2009


(years)Patents - commercialized technology

$
440,000


$
440,000



5Patents – other


201,328



172,913



15Customer relationships and contracts


1,130,000



1,130,000



5Accumulated amortization


(1,627,731
)


(1,420,740
)Net definite-lived intangible asset

$
143,597


$
322,173





F-16


Patents are amortized over their estimated useful life but not to exceed the legal life of the patent. Customer relationships and contracts are amortized over the contractual term of the existing contracts plus anticipated contract renewals. In determining the estimated useful life of the customer relationships and contracts, the Company considered a number of factors including, its history with these customers which dates back to 1993, the remaining term of existing contracts, the status of outstanding bids submitted for additional contracts or contract extensions, the stage of development of the major tasks covered by existing contracts, the likelihood of receiving additional contracts or contract extensions and the term over which the Company could reasonably predict future revenues from existing customers.





Amortization expense was $206,990 for the year ended June 30, 2010 and $324,741 for the year ended June 30, 2009.  Costs incurred on new patent registrations during the year ended June 30, 2010 was $28,414 and for the year ended June 30, 2009 was $11,803.  Future amortization expense related to the definite-lived intangible asset is $10,741 for each of the next five years ended June 30.





6.  AMERICAN ASSET FINANCING





On November 3, 2009, the Company received $150,000 from American Asset Finance LLC (“AAF”) for general working capital purposes. On December 24, 2009, the loan was repaid for $180,000.  The Company recorded $30,000 of interest expense related to this loan at the time of repayment.





7.  SERIES D REDEEMABLE, CONVERTIBLE PREFERRED STOCK





On October 1, 2008, the Company’s Board of Directors approved the designation of 3,000 shares of Series D Redeemable, Convertible Preferred Stock (“Series D Preferred”).  The Series D Preferred 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.





Dividends accrued on the Series D Preferred quarterly at a rate of 5% per year and the Series D Preferred ranked pari passu with the holders of the Series A and Series C Preferred Stock (see Note 8).





On October 31, 2008, the Company sold 1,300 shares of its Series D Preferred to Southridge Partners, LP (“Southridge”), for a purchase price of $650,000 ($500 per share).  On May 20, 2009, the Company sold 140 shares of its Series D Preferred to Southridge Capital Management LLC (“Southridge LLC”), for a purchase price of $70,000 ($500 per share).  On June 11, 2009, the Company sold 200 shares of its Series D Preferred to Southridge LLC for a purchase price of $100,000 ($500 per share.On July 17, 2009, the Company sold 300 shares of its Series D Preferred to Southridge Capital Management LLC for a purchase price of $150,000 ($500 per share).





The Company determined that as of the date of each issuance there was a beneficial conversion feature which is the aggregate amounted to $516,000 for the fiscal 2009 issuances and $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 $1,336,000 and $255,000 in fiscal 2009 and 2010, respectively (prior to conversion).  The carrying value was further adjusted by additional dividends earned prior to conversion.  Total dividends accrued in 2010 on all outstanding Series D Preferred amounted to $36,305.  Cumulative accrued dividends on all outstanding Series D Preferred immediately prior to conversion amounted to $86,789.





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





8.  STOCKHOLDERS' EQUITY





Series A Convertible Preferred Stock





On February 8, 2005, the Company's Board of Directors designated 150 shares of preferred stock as Series A Convertible Preferred Stock (“Series A Preferred Stock”). The Series A Preferred Stock was non-interest bearing, was not entitled to receive dividends and was not redeemable. The Series A Preferred Stock had a liquidation preference of $1,000 per share.




F-17








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





Series C Convertible Preferred Stock





The Series C Convertible Preferred Stock (“Series C Preferred Stock”) was convertible into Technest common stock at any time at the option of the stockholder. The number of shares of Technest common stock into which each share of Series C Preferred Stock was convertible was determined by dividing $2.175 by the Series C Conversion Price of $2.175. Shares of the Series C Preferred Stock had a liquidation preference of approximately $2.175 per share, receive dividends on an as converted basis whenever dividends were made to the Technest common stock holders, and were not redeemable.





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





Other Common Stock Issuances





During the year ended June 30, 2010, the Company also issued 1,160,500 shares of its Common Stock with a fair value of $175,000 to five non-employee directors of the Company as compensation for service on the Company’s Board of Directors for the period July 1, 2008 to March 31, 2010.









9.  CAPITAL DISTRIBUTION





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





10.  OPTIONS, WARRANTS AND STOCK-BASED COMPENSATION





Options





In June 2001, the Company established the 2001 Stock Option Plan ("Plan") which provides for the granting of options which are intended to qualify either as incentive stock options ("Incentive Stock Options") within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, or as options which are not intended to meet the requirements of such section ("Non-Statutory Stock Options"). The total number of shares of common stock for issuance under the 2001 Plan shall not exceed 10,000,000. Options to purchase shares may be granted under the Plan to persons who, in the case of Incentive Stock Options, are key employees (including officers) of the Company or, in the case of Non-statutory Stock Options, are key employees (including officers) or nonemployee directors of, or nonemployee consultants to, the Company.





F-18




The exercise price of all Incentive Stock Options granted under the Plan must be at least equal to the fair market value of such shares on the date of the grant or, in the case of Incentive Stock Options granted to the holder of more than 10% of the Company's common stock, at least 110% of the fair market value of such shares on the date of the grant. The maximum exercise period for which Incentive Stock Options may be granted is ten years from the date of grant (five years in the case of an individual owning more than 10% of the Company's common stock). The aggregate fair market value (determined at the date of the option grant) of shares with respect to which Incentive Stock Options are exercisable for the first time by the holder of the option during any calendar year shall not exceed $100,000.





The exercise price of all Non-Statutory Stock Options granted under the Plan must be at least equal to 80% of the fair market value of such shares on the date of the grant.





No options were granted pursuant to the Plan during the years ended June 30, 2010 and 2009 and there are currently no options outstanding under the Plan. At June 30, 2010, 10,000,000 shares are available for issuance under the Plan.





Warrants





During the year ended June 30, 2010, no warrants were issued or exercised but 374,286 warrants expired without being exercised.  No warrants were issued, exercised or expired in the year ended June 30, 2009.





The following table summarizes the Company's warrants outstanding at June 30, 2010:





Exercise price

Number

Expiration Date$5.85

75,000

08/03/2013$1.89

200,000

07/17/2011275,000Weighted average remaining life

1.6 years





As of June 30, 2010 all warrants are exercisable. There is no aggregate intrinsic value for warrants outstanding as of June 30, 2010.





Stock Award Plan





On March 13, 2006, Technest adopted the Technest Holdings, Inc. 2006 Stock Award Plan (the “2006 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 2006 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 2006 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.





The following is a summary of the activity under the Stock Award Plan:





Shares


Weighted-Average

Grant-Date

Fair ValueNonvested at June 30, 2008


164,999


$
4.47Granted


170,876



0.40Vested


(335,875
)


2.39Forfeited


--Nonvested at June 30, 2009


--Granted


1,160,500



0.15Vested


(1,160,500
)


0.15Forfeited


--Nonvested at June 30, 2010


--


$
--





Of the shares granted and vested in 2010, 651,230 shares with a grant date fair value of $0.15 per share were issued to Company directors in satisfaction of services performed, and expensed, in 2009. Total stock-based compensation related to shares that vested in the years ended June 30, 2010 and 2009 was $0 and $110,854, respectively.  The fair value of restricted stock granted in the year ended June 30, 2009 was $92,349.




F-19




As of June 30, 2010, there was no unrecognized compensation cost related to non-vested restricted stock.





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 June 30, 2010, the Company has 111,845 shares available for future grant under the Plan.





11.  NET LOSS PER SHARE





Securities that could potentially dilute basic earnings per share ("EPS") and that were not included in the computation of diluted EPS because to do so would have been anti-dilutive for the years ended June 30, 2010 and 2009 consist of the following:





Shares Potentially Issuable2010


2009Series A Convertible Preferred Stock


--



306,047Series C Convertible Preferred Stock


--



402,301Series D Redeemable, Convertible Preferred Stock


--



8,452,417Warrants


275,000



649,286Total


275,000



9,810,051





12.  COMMITMENTS AND CONTINGENCIES





Facility Rental





Technest currently leases offices with approximately 6,848 square feet in Bethesda, Maryland, pursuant to a five-year lease which expires March 31, 2011. Monthly lease amounts for this facility total approximately $16,053. Rent expense for continuing operations in the years ended June 30, 2010 and 2009 was $188,423 and $183,010, respectively. The future minimum rental payments required under this operating lease through expiration is March 2011 is $144,473.





Government Contracts





In the year ended June 30, 2010, the Company billed approximately $84,000 representing the difference between provisional indirect cost rates for the fiscal year 2009 and final rates resulting from the submission to the Defense Contract Audit Agency (DCAA) of the annual Incurred Cost report for the year ended June 30, 2009.   During the year ended June 30, 2010, the Company also started billing at the increased provisional indirect cost rates for fiscal 2010 approved by the DCAA in May 2010.





The Company's billings related to certain U.S. Government contracts are based on provisional general and administrative and overhead rates which are subject to audit by the contracting government agency.





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





On January 14, 2008, Technest entered into employment agreements with its Chief Executive Officer, Mr. Gino M. Pereira and its Chief Financial Officer, Mr. Nitin V. Kotak. The employment agreements provide for:




●
a term of five years beginning on January 14, 2008;●
a base salary of $350,000 per year to Mr. Pereira and a base salary of $220,000 per year to Mr. Kotak.●
payment of all necessary and reasonable out-of-pocket expenses incurred by the executive in the performance of his duties under the agreement;●
$5,000 per month for auto expense, home office expense and other personal expenses to Mr. Pereira
 
 Mr Pereira has currently reduced his base salary to $300,000 commencing January 1, 2010 and is no longer drawing an expense allowance.




F-20


Mr. Pereira is entitled to receive a bonus of 5% of the Company’s EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) calculated on an annual basis at the end of the Company’s fiscal year, up to a maximum allowable cash bonus of 300% of his annual salary (the EBITDA Bonus). In addition, Mr. Pereira is eligible to receive equity bonus compensation under the Company’s 2006 Stock Award Plan in the amounts determined as follows: shares of common stock calculated by dividing 7% of the increase, if any, of the Market Capitalization of the Company’s common stock as of the prior fiscal year end compared to the following fiscal year end, by the closing price of the Company’s common stock on the trading day immediately prior to the issuance of such shares (the Market Cap Bonus Shares).  At June 30, 2010, the Company has not accrued any cash or equity bonus for Mr. Pereira.





Mr. Kotak is entitled to receive cash bonus and equity bonus compensation from time to time as determined by the Board of Directors of the Company, or a compensation committee of the Board of Directors of the Company, or subset of such committee, composed in accordance with the corporate governance requirements of the listing exchange.  Mr. Kotak has been granted an initial stock award of 50,000 shares of the Company’s common stock which vested on the first anniversary of the agreement.  At June 30, 2010, the Company has not accrued any cash bonus for Mr. Kotak.





The employment agreements provide that in the event that the executive's employment with Technest is terminated by Technest without cause (as that term is defined in clause (iii) of Section 8(a) of the agreement), or by the executive for "Good Reason" (as that term is defined in clause (v) of Section 8(a) of the agreement), Technest will continue to pay the executive’s cash salary and provide medical benefits comparable to those the executive participated in during his engagement with the Company for the executive and his eligible dependents for a period of one year from the date of termination. In such an event Mr. Pereira shall further be paid the EBITDA Bonus calculated on the company’s EBITDA as of the month immediately prior the date of termination and the Market Cap Bonus Shares calculated by dividing 7% of the increase, if any, of the market capitalization as of the fiscal year end prior to the date of termination compared to the 20 trading days immediately preceding the date of termination by the closing price for the trading day immediately preceding the date of termination.   In the event that the executive’s employment with Technest is terminated for any other reason, there will be no continuation of cash salary payments or medical benefits.





Mr. Pereira’s employment agreement also provides that in the event that a change of control (as defined in the agreement) occurs during the term of the agreement and the executive is terminated by the Company as a result of such change of control (other than for cause) or the executive terminates for good reason as a result of the change of control, the executive shall be entitled to an amount equal to two multiplied by the annual salary and the EBITDA Bonus calculated on the Company’s EBITDA as of the month immediately prior to the change of control and the Market Cap Bonus Shares calculated by dividing 7%of the increase, if any, of the market capitalization as of the fiscal year end prior to the change of control compared to the 20 trading days immediately preceding the change of control by the closing price for the trading day immediately preceding the change of control.





Mr. Kotak’s employment agreement also provides that in the event that a change of control (as defined in the agreement) occurs during the term of the agreement and the executive is terminated by the Company as a result of such change of control (other than for cause) the executive shall be entitled to an amount equal to the annual salary.





13.  INCOME TAXES





The income tax provision (benefit) for the years ended June 30, 2010 and 2009 was as follows:





2010


2009Continuing Operations -Current:U.S. federal

$
--


$
--State and local


--



--Deferred:U.S. federal


--



--State and local


--



--Total provision (benefit) – continuing operations

$
--


$
--Discontinued Operations -Current:U.S. federal

$
11,753


$
166,091State and local


64,972



--Deferred:U.S. federal






(636,000
)State and local






(96,000
)Total provision (benefit) – discontinued operations


76,725



(565,909
)Total provision (benefit)

$
76,725


$
(565,909
)




F-21


The income tax benefit differs from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income from continuing operations for the years ended June 30, 2010 and 2009, due to the following:





2010


2009Computed “expected” tax benefit


(35%
)


(35%
)Increase (decrease) in income taxes resulting from:State taxes, net of federal benefit


(2%
)


(3%
)Stock-based compensation


0%



0%Other permanent differences


5%



4%Increase in the valuation reserve


38%



19%6%



(15%
)





Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities at June 30, 2010 and 2009 are as follows:





2010


2009Deferred tax assets:Net operating loss carryforward

$
3,573,000


$
3,855,000Stock-based compensation


97,000



97,000Intangibles


423,000



385,000Miscellaneous accruals


140,000



611,000Property and equipment


7,000



5,000Valuation allowance


(3,500,000
)


(3,045,000
)Deferred tax assets


740,000



1,908,000Deferred tax liabilities:Accrued interest


(338,000
)


(298,000Deferred gain on sale of EOIR


(402,000
)


(1,610,000
)Deferred tax liabilities


(740,000
)


(1,908,000
)Net deferred tax asset (liability)

$
--


$
---





As of June 30, 2010 and 2009, the Company had a valuation allowance of $3,500,000 and $3,045,000, respectively.  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 years ended June 30, 2010 and 2009, the valuation allowance increased (decreased) by $455,000 and $676,000, respectively.  The increase in the valuation allowance in the year ended June 30, 2010 related to the Company’s current year recognition of a portion of the deferred gain on the sale of EOIR (see Note 3).  As of June 30, 2010, the Company has net operating loss carryforwards not subject to IRC Section 382 limitations of approximately $3,150,000 which begin to expire in 2024.





In the year ended June 30, 2010, the Company recorded a current federal and state tax payable of approximately $77,000 primarily related to states taxes which were not able to be offset by state net operating losses as a result of the Company’s use of the installment method related to the gain on the sale of EOIR.





During the years ended June 30, 2010 and 2009, the Company did not recognize any interest and penalties. Tax years subsequent to 2004 are subject to examination by federal and state authorities. Tax returns subsequent to 2007 are in the process of being filed.





14.  RELATED PARTY TRANSACTIONS





The Company’s Chief Executive Officer beneficially owns 23% of Technest, Inc. (see Note 4).





During 2009 and 2010, Technest Holdings, Inc. sold shares of its Series D 5% Convertible Preferred Stock to Southridge Partners, LP, the holder of a majority of Technest’s shares of common stock and Southridge Capital Management LLC, an affiliate of Southridge Partners, LP (see Note 7).




F-22




On December 8, 2009, in accordance with the Series D 5% Convertible Preferred Stock (“Series D”) Certificate of Designation, Southridge Partners LP and Southridge Capital Management LLC, the only holders of Series D, converted all of their shares of Series D into Technest Common Stock (see Note 7).









15.  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 these plans in the years ended June 30, 2010 and 2009 were $107,612 and $99,044, respectively.





16.  LITIGATION





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




F-23


Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure





None.





Item 9A(T). Controls and Procedures





Disclosure Controls and Procedures





We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the specified time periods and accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding disclosure.





Our management, with the participation of our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) promulgated under the Exchange Act) as of June 30, 2010, the end of our fiscal year. In designing and evaluating disclosure controls and procedures, we and our management recognize that any disclosure controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objective. As of June 30, 2010, management concludes that our disclosure controls and procedures are effective.





Management’s Report on Internal Control over Financial Reporting





Our management is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rule 13a-15(f) and 15-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of consolidated financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.





Our internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our consolidated financial statements.





Our management performed an assessment of the effectiveness of our internal control over financial reporting as of June 30, 2010. Management based its assessment on the criteria described in the “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The objective of this assessment was to determine whether our internal control over financial reporting was effective as of June 30, 2010. Management’s assessment included evaluation of elements such as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment. Based on our evaluation of internal control over financial reporting, our management concluded that our internal control over financial reporting was effective as of June 30, 2010.





Attestation Report of the Registered Public Accounting Firm





This annual report does not include an attestation report of our registered public accounting firm, Wolf & Company, P.C., regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management's report in this annual report.





Changes in Internal Controls





There were no changes in our internal controls over financial reporting during the fourth quarter of fiscal 2010 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.





23





Limitations on the Effectiveness of Controls





Our management, including our CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.





ITEM 9B. Other Information.





None.




24


PART III





ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT AND CORPORATE GOVERNANCE





Our current directors and executive officers are:





Name
Age
Position
Year BeganGino M. Pereira
53
Chief Executive Officer, President, Chairman of the Board of Directors
2005Nitin V. Kotak
53
Chief Financial Officer
2005Robert A. Curtis
55
Director
2008Laurence J. Ditkoff
50
Director
2008David R. Gust
67
Director
2006Stephen M. Hicks
50
Director
2008Henry Sargent
43
Director
2008


_______________________


Our executive officers are appointed by, and serve at the discretion of, our board of directors.





Gino M. Pereira has been our Chief Executive Officer since January 1, 2008 and had been our Chief Financial Officer since February 14, 2005. On January 6, 2006, Mr. Pereira was elected to our Board of Directors. Mr Pereira has over 25 years of executive, operational and financial experience with technology companies in the United States, Europe and the Far East. He has also helped to develop several technology start-ups as well as served in an executive capacity in a large multinational public company. In November 2001, Mr. Pereira became a founder and principal at Interim Management Solutions in Oxford, Connecticut. There, Mr. Pereira acted as a consultant for several small public and emerging companies. Prior to November 2001 Mr. Pereira was Chief Operating Officer for CDC Technologies, a medical device company, Divisional Vice President of Finance for Williams Holdings plc, a multinational public company, Group Financial Controller of Smallbone plc and Chief Accounting Officer of Norgine Pharmaceuticals Ltd. Mr. Pereira is a Fellow of the Chartered Association of Certified Accountants (UK) and has an MBA, with a specialty in finance, from the Manchester Business School in England.





Nitin V. Kotak has been our Chief Financial Officer since January 1, 2008 and had been our Vice President, Finance & Operations since November 2005.  Mr. Kotak has more than 25 years of experience in managing finance, accounting, reporting, investor relations, taxation and information technology functions in various industries and countries. Prior to joining Technest, Mr. Kotak was the Vice President of Finance & Accounting for Able Laboratories, Inc., New Jersey, a publicly traded company with a market capitalization of about $500 million from October 2003. Prior to joining Able, from December 1999 to September 2003, Mr. Kotak was the Chief Financial Officer, Corporate Secretary and the Finance Member of the Board of Directors of Mattel Toys (India) Private Limited, a wholly owned subsidiary of Mattel Inc. Mr. Kotak is a Fellow of the Chartered Association of Certified Accountants (India). Mr. Kotak received his Bachelor of Commerce in Accounting from the University of Calcutta.





Dr. Robert A. Curtishas served on our Board of Directors since January 14, 2008.  Dr. Curtis is currently the Chief Executive Officer of the Regional Technology Development Corporation in Woods Hole, Massachusetts, an innovation accelerator broadly focused on commercialization including licensing and start-up companies based on technology discovered and developed from the Woods Hole Oceanographic Institution and the Marine Biological Laboratory.  He was most recently co-founder, President and CEO of HistoRx, Inc. a tissue based diagnostics company formed with the Yale University School of Medicine.  Over the last 17 years, he has founded or been directly involved in the early stages of nine start-up companies, primarily in the life sciences area including Combichem, Inc, Pharmacopeia, Inc, MetaMorphix, Inc, Cape Aquaculture Technologies, Inc. and Cambridge Neuroscience, Inc. Prior to his entrepreneurial activities, Dr. Curtis held a variety of positions at Pfizer, Inc., including Director of Licensing and Development, where he was responsible for worldwide pharmaceutical licensing and technology acquisition. He started his career as an Assistant Professor at the University of Illinois Medical Center in Chicago. Dr. Curtis earned a B.S. degree in Pharmacy from the Massachusetts College of Pharmacy, a Doctor of Pharmacy degree and Residency in Clinical Pharmacology from the University of Missouri, and a M.B.A. from Columbia University. Dr. Curtis is currently an advisor to a number of private entrepreneurial companies and has served as a judge for the MIT $50K Entrepreneurial Award-Business Plan Competition.





Laurence J. Ditkoff, CFA, CPA, has served on our Board of Directors since March 11, 2008. Mr. Ditkoff is the Director of Research for Southridge LLC and responsible for investment evaluation and selection, due diligence, and transaction structuring. He joined Southridge in 2000. He spent 14 years at Bell Atlantic Corporation and NYNEX, where he was responsible for financial oversight, cash flow forecasting, financial statement analysis, competitive threat analysis, and financial evaluation of new products. Mr. Ditkoff received a BA in Accounting from the University of Pennsylvania, and an MBA in Finance from Pace University, NY. He is a Certified Public Accountant for the State of New York.





Major General David R. Gust, USA, Ret.has served on our Board of Directors and as the chairperson of our Compensation Committee since March 15, 2006. General Gust presently does consulting work for his own company, David R. Gust & Associates, LLC.  Between April 2007 and May 2009, General Gust was the President of USfalcon, a privately-held company working with the US Defense sector, primarily in information technology. Previously, General Gust had served as the Manager for Federal Telecommunications for Bechtel National, Inc. from November 2004 to March 2007. Prior to that, he was the President and Chief Executive Officer of Technical and Management Services Corporation from 2000 to 2004. General Gust retired from the United States Army in 2000 after completing a career of 34 years of service. At retirement, he was the US Army Deputy Chief of Staff for Research, Development and Acquisition, Army Material Command. General Gust received his B.S. in Electrical Engineering from the University of Denver and Master’s Degrees in Systems Management and National Security and Strategy from the University of Southern California and the United States Naval War College, respectively.




25




Stephen M. Hicks has served on our Board of Directors since March 11, 2008. Mr. Hicks founded Southridge LLC in 1996 and serves as its Chairman and Chief Executive Officer. Mr. Hicks sets the overall strategic direction for the Southridge group of companies and is responsible for business development and execution. Active in the investment industry for over 25 years, Mr. Hicks has broad experience in financial structuring, derivatives, risk arbitrage, and investment banking. He received his BS in Business Administration from King's College in Briarcliff Manor, New York, and an MBA from Fordham University, in New York City.





Henry Sargent, JD, CFA, has served on our Board of Directors since March 11, 2008. Mr. Sargent serves as General Counsel and Chief Operating Officer of Southridge LLC. His responsibilities include investment selection, deal structuring, workouts, and reorganization. Prior to joining Southridge in 1998, Mr. Sargent spent several years at a New York-based corporate and securities law firm, specializing in private placements, venture capital financing, and corporate reorganizations. He received a JD from Fordham University School of Law, New York, New York. Mr. Sargent is a member of the New York Bar Association, the CFA Institute, and the New York Society of Security Analysts.





Code of Ethics





The board of directors has adopted a code of ethics applicable to all of our directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer. A copy of the Code of Ethics is available at our website www.technestinc.com.





Section 16(a) Beneficial Ownership Reporting Compliance





Our executive officers and directors and persons who own beneficially more than ten percent of our equity securities are required under Section 16(a) of the Securities Exchange Act of 1934 to file reports of ownership and changes in their ownership of our securities with the Securities and Exchange Commission.  They must also furnish copies of these reports to us.  Based solely on a review of the copies of reports furnished to us and written representations that no other reports were required, we believe that for fiscal year 2010, our executive officers, directors and 10% beneficial owners complied with all applicable Section 16(a) filing requirements, except that (i) Mr. Hicks filed a late Form 4 on December 21, 2009 which was due on December 14, 2009 and on May 11, 2010 which was due on May 10, 2010, both for the issuance of shares of Common Stock to Mr. Hicks by the Company; (ii) Mr. Sargent filed a late Form 4 on December 21, 2009 which was due on December 14, 2009 and on May 11, 2010 which was due on May 10, 2010, both for the issuance of shares of Common Stock to Mr. Sargent by the Company; and (iii) Mr. Ditkoff filed a late Form 4 on December 18, 2009 which was due on December 14, 2009 and on May 11, 2010 which was due on May 7, 2010, both for the issuance of shares of Common Stock to Mr. Ditkoff by the Company.




26


ITEM 11.  EXECUTIVE COMPENSATION





Executive Officer Compensation





Summary Compensation:The following table sets forth certain compensation information for our chief executive officer and our other most highly compensated executive officer (other than our chief executive officer) who served as an executive officer during the year ended June 30, 2010 and whose annual compensation exceeded $100,000 for that year.





Summary Compensation Table





Name and Principal Position

Year

Salary

($)


Bonus

($)


Stock

Awards ($)


All other compensation

($)


Total ($)Gino M. Pereira

2010

$
325,000
(1)

$
-


$
-


$
662,425
(2)

$
987,425Chief Executive Officer and President

2009


350,000
(3)


-



-



69,775
(4)


419,775Nitin V. Kotak

2010

$
220,000


$
-


$
-


$
15,420
(5)

$
235,420Chief Financial Officer

2009


220,000
(3)


-




-


10,980
(5)


230,980


_____________________________


(1)
From July 1, 2009 to December 31, 2009, Mr. Pereira was paid at an annual rate of $350,000. Beginning on January 1, 2010, Mr. Pereira agreed to reduce his salary to an annual rate of $300,000.





(2)
Consists of (i) $615,000 paid to Mr. Pereira in accordance with his March 13, 2006 employment agreement which payment was triggered by the sale of EOIR Technologies, Inc., (ii) $30,000 earned by Mr. Pereira from July 1, 2009 through December 31, 2009 as the executive’s fixed amount per month for auto expense, business office expense and other personal expenses pursuant to Mr. Pereira’s employment agreement (as of January 1, 2010, the executive agreed to  no longer receive this payment), and (iii) $17,425 as Technest’s matching and safe harbor contributions under its 401(k) plan.





(3)
Salaries include voluntary deferred cash compensation by Mr. Pereira and Mr. Kotak of $114,000 and $37,000, respectively, which were fully paid in fiscal year ended June 30, 2010.





(4)
Consists of (i) $60,000 earned by Mr. Pereira as the executive’s fixed amount per month for auto expense, business office expense and other personal expenses pursuant to Mr. Pereira’s employment agreement, and (ii) $9,775 as Technest’s matching and safe harbor contributions under its 401(k) plan.





(5)
Consists of Technest’s matching and safe harbor contributions under its 401(k) plan.








Outstanding Equity Awards at Fiscal Year-End





As of June 30, 2010, none of our named executive officers had any unvested equity awards.





Employment Agreement with Gino M. Pereira





On January 14, 2008, Technest Holdings, Inc. entered into a new employment agreement with our Chief Executive Officer, Mr. Gino M. Pereira.  Mr. Pereira’s employment agreement provides for:




●
a term of five years beginning on January 14, 2008;●
a base salary of $350,000 per year, which is the same base salary as set forth in Mr. Pereira’s prior employment agreement (the “Annual Salary”);●
payment of all necessary and reasonable out-of-pocket expenses incurred by Mr. Pereira in the performance of his duties under the agreement;●
$5,000 per month for auto expense, business office expense and other personal expenses, which is the same amount as set forth in Mr. Pereira’s prior employment agreement;●
eligibility to receive a performance based bonus of 5% of  Technest’s EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) calculated on an annual basis at the end of Technest’s fiscal year, up to a maximum allowable cash bonus of 300% of the Annual Salary (the “EBITDA Bonus”), payable by Technest within 90 days of the end of Technest’s fiscal year; and 
 27
 
 ●
eligibility to receive a performance based stock award under Technest’s 2006 Stock Award Plan calculated by dividing (x) 7% of the increase, if any, of the Market Capitalization (as defined below) of Technest’s Common Stock as of the prior fiscal year end compared to the following fiscal year end, by (y) the closing price of Technest’s Common Stock on the trading day immediately prior to the issuance of such shares (the “Market Cap Bonus Shares”).  Such Market Cap Bonus Shares shall be issued within 7 days of the end of the Company’s fiscal year.  For purposes of the employment agreement, “Market Capitalization” shall mean the average closing price of Technest’s Common Stock as traded on the Over-the-Counter Bulletin Board (or if the Common Stock is no longer listed on that market, the principal securities exchange or trading market on which the Common Stock is listed, quoted or traded), for 20 consecutive trading days ending immediately prior to the measurement date, multiplied by the average number of shares of Technest’s Common Stock outstanding for the same 20 consecutive trading days.




The employment agreement provides that in the event that Mr. Pereira's engagement with Technest is terminated by Technest without cause (as that term is defined in Section 8(b) of the agreement), or by Mr. Pereira for “Good Reason” (as that term is defined in Section 8(c) of the agreement), Technest will continue to pay Mr. Pereira's Annual Salary and provide health insurance for a period of one year from the date of termination plus the EBITDA Bonus and the Market Cap Bonus Shares as calculated in Section 8(f) of the agreement. In the event that Mr. Pereira is terminated by Technest as a result of a Change of Control (as defined in the agreement) or Mr. Pereira terminates his employment for Good Reason as a result of a Change of Control, he would be entitled to two times the Annual Salary, plus the EBITDA Bonus and the Market Cap Bonus Shares as calculated in Section 8(g) of the agreement. In the event that Mr. Pereira's employment with Technest is terminated for any other reason, there will be no continuation of cash salary payments or health insurance.





The above description summarizes the material terms of Mr. Pereira’s employment agreement, which is filed as Exhibit 10.1 to our Current Report on Form 8-K filed on January 18, 2008 and is incorporated by reference herein. For further information on Mr. Pereira’s employment agreement, please refer to Exhibit 10.1.





As of January 1, 2010, Mr Pereira has reduced his base salary to $300,000 and declined his monthly expense allowance.





Employment Agreement with Nitin V. Kotak





On January 14, 2008, Technest entered into an employment agreement with our Chief Financial Officer, Mr. Nitin V. Kotak.  Mr. Kotak’s employment agreement provides for:




●
a term of five years beginning on January 14, 2008;●
An initial base salary of $220,000 per year (the “Annual Salary”);●
payment of all necessary and reasonable out-of-pocket expenses incurred by Mr. Kotak in the performance of his duties under the agreement;●
eligibility to receive cash bonuses as determined by the board of directors; and●
eligibility to receive equity awards under Technest’s 2006 Stock Award Plan as determined by the board of directors, with an initial award of 50,000 shares of Common Stock which vested on January 14, 2009.




The employment agreement provides that in the event that Mr. Kotak's engagement with Technest is terminated by Technest without cause (as that term is defined in Section 8(b) of the agreement), or by Mr. Kotak for “Good Reason” (as that term is defined in Section 8(c) of the agreement), Technest will continue to pay Mr. Kotak's Annual Salary and provide health insurance for a period of one year from the date of termination. In the event that Mr. Kotak is terminated as a result of a Change of Control (as defined in the agreement), he would be entitled to his Annual Salary. In the event that Mr. Kotak's employment with Technest is terminated for any other reason, there will be no continuation of cash salary payments or health insurance.





The above description summarizes the material terms of Mr. Kotak’s employment agreement, which is filed as Exhibit 10.2 to our Current Report on Form 8-K filed on January 18, 2008 and is incorporated by reference herein. For further information on Mr. Kotak’s employment agreement, please refer to Exhibit 10.2.





28




Director Compensation





Summary Compensation:The following table sets forth the compensation of our directors for the year ended June 30, 2010.





Name and Principal Position

Director

Fees

($) (1)


Stock Awards

($)(2)


All other compensation

($)


Total

($)Robert A. Curtis


$5,000—


$
15,000 (3)(4)



—


$
20,000Laurence Ditkoff


5,000—



15,000 (3)(5)



—



20,000David R. Gust


5,000—



15,000 (3)(6)



—



20,000Stephen Hicks


5,000—



15,000 (3)(5)



—



20,000Henry Sargent


5,000—



15,000 (3)(5)



—



20,000


_____________________________


(1)
Director fees include all fees earned for director services including an annual retainer and committee chairman fees, to the extent applicable.  This amount reflects the amount of director fees earned by each director for their services during the quarter ended June 30, 2010 which has not yet been satisfied.


(2)
The fair value of the stock awarded on December 14, 2009 and May 10, 2010.


(3)
Each director received 130,246 shares of Technest Common Stock as compensation for their services for the fiscal year ended June 30, 2009 and 101,854 shares of Technest Common Stock as compensation for their services from July 1, 2009 through March 31, 2010.


(4)
As of June 30, 2010, Dr. Curtis has been awarded a total of 277,015 shares of Technest Common Stock for his services as a director, all of which remain outstanding.


(5)
As of June 30, 2010, Messrs. Ditkoff, Hicks and Sargent each have been awarded a total of 243,017 shares of Technest Common Stock as compensation for their services as directors, all of which remain outstanding.


(6)
As of June 30, 2010, General Gust has been awarded a total of 310,310 shares of Technest Common Stock for his services as a director, all of which remain outstanding.





Director Fees and Stock Awards. During our fiscal year ended June 30, 2010, our non-employee directors were to be paid $20,000 per year as compensation for their services paid in Technest Common Stock on a quarterly basis; the number of shares to be issued was determined by using the average closing price for the last five trading days of the respective quarter. The payment of $5,000 for the quarter ended June 30, 2010 has not yet been satisfied. Directors who are also our employees receive no additional compensation for serving as directors.





29




Equity Compensation Plan Information





The following table provides information about the securities authorized for issuance under the Company's equity compensation plans as of June 30, 2010:





Plan category

Number of securities to be issued upon exercise of outstanding options, warrants and rights


Weighted average exercise price of outstandingoptions,

warrants andrights


Number of securities remaining available for future issuance(a)


(b)


(c)Equity compensation plans approved by security holders (1)


0


$
0



10,000,000Equity compensation plans not approved by security holders (2)


0



0



111,845
(2)Total


0


$
0



10,111,845
(2)





(1)
2001 Stock Option Plan.





(2)
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.  On September 21, 2009, the Board of Directors of Technest increased the number of shares issuable under the plan from 1,000,000 shares to 2,000,000 shares. The purpose of this plan is to secure for Technest and its shareholders the benefits arising from capital stock ownership by employees, officers and directors of, and consultants or advisors to, Technest and its subsidiaries who are expected to contribute to the Company’s future growth and success.  Technest has broad discretion in making grants under the plan and may make grants subject to such terms and conditions as determined by the board of directors or the committee appointed by the board of directors to administer the plan.  Stock awards under the plan will be subject to the terms and conditions, including any applicable purchase price and any provisions pursuant to which the stock may be forfeited, set forth in the document making the award.  As of June 30, 2010, the Company had 111,845 shares available for issuance under the plan.





30




ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS





The following tables set forth information regarding the beneficial ownership of our common stock as of September 23, 2010 by:





-
each of our directors and officers;


-
each person (including any group) who is known by us to own beneficially 5% or more of our common stock; and


-
all current directors and executive officers as a group.





Beneficial ownership is determined in accordance with the rules of the SEC. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of Common Stock subject to options, warrants and any other type of convertible securities held by that person that are currently exercisable or exercisable within 60 days of September 23, 2010, are deemed issued and outstanding. These shares, however, are not deemed outstanding for purposes of computing percentage ownership of each other stockholder. Percentage of ownership is based on 32,678,056 shares of common stock outstanding on September 23, 2010, subject to adjustment for options, warrants and any other type of convertible securities as previously described.





Except as indicated in the footnotes to this table, each stockholder named in the table has sole voting and investment power with respect to the shares shown as beneficially owned by them. Unless otherwise noted below, the address of the beneficial owners is Technest Holdings, Inc., 10411 Motor City Drive, Suite 650, Bethesda, Maryland 20817.





Beneficial Owner of 5% or more

Number of Shares

Beneficially OwnedShares


PercentSouthridge Partners LP

90 Grove Street

Ridgefield, CT 06877


13,170,173
(1)


40.3
% (1)Pine Street Associates

c/o CRT Capital

262 Harbor Drive

Stamford, CT 06902


4,543,990



13.91
%Southridge Capital Management LLC

90 Grove Street

Ridgefield, CT 06877


3,274,639
(2)


10.02
% (2)Aberdeen Avenue LLC

Cayside, 2nd Floor Georgetown,

Grand Cayman, Cayman Islands, British West Indies


1,814,782
(3)


5.5%
(3)Directors and Executive OfficersGino M. Pereira, Chief Executive Officer, President and Director


447,000



2.10
%Nitin V. Kotak, Chief Financial Officer


50,000



*Robert A. Curtis, Director


277,015



*Laurence Ditkoff, Director


243,017



*David R. Gust, Director


310,310



*Stephen Hicks, Director


20,345,665
(4)


62.23
%Henry Sargent, Director


433,620
(5)


1.33
%All Current Directors and Executive Officers as a Group (7 Persons)


22,106,627
(4)(5)


67.65
% (4)(5)





31





*Less than 1%





(1) Stephen Hicks has voting and investment control over the securities held by Southridge Partners, LP and disclaims beneficial ownership of such shares.





(2) Stephen Hicks has voting and investment control over the securities held by Southridge Capital Management LLC and disclaims beneficial ownership of such shares.





(3) Aberdeen Avenue LLC is the beneficial owner of an aggregate of 1,814,782 shares of Technest Common Stock, which includes (i) 1,416,101 shares of Technest Common Stock; and (ii) as reported in Schedule 13D/A filed in October 2009, 1,203.18 shares of Series G Preferred Stock issued by Markland Technologies Inc., convertible subject to certain restrictions into an additional 398,681 shares of Technest Common Stock.





Each of David Sims and Stephen Hicks  has voting and investment control over the securities held by Aberdeen Avenue LLC and each disclaims beneficial ownership of such shares.





(4) Includes (i) the shares beneficially owned by Southridge Partners, LP, Southridge Capital Management LLC and Aberdeen Avenue LLC, see forth in footnotes (1), (2) and (3), (ii) 243,017 shares of Technest Common Stock owned directly by Mr. Hicks;  (iii) 1,035,208 shares beneficially owned by Southshore Capital Fund Ltd.; (iv)  as reported in Schedule 13D/A filed in October 2009, 111.81 shares of Series G Preferred Stock issued by Markland Technologies Inc., convertible subject to certain restrictions into an additional 37,049 shares of Technest Common Stock are owned by Southshore Capital Fund Ltd., (v) 304,578 shares of Technest Common Stock owned by Garth LLC; and  (vi) 466,219 shares of Common Stock owned by Trillium Partners, LP for which Mr. Hicks is the President of the general partner. Each of David Sims and Stephen Hicks has voting and investment control over the securities held by Southshore Capital Fund Ltd. and Garth LLC and each disclaims beneficial ownership of such shares.





(5) Includes 190,603 shares of Common Stock owned by Mountain West Partners LLC, for which Mr. Sargent is the managing member.




32


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE





Conversion of Series A Convertible Preferred Stock and Series C Convertible Preferred Stock





On December 14, 2009, in accordance with the Series A Certificate of Designation, as amended, Garth LLC, the only holder of Technest Series A Convertible Preferred Stock, converted all of its shares of Technest Series A Convertible Preferred Stock into 304,578 shares of Technest Common Stock.  After this conversion, there are no longer any shares of Technest Series A Convertible Preferred Stock outstanding.  The issuance of the shares of Common Stock in this transaction was exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”), pursuant to Section 3(a)(9) of the Securities Act.





On December 14, 2009, in accordance with the Series C Certificate of Designation, as amended, Southridge Partners LP and Southshore Capital Fund Ltd., the only holders of Technest Series C Convertible Preferred Stock, converted all of their shares of Technest Series C Convertible Preferred Stock into 344,827 shares of Technest Common Stock and 57,467 shares of Technest Common Stock, respectively. After these conversions, there are no longer any shares of Technest Series C Convertible Preferred Stock outstanding.  The issuance of the shares of Common Stock in these transactions was exempt from registration under the Securities Act pursuant to Section 3(a)(9) of the Securities Act.





Conversion of Series D 5% Convertible Preferred Stock





On December 8, 2009, in accordance with the Series D 5% Convertible Preferred Stock (“Series D”) Certificate of Designation, Southridge Partners LP and Southridge Capital Management LLC, the only holders of Series D, converted all of their shares of Series D into Technest Common Stock.  Upon conversion of the Series D, 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, Southridge Capital Management LLC acquired 3,274,639 shares of Technest Common Stock, which included 74,639 shares in payment of the accrued cumulative dividend of 5% per annum. After these conversions, there are no longer any shares of Technest Series D outstanding. The issuance of the shares of Common Stock in these transactions was exempt from registration under the Securities Act pursuant to Section 3(a)(9) of the Securities Act.





The Certificate of Designation of the Series D was filed as Exhibit 4.18 to Technest’s annual report on Form 10-KSB for the year ended June 30, 2008 filed with the Securities and Exchange Commission on October 2, 2008 and is incorporated by reference herein.





Any transactions required to be disclosed herein must be approved by the Company’s board of directors.





Director Independence





For the fiscal year ended June 30, 2010, our Board of Directors determined that two of the six directors- Robert A. Curtis and David R. Gust, were independent directors as defined by the NASDAQ Rule 4200(a)(15) governing the independence of directors.





In March 2006, our Board of Directors created three standing committees: Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee. Since the resignation of Mr. Robert Doto and Ms. Darlene Deptula-Hicks, we have had vacancies on the Compensation Committee and the Nominating and Corporate Governance Committee. Currently, the full Board of Directors is serving the functions of the Compensation Committee and the Nominating and Corporate Governance Committee. Upon Ms. Depula-Hicks’ resignation on August 9, 2007, Technest no longer had an audit committee financial expert. Until such time as another independent director, who also qualifies as an audit committee financial expert, is elected to Board of Directors, the Audit Committee has been disbanded and the full Board of Directors serves the functions of the Audit Committee.





33





ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES





Fees and Services





Audit Fees.The aggregate audit fees billed for professional services rendered by the independent registered public accounting firm for the audit of our financial statements as of and for the years ended June 30, 2010 and 2009, the reviews of our quarterly financial statements for the respective years, our filings with the Securities and Exchange Commission and other audit fees were $90,000 and $97,250, respectively.





Audit Related Fees.The aggregate audit related fees billed for professional services by the independent registered public accounting firm as of and for the years ended June 30, 2010 and June 30, 2009 were $0 and $2,400, respectively. In the year ended June 30, 2009, the audit related fees include services rendered for issuing and assisting with SEC comment letter responses.





Tax Fees.The aggregate tax fees billed for professional services by the independent registered public accounting firm as of and for the years ended June 30, 2010 and 2009 were $25,400 and $41,125, respectively.  The tax fees for both periods include fees for the preparation of federal and state income tax returns.  The 2009 fees also include assistance with IRC Section 382 analysis as well as due diligence assistance with the EOIR transaction.





All Other Fees.No other fees were billed by or paid to the independent registered public accounting firm during the years ended June 30, 2010 or 2009.





Other than the services discussed above, Wolf & Company, P.C. has not rendered any non-audit related services for the period ended June 30, 2010.





At this time, we do not have a stand-alone Audit Committee. Until an independent director who also qualifies as an audit committee financial expert is elected to the Board of Directors, the full Board of Directors is serving the function of the Audit Committee.





For the year ended June 30, 2010, the full Board of Directors, functioning as the Audit Committee, approved the audit or non-audit services before the accounting firm was engaged to perform any such services.  Management must obtain the specific prior approval of the Board of Directors for each engagement of the independent registered public accounting firm to perform any audit-related or other non-audit services.  The Board of Directors does not delegate its responsibility to approve services performed by the independent registered public accounting firm to any member of management.





Item 15.  Exhibits.





Exhibit No.
Description
Filed with this

10-K
Incorporated

by reference

From
Filing Date
Exhibit No.2.1
2001 Stock Option Plan

DEF 14A
June 14, 2001
C2.2
Stock Purchase Agreement dated September 10, 2007 between Technest Holdings, Inc., EOIR Holdings, LLC and E-OIR Technologies, Inc.

8-K
September 13, 2007
2.12.3
Form of Voting Agreement with a list of signatories.

8-K
September 13, 2007
2.22.4
First Amendment to Stock Purchase Agreement dated December 31, 2007 among Technest Holdings, Inc., EOIR Holdings, LLC and EOIR Technologies, Inc.

8-K
January 4, 2008
2.33.1
Restated Articles of Incorporation dated December 22, 1998

SB-2
February 26, 1999
3.13.2
Restated Articles of Incorporation of Registrant, dated as of December 14, 2000, as filed with the Secretary of State of the State of Nevada on March 2, 2001.

10-KSB
April 16, 2001
3.2





3.3
Certificate of Amendment to Articles of Incorporation

8-K
August 9, 2001
3.1 34
  3.4
Amended and Restated By-Laws dated May 21, 2001.

DEF 14A
June 14, 2001
B3.5
Bylaw Amendments

8-K
December 20, 2006
3.13.6
By-law Amendments

8-K
October 4, 2007
3.14.1
Form of Common Stock Certificate

SB-2
February 26, 1999
4.14.2
Series A Convertible Preferred Stock Certificate of Designations, filed with the Secretary of State of Nevada on February 8, 2005.

8-K
February 14, 2005
4.1





4.3
Form of Technest Common Stock Purchase Warrant

8-K
February 15, 2005
4.64.4
Technest Series B Convertible Preferred Stock Certificate of Designations filed with the Secretary of State of Nevada on February 14, 2005.

8-K
February 15, 2005
4.74.5
Technest Series C Convertible Preferred Stock Certificate of Designations filed with the Secretary of State of Nevada on February 14, 2005

8-K
February 15, 2005
4.84.6
Technest Common Stock Warrant issued to Silicon Valley Bank dated August 4, 2006.

8-K
August 14, 2006
4.14.7
Registration Rights Agreement between Technest Holdings, Inc. and Silicon Valley Bank dated August 4, 2006.

8-K
August 14, 2006
4.24.8
Technest Common Stock Warrant issued to Crystal Research Associates LLC dated July 17, 2006

10-KSB
October 13, 2006
4.154.9
Registration Rights Agreement between Technest Holdings, Inc. and Crystal Research Associates LLC dated July 17, 2006.

10-KSB
October 13, 2006
4.164.10
Technest Series D 5% Convertible Preferred Stock Certificate of Designations filed with the Secretary of State of Nevada on October 1,  2008

10K-SB
October 2, 2008
4.184.11
Amendments to Technest Series A Convertible Preferred Stock Certificate of Designation, filed with the Secretary of State of Nevada on December 10, 2009

8-K
December 14, 2009
4.44.12
Amendments to Technest Series C Convertible Preferred Stock Certificate of Designation, filed with the Secretary of State of Nevada on December 10, 2009

8-K
December 14, 2009
4.510.1
Office Lease Agreement between Motor City Drive, LLC and Genex Technologies, Inc., dated December 20, 2005.

10-QSB
February 21, 2006
10.710.2*
Form of Restricted Stock Agreement between Gino M. Pereira and Technest Holdings, Inc.

8-K
March 17, 2006
10.610.3*
Technest Holdings, Inc. 2006 Stock Award Plan.

8-K
March 17, 2006
10.8





35




10.4
Indemnification Agreement between Technest Holdings, Inc. and Markland Technologies, Inc. dated September 1, 2006.

10-KSB
October 13, 2006
10.3610.5
Office Lease Agreement Amendment No. 1 by and among Genex Technologies, Incorporated, Technest Holdings, Inc. and Motor City Drive, LLC dated as of November 1, 2006.

10-QSB
February 14, 2007
10.110.6
Asset Contribution Agreement between Technest Holdings, Inc. and Genex Technologies Incorporated dated November 1, 2006.

10-QSB
February 14, 2007
10.210.7
Release Agreement dated August 31, 2007 between Technest Holdings, Inc. and Southridge Partners, LP

8-K
September 7, 2007
10.110.8
Form of Non-competition Agreement entered into between EOIR Technologies, Inc. and Technest Holdings, Inc. and Genex Technologies, Inc.

Definitive

Information

Statement on Schedule 14C
December 7, 2007
Annex D10.9
Form of Release entered into by Technest Holdings, Inc. and Genex Technologies, Inc. and acknowledged by EOIR Holdings LLC

Definitive

Information

Statement on Schedule 14C
December 7, 2007
Annex C10.10*
Employment Agreement between Gino M. Pereira and Technest Holdings, Inc. dated January 14, 2008.

8-K
January 18, 2008
10.110.11*
Employment Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated January 14, 2008.

8-K
January 18, 2008
10.210.12*
Restricted Stock Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated January 15, 2008.

8-K
January 18, 2008
10.310.13*
Restricted Stock Agreement between David R. Gust and Technest Holdings, Inc. dated January 15, 2008.

8-K
January 18, 2008
10.510.14*
Restricted Stock Agreement between Dr. Robert A. Curtis and Technest Holdings, Inc. dated January 15, 2008.

8-K
January 18, 2008
10.610.15*
Severance Agreement between Joseph P. Mackin and Technest Holdings, Inc. dated December 31, 2007.

10-QSB
February 19, 2008
10.810.16*
Agreement between Gino M. Pereira and Technest Holdings, Inc. dated December 31, 2007.

10-QSB
February 19, 2008
10.910.17
Asset Contribution Agreement between Technest Holdings, Inc. and Technest, Inc. dated September 17, 2008, effective as of October 1, 2008.

10-KSB
October 2, 2008
10.48





36




10.18
Securities Purchase Agreement dated October 31, 2008 between Technest Holdings, Inc. and Southridge Partners, LP.

8-K
November 5, 2008
10.110.19
Securities Purchase Agreement dated May 20, 2009 between Technest Holdings, Inc. and Southridge Capital Management LLC

8-K
May 27,2009
10.110.20
Securities Purchase Agreement dated June 11, 2009 between Technest Holdings, Inc. and Southridge Capital Management LLC

8-K
June 16, 2009
10.110.21
Securities Purchase Agreement dated July 17, 2009 between Technest Holdings, Inc. and Southridge Capital Management LLC

8-K
July 22, 2009
10.110.22
Form of Non-Employee Director Restricted Stock Grant Agreement entered into by each non-employee director and Technest Holdings, Inc. dated September 21, 2009

10-K
October 19, 2009
10.2210.23
Settlement Agreement among Technest Holdings, Inc., EOIR Holdings, LLC and EOIR Technologies, Inc. dated October 26, 2009

8-K
October 29, 2009
10.110.24*
Technest Holdings, Inc. 2006 Stock Award Plan, As amended  September 21, 2009

10-Q
November 16, 2009
10.210.25
Form of Non-Employee Director Restricted Stock Grant Agreement entered into by each non-employee director and Technest Holdings, Inc. dated December 2009

8-K
December 14, 2009
10.110.26
Form of Non-Employee Director Restricted Stock Grant Agreement entered into by each non-employee director and Technest Holdings, Inc. dated May 2010

10-Q
May 14, 2010
10.1





21.1
List of the Subsidiaries of Technest Holdings, Inc.
x23.1
Consent of Wolf & Company, PC
x31.1
Certification by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).
x31.2
Certification by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).
x32.1
Certification by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section 1350
x





* Indicates a management contract or compensatory plan.




37


Signatures





In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on September 28, 2010.





TECHNEST HOLDINGS, INC.By:
/s/ Gino Miguel PereiraGino Miguel PereiraChief Executive Officer





In accordance with the Exchange Act, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.





Signature

Title

Date/s/ Gino Miguel Pereira

Chief Executive Officer, President and Chairman of the Board of Directors

September 28, 2010Gino Miguel Pereira/s/ Nitin V. Kotak

Chief Financial Officer and Principal Accounting Officer

September 28, 2010Nitin V. Kotak/s/ Robert Curtis

Director

September 28, 2010Robert Curtis/s/ Laurence Ditkoff

Director

September 28, 2010Laurence Ditkoff/s/ David R. Gust

Director

September 28, 2010David R. Gust/s/ Stephen Hicks

Director

September 28, 2010Stephen Hicks/s/ Henry Sargent

Director

September 28, 2010Henry Sargent