U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: September 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
COMMISSION FILE NUMBER 000-28863
MARKLAND TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
FLORIDA | 84-1334434 |
(STATE OR OTHER JURISDICTION OF | (IRS EMPLOYER |
INCORPORATION OR ORGANIZATION) | IDENTIFICATION NO.) |
88 Royal Little Drive
Providence, RI 02904
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
(617)973 5104
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to filed such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X
As of November 21, 2005, there were 350,449,710 shares of common stock, $0.0001 par value, of the registrant issued and outstanding.
Transitional Small Business Disclosure Format (CHECK ONE):
Yes [ ] No [X]
MARKLAND TECHNOLOGIES, INC.
FORM 10-QSB
September 30, 2005
Statements contained in this quarterly report on Form 10-QSB, for the quarter ended September 30, 2005, which are not historical facts constitute forward-looking statements and are made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as "may", "will", "expect", "anticipate", "believe", "estimate", "continue", and similar words. You should read statements that contain these words carefully. All forward-looking statements included in this quarterly report on Form 10-QSB, for the quarter ended September 30, 2005, are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Each forward-looking statement should be read in conjunction with the financial statements and notes thereto in Part I, Item 1, of this quarterly report and with the information contained in Item 2 together with Management's Discussion and Analysis or Plan of Operation contained in our annual report on Form 10-KSB for the year ended June 30, 2005, including, but not limited to, the section therein entitled "Risk Factors."
MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
AT SEPTEMBER 30, 2005
(UNAUDITED)
ASSETS | ||||
CURRENT ASSETS: | ||||
Cash | $ | 4,532,710 | ||
Accounts receivable | 7,888,130 | |||
Inventory and work in process | 291,312 | |||
Restricted cash | 291,459 | |||
Other current assets | 289,909 | |||
TOTAL CURRENT ASSETS | 13,293,520 | |||
PROPERTY AND EQUIPMENT- NET | 847,155 | |||
OTHER ASSETS: | ||||
Amortizable intangible assets, net | 12,931,139 | |||
Goodwill | 14,035,551 | |||
TOTAL OTHER ASSETS | 26,966,690 | |||
TOTAL ASSETS | $ | 41,107,365 | ||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||
CURRENT LIABILITIES: | ||||
Accounts payable | $ | 10,171,184 | ||
Accrued expenses and other current liabilities | 3,604,324 | |||
Convertible secured notes, net of discount of $69,344 | 1,328,031 | |||
Dividend payable | 1,885,529 | |||
Current portion of long-term debt | 2,322,193 | |||
TOTAL CURRENT LIABILITIES | 19,331,261 | |||
NON-CURRENT LIABILITIES | ||||
Long-term debt, less current portion and discount of $1,100,967 | 5,484,435 | |||
TOTAL LIABILITIES | 24,795,696 | |||
MINORITY INTEREST | 5,071,079 | |||
COMMITMENTS AND CONTINGENCIES | ||||
STOCKHOLDERS' EQUITY: | ||||
Series A redeemable convertible preferred stock - no par value; 30,000 authorized, issued and outstanding; liquidation preference of $300,000 | 300,000 | |||
Series C 5% cumulative convertible preferred stock - $.0001 par value; 8,000 authorized; 0 issued and outstanding; | -- | |||
Series D convertible preferred stock - $.0001 par value; 40,000 authorized; 9,268 issued and outstanding; liquidation preference of $9,268,000 | 2 | |||
Common stock - $.0001 par value; 500,000,000 authorized; 293,222,935 shares issued and outstanding | 29,322 | |||
Additional paid-in capital | 76,623,747 | |||
Unearned compensation | (12,861,373 | ) | ||
Accumulated deficit | (52,851,108 | ) | ||
TOTAL STOCKHOLDERS' EQUITY | 11,240,590 | |||
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | 41,107,365 |
The accompanying notes are an integral part of these condensed consolidated financial statements
MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF LOSS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
2005 | 2004 | ||||||
REVENUES | $ | 18,996,341 | $ | 15,769,851 | |||
COST OF REVENUES | 15,590,455 | 12,442,893 | |||||
GROSS PROFIT | 3,405,886 | 3,326,958 | |||||
OPERATING EXPENSES: | |||||||
Selling, general and administrative | 4,860,132 | 3,593,619 | |||||
Research and development | 171,935 | -- | |||||
Amortization of intangible assets | 474,202 | 481,992 | |||||
TOTAL OPERATING EXPENSES | 5,506,269 | 4,075,611 | |||||
OPERATING LOSS | (2,100,383 | ) | (748,653 | ) | |||
OTHER EXPENSES | |||||||
Interest expense | 2,003,724 | 503,215 | |||||
Other income, net | (38,731 | ) | (5,847 | ) | |||
TOTAL OTHER EXPENSES, NET | 1,964,993 | 497,368 | |||||
NET LOSS BEFORE MINORITY INTEREST | (4,065,376 | ) | (1,246,021 | ) | |||
MINORTITY INTEREST | 23,266 | -- | |||||
NET LOSS AFTER MINORITY INTEREST | (4,042,110 | ) | (1,246,021 | ) | |||
Deemed Dividend to Preferred Stockholders - Series D | 159,552 | -- | |||||
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS | $ | (4,201,662 | ) | $ | (1,246,021 | ) | |
BASIC AND DILUTED LOSS PER COMMON SHARE | $ | (0.02 | ) | $ | (0.03 | ) | |
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING | 215,804,637 | 38,352,594 | |||||
The accompanying notes are an integral part of these condensed consolidated financial statements
MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005
Series A Convertible | Series C Convertible | ||||||||||||||||||
Common Stock | Preferred Stock | Preferred Stock | |||||||||||||||||
Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||
Balance - July 1, 2005 | 184,215,208 | $ | 18,421 | 30,000 | $ | 300,000 | - | $ | - | ||||||||||
Conversion of Series D convertible preferred stock into common stock | 45,840,657 | 4,584 | - | - | - | - | |||||||||||||
Amortization of employment and consulting agreements | - | - | - | - | - | - | |||||||||||||
Repurchase of common stock related to cancelled employment agreement | (6,555,088 | ) | (656 | ) | - | - | - | - | |||||||||||
Stock issued in settlement of liquidated damages related to registration rights | 5,589,299 | 559 | - | - | - | - | |||||||||||||
Stock issued in connection with conversion of promissory notes | 63,244,562 | 6,325 | - | - | - | - | |||||||||||||
Stock issued in connection with interest on promissory notes | 888,297 | 89 | - | - | - | - | |||||||||||||
Beneficial conversion feature on convertible promissory notes | - | - | - | - | - | - | |||||||||||||
Exchange of Series D convertible preferred stock for Technest Series B convertible preferred stock | - | - | - | - | - | - | |||||||||||||
Reclassification of warrants from permanent equity to liabilities | - | - | - | - | - | - | |||||||||||||
Dividend payable | - | - | - | - | - | - | |||||||||||||
Net loss after minority interest | - | - | - | - | - | - | |||||||||||||
Balance - September 30, 2005 | 293,222,935 | $ | 29,322 | 30,000 | $ | 300,000 | - | $ | - | ||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements
MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005
Series D Convertible | Unearned | |||||||||
Preferred Stock | Compensation | |||||||||
Shares | Amount | Amount | ||||||||
Balance - July 1, 2005 | 12,598 | $ | 2 | $ | (13,778,332 | ) | ||||
Conversion of Series D convertible preferred stock into common stock | (3,830 | ) | - | - | ||||||
Amortization of employment and consulting agreements | - | - | 916,959 | |||||||
Repurchase of common stock related to cancelled employment agreement | - | - | - | |||||||
Stock issued in settlement of liquidated damages related to registration rights | - | - | - | |||||||
Stock issued in connection with conversion | ||||||||||
of promissory notes | - | - | - | |||||||
Stock issued in connection with interest on promissory notes | - | - | - | |||||||
Beneficial conversion feature on convertible promissory notes | - | - | - | |||||||
Exchange of Series D convertible preferred stock for Technest Series B convertible preferred stock | 500 | - | - | |||||||
Reclassification of warrants from permanent equity to liabilities | - | - | - | |||||||
Dividend payable | - | - | - | |||||||
Net loss after minority interest | - | - | - | |||||||
Balance - September 30, 2005 | 9,268 | $ | 2 | $ | (12,861,373 | ) |
The accompanying notes are an integral part of these condensed consolidated financial statements
MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005
Additional | Total | |||||||||
Paid-in | Accumulated | Stockholders' | ||||||||
Capital | Deficit | Equity | ||||||||
Amount | Amount | Amount | ||||||||
Balance - July 1, 2005 | $ | 75,375,199 | $ | (48,808,998 | ) | $ | 13,106,292 | |||
Conversion of Series D convertible preferred stock into common stock | (4,584 | ) | - | - | ||||||
Amortization of employment and consulting agreements | - | - | 916,959 | |||||||
Repurchase of common stock related to cancelled employment agreement | (64,895 | ) | - | (65,551 | ) | |||||
Stock issued in settlement of liquidated damages related to registration rights | 625,944 | - | 626,503 | |||||||
Stock issued in connection with conversion of promissory notes | 2,533,665 | - | 2,539,990 | |||||||
Stock issued in connection with interest on promissory notes | 67,791 | - | 67,880 | |||||||
Beneficial conversion feature on convertible promissory notes | 69,344 | - | 69,344 | |||||||
Exchange of Series D convertible preferred stock for Technest Series B convertible preferred stock | 61,812 | - | 61,812 | |||||||
Reclassification of warrants from permanent equity to liabilities | (155,000 | ) | - | (155,000 | ) | |||||
Dividend payable | (1,885,529 | ) | - | (1,885,529 | ) | |||||
Net loss after minority interest | - | (4,042,110 | ) | (4,042,110 | ) | |||||
Balance - September 30, 2005 | $ | 76,623,747 | $ | (52,851,008 | ) | $ | 11,240,590 |
The accompanying notes are an integral part of these condensed consolidated financial statements
MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
2005 | 2004 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||
Net loss after minority interest | $ | (4,042,110 | ) | $ | (1,246,021 | ) | |
Adjustment to reconcile net loss to net cash provided by (used in) operating activities: | |||||||
Minority interest in net loss of subsidiary | (23,266 | ) | -- | ||||
Depreciation and amortization of property and equipment | 86,933 | 77,456 | |||||
Amortization of intangible assets | 474,202 | 481,992 | |||||
Loss on disposal of equipment | 29,615 | 23,722 | |||||
Non-cash interest expense | 1,383,974 | 314,166 | |||||
Amortization and remeasurement of compensatory stock compensation | 916,959 | (19,143 | ) | ||||
Changes in operating assets and liabilities: | |||||||
Accounts receivable | (236,525 | ) | (834,641 | ) | |||
Inventory and work in process | 85,475 | -- | |||||
Restricted cash | (40,255 | ) | -- | ||||
Other current assets | 27,029 | (104,582 | ) | ||||
Accounts payable | (651,201 | ) | 4,069,967 | ||||
Accrued expenses and other current liabilities | 428,988 | (259,057 | ) | ||||
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES | (1,560,182 | ) | 2,503,859 | ||||
CASH USED IN INVESTING ACTIVITIES: | |||||||
Proceeds from sale of property and equipment | -- | 2,100 | |||||
Additional transaction costs relating to purchase of EOIR | -- | (61,611 | ) | ||||
Purchase of property and equipment | (55,409 | ) | (66,749 | ) | |||
NET CASH USED IN INVESTING ACTIVITIES | (55,409 | ) | (126,260 | ) | |||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Repurchase of common stock | (65,551 | ) | -- | ||||
Repayments of long-term debt | (610,592 | ) | (325,024 | ) | |||
Repayments of credit line | -- | (600,000 | ) | ||||
Proceeds from convertible secured notes, net | -- | 3,458,780 | |||||
NET CASH PROVIDED BY (USED BY) FINANCING ACTIVITIES | (676,143 | ) | 2,533,756 | ||||
NET (DECREASE)INCREASE IN CASH | (2,291,734 | ) | 4,911,355 | ||||
CASH - BEGINNING | 6,824,444 | 1,101,088 | |||||
CASH - ENDING | $ | 4,532,710 | $ | 6,012,443 |
The accompanying notes are an integral part of these condensed consolidated financial statements
MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
2005 | 2004 | ||||||
Cash paid during the periods for: | |||||||
Interest | $ | 89,749 | $ | 178,520 | |||
Taxes | $ | -- | $ | -- | |||
Non-cash investing and financing activities: | |||||||
Stock issued for payment of accrued interest | $ | 67,880 | $ | -- | |||
Beneficial conversion feature of convertible secured notes | $ | 69,344 | $ | -- | |||
Stock issued in settlement of liquidated damages concerning registration statements | $ | 626,503 | $ | -- | |||
Stock issued upon conversion of promissory notes | $ | 2,539,990 | $ | -- | |||
Exchange of Series D preferred stock for Technest Series B preferred stock | $ | 61,812 | $ | -- | |||
Dividend declared | $ | 1,885,529 | $ | -- | |||
Warrants reclassified from permanent equity to liabilities | $ | 155,000 | $ | -- |
The accompanying notes are an integral part of these condensed consolidated financial statements
MARKLAND TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS
For the Three Months Ended September 30, 2005 and 2004
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Markland Technologies, Inc. and Subsidiaries ("Markland" or the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, without being audited, pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the financial statements not misleading have been included. Operating results for the three months ended September 30, 2005 are not necessarily indicative of the result that may be expected for the year ending June 30, 2006. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company's 10-KSB for the year ended June 30, 2005 filed with the Securities and Exchange Commission.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Markland and its wholly-owned subsidiaries, Security Technology, Inc. ("STI"), Ergo Systems, Inc. ("Ergo"), and Science and Technology Research Corporation, Inc. ("STR"), and its majority-owned subsidiary, Technest Holdings, Inc. (“Technest”), and Technest’s wholly-owned subsidiaries, E-OIR Technologies, Inc. ("EOIR"), and Genex Technologies, Inc. (“Genex”). The minority interest represents outsiders’ interest in preferred stock of Technest (see Note 8). All significant inter-company balances and transactions have been eliminated in consolidation.
Use of Estimates in Preparation of Financial Statements
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. Significant estimates that are particularly susceptible to change are the determination of the fair value of assets acquired and liabilities assumed in business combinations, impairment of identified intangible assets, goodwill and long lived assets, the fair value of equity instruments issued, valuation reserves on deferred tax assets, amounts due to contracting government agencies as a result of their audits and revenue and costs recognized on long-term, fixed-price contracts.
Concentrations
Markland has cash balances in banks in excess of the maximum amount insured by the FDIC as of September 30, 2005.
Substantially all revenue is generated from contracts with Federal government agencies. Consequently, substantially all accounts receivable are due from Federal government agencies either directly or through other government contractors.
Restricted Cash
Restricted cash represents one year certificates of deposit collateralizing letters of credit in the amount of $250,000 and $40,000 issued in favor of two banks in conjunction with the Company’s corporate credit cards.
Accounts Receivable
Accounts receivable represent the amount invoiced for product shipped and 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 trouble accounts, historical experience and other currently available evidence. If management determines amounts to be uncollectible, they will be charged to operations when that determination is made. The Company has not experienced any material losses in accounts receivable and has provided no allowance at September 30, 2005. If management determines amounts to be uncollectible, they will be charged to operations when that determination is made.
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 contracts.
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. 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:
Category | Estimated Useful Life | ||
Software | 3 years | ||
Computers and equipment | 3 years | ||
Vehicles | 5 years | ||
Leasehold improvements | Shorter of useful life or lease term | ||
Furniture and fixtures | 5-7 years |
Property and equipment, net consisted of the following at September 30, 2005:
Software | $ | 158,308 | ||
Computers and equipment | 590,335 | |||
Vehicles | 55,268 | |||
Leasehold improvements | 222,338 | |||
Furniture and fixtures | 205,197 | |||
$ | 1,231,446 | |||
Less accumulated depreciation and amortization | (384,291 | ) | ||
$ | 847,155 |
Depreciation and amortization expense for the three months ended September 30, 2005 and 2004 was $86,933 and $77,456, respectively.
Income Taxes
The Company accounts for income taxes using the asset and liability method. 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.
Revenue Recognition
We recognize revenue when the following criteria are met: (1) we have persuasive evidence of an arrangement, such as contracts, purchase orders or written requests; (2) we have completed delivery and no significant obligations remain, (3) our price to our customer is fixed or determinable, and (4) collection is probable. We recognize revenues at the time we perform services related to border security logistic support.
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 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.
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 revision to cost and income and are recognized in the period in which the revisions are determined.
EOIR participates in teaming agreements where they are the primary contractor and they participate with other organizations to provide complex integrated remote sensor product and technology development services to the Federal government. EOIR has managerial and oversight responsibility for all team members as well as the responsibility for the ultimate acceptability of all integrated technical performance criteria under the contracts for deliverable services and products. EOIR includes as revenues the amounts that they bill under these teaming arrangements and include as direct costs amounts that are reimbursable or paid to team members.
Fair Value of Financial Instruments
The financial statements include various estimated fair value information at September 30, 2005, as required by Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments." 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 maximum potential loss may exceed any amounts recognized in the consolidated balance sheets.
The fair value of cash, accounts receivable, accounts payable and other long-term debt approximate their recorded amounts because of their relative market and settlement terms. The fair value of the notes payable issued to the former owners of EOIR have been recorded at their fair value, as determined by management with regard to a number of considerations including an independent valuation, which is less than the face value due to a below market interest rate. The convertible secured notes have been recorded at relative fair value which is less than face value as a result of the relative fair value of warrants issued in conjunction with the notes and the related beneficial conversion feature.
Shipping Costs
Delivery and shipping costs are included in cost of revenue in the accompanying consolidated statements of loss.
Research and Development
Research and development costs are charged to expense as incurred. Markland 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.
Loss Per Share
Basic and diluted net loss per common share has been computed based on the weighted average number of shares of common stock outstanding during the periods presented.
Common stock equivalents, consisting of convertible debt, Series A and D Convertible preferred stock, Technest’s Series B preferred stock, options and warrants, were not included in the calculation of the diluted loss per share because their inclusion would have had the effect of decreasing the loss per share otherwise computed.
Impairment of Intangible Assets
The Company records as goodwill the excess of purchase price over the fair value of the identifiable net assets acquired. Statements of Financial Accounting Standards (SFAS ) No. 142, "Goodwill and Other Intangible Assets", prescribes a two-step process for impairment testing of goodwill, which is performed annually, as well as when an event triggering impairment may have occurred. The first step tests for impairment, while the second step, if necessary, measures the impairment. The Company has elected to perform its annual analysis during the fourth quarter of each fiscal year. No impairment charges were recorded in the three months ended September 30, 2005 and 2004.
Impairment of Long-Lived Assets
Pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets", Markland 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 or impairment are present, Markland evaluates the carrying value of such assets in relation to the operating performance and future undiscounted cash flows of the underlying assets. Markland's policy is to record an impairment loss when it is determined that the carrying amount of the asset may not be recoverable. No impairment charges were recorded in the three months ended September 30, 2005 and 2004.
Stock-Based Compensation
At September 30, 2005, as permitted under SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", which amended SFAS No. 123, "Accounting for Stock-Based Compensation", Markland has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangements as defined by Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees", and related interpretation including Financial Accounting Standards Board ("FASB") Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation", an interpretation of APB No. 25. Had the Company followed the fair value method in accounting for its stock-based employee compensation it would have had the following effect on the net loss for the three months ended September 30, 2005 and 2004.
Three months ended | |||||||
September 30, | |||||||
2005 | 2004 | ||||||
Net loss as reported | $ | (4,042,110 | ) | $ | (1,246,021 | ||
Add: stock-based employee compensation under intrinsic value method included in net loss | 96,339 | 198,848 | |||||
Deduct: stock-based employee compensation under fair value method | (243,639 | ) | (258,710 | ) | |||
Pro forma net loss | (4,189,410 | ) | (1,186,159 | ) | |||
Deemed dividends to preferred stockholders | 159,552 | -- | |||||
Pro forma net loss to applicable to common stockholders | $ | (4,348,932 | ) | $ | (1,186,159 | ||
Basic and diluted loss per share - as reported | $ | (0.02 | ) | $ | (0.03 | ||
Basic and diluted loss per share - pro forma | $ | (0.02 | ) | $ | (0.03 |
Impact of Recently Issued Accounting Standards
In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and Amends SFAS No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is not an alternative. SFAS No. 123(R) must be adopted no later than the first interim period for fiscal years beginning after December 15, 2005. The Company expects to adopt SFAS No. 123(R) on July 1, 2006.
SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods: a “modified prospective” approach or a “modified retrospective” approach. Under the modified prospective approach, compensation cost is recognized beginning with the effective date based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and the requirements of SFAS No. 123(R) for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date. The modified retrospective approach includes the requirements of the modified prospective approach but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either for all prior periods presented or prior interim periods of the year of adoption. The Company is evaluating which method to adopt.
As permitted by SFAS No. 123, the Company currently accounts for the share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. However, grants of stock to employees have always been recorded at fair value as required under existing accounting standards. The Company expects the adoption of SFAS No. 123(R) to have a material effect on its results of operations. Additionally, the Company’s results of operations could be materially effected by share-based payments issued after the adoption of SFAS 123(R). The impact of the adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in Note 2 to the financial statements.
SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than an operating cash flow under current accounting literature. Since the Company does not have the benefit of tax deductions in excess of recognized compensation cost, because of net operating loss position, the change will have no immediate impact on the consolidated financial statements.
3. ACQUISITIONS
Purchase of Technest Holdings, Inc. and Genex Technologies, Inc.
On February 14, 2005, Markland entered into definitive agreements with Technest, a public company with no revenue and minimal assets and operations, Genex, and certain investors, which resulted in Markland acquiring controlling interests in Technest simultaneously with and conditioned upon the Technest acquisition of Genex.
In accordance with a Securities Purchase Agreement between Technest and Markland, Technest issued 412,650,577 (1,954,023 post reverse split) shares of its common stock to Markland in exchange for 10,168,764 shares of Markland’s common stock (“the Markland Investment”). On February 14, 2005, the common stock received from Technest represents a 93% interest in Technest’s common stock on a primary basis. Consequently, Technest became a majority owned subsidiary of Markland on February 14, 2005. The Securities Purchase Agreement contains provisions for Markland to deliver additional shares of its common stock to Technest in conjunction with the conversion of the Technest Series B Convertible Preferred Stock (see below).
Immediately after the acquisition by Markland of a controlling interest in Technest, certain investors paid $5,000,000 in cash for shares of Technest Series B Preferred Stock, Technest Series C Convertible Preferred Stock and five-year warrants to purchase Technest common stock (see Note 9).
The acquisition of Genex was effected pursuant to an Agreement and Plan of Merger dated February 14, 2005, by and among Markland, Technest, MTECH Acquisition, Inc. ("MTECH"), a wholly-owned subsidiary of Technest, Genex and Jason Geng (“Dr. Geng”), the sole stockholder of Genex. As a result of the merger, all of the outstanding shares of the capital stock of Genex were automatically converted into the right to receive in the aggregate (i) $3 million of cash; (ii) 10,168,764 shares of Markland's common stock valued at $6,101,259 (the shares of Markland common stock issued to Technest); and (iii) if earned, contingent payments in the form of additional shares of Technest common stock. A brokerage fee in connection with this acquisition of $300,000 was also paid. In addition, Dr. Geng was to receive a twelve month unsecured promissory note in the principal amount of $550,000 that paid interest at the rate of 6% per annum. Dr. Geng's share consideration was to be adjusted to reflect changes in the closing bid price of Markland common stock in the 10 trading days following February 14, 2005, subject to limitations set forth in the Merger Agreement. Following the acquisition, the Company discovered what it believes were material misrepresentations made by Dr. Geng in the Merger Agreement. As a result of damages arising in connection with these breaches, the Company has refused to issue the promissory note, the additional shares of Markland common stock or the contingent consideration of Technest common stock, if any.
Genex is a supplier of advanced imaging, surveillance and security sensor technologies.
Unaudited Condensed Pro Forma Information
Unaudited condensed pro forma information for Markland's acquisition of Genex assuming it was acquired on July 1, 2003 is as follows:
Three Months Ended | ||||
September 30, 2004 | ||||
Revenues | $ | 17,103,000 | ||
Loss from operations | $ | (646,000 | ) | |
Net loss applicable to common stockholders | $ | (1,142,000 | ) | |
Net loss applicable to common stockholders per common share | $ | (0.03 | ) |
Push Down Accounting
Based on the substantial change in ownership and control of Technest, as well as the fact that the investors in the Technest financing represent a collaborative group brought together to promote the acquisition of Genex, the push down basis of accounting has been applied to the acquisition of Technest by Markland. In accordance with the push down basis of accounting, Technest recorded Genex’s net assets, which are included in our consolidated financial statements, at their estimated fair values as of the date of acquisition which resulted in the basis of the net assets acquired being adjusted as disclosed above. Technest’s accumulated deficit was reset to zero as of the acquisition date. The purchase price was allocated to the estimated fair value of Genex’s assets and liabilities as determined by management based on a number of considerations including an independent purchase price allocation analysis.
Reorganization and Stock Dividend
On August 17, 2005, Markland sold all of the outstanding stock of EOIR to its majority-owned subsidiary, Technest pursuant to a Stock Purchase Agreement with Technest. As consideration for the stock of EOIR, Technest issued 12 million shares of its common stock to Markland, and, as a result, Markland’s ownership of Technest increased from 85% immediately prior to the transaction to approximately 98% on a primary basis and from 39% to approximately 82% on a fully diluted basis (assuming the conversion of all of Technest’s 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 and as a result, no pro forma financial information is considered necessary. We did not need stockholder consent in order to complete this reorganization. Since this is a transaction between entities under common control, in accordance with Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations”, Appendix D, Technest recorded the net assets of EOIR at their carrying value on the date of transfer and there was no impact on the consolidated group.
In connection with this reorganization, the Board declared a stock dividend of $10 million worth of its Technest common stock to Markland common stockholders up to a maximum of 2.5 million shares of Technest common stock. The record date for the dividend is May 1, 2006 and the dividend date is July 5, 2006. The actual number of shares of Technest common stock to be distributed will be calculated based on a per share price equal to the average closing price of the Technest Stock as reported by the National Association of Securities Dealers Automatic Quotations service for the ten trading days ending June 30, 2006; however, in no event shall the number of shares of Technest common stock distributed exceed 2.5 million.
The distribution of shares of Technest common stock to the shareholders of Markland is considered a nonreciprocal transfer to the owners of Markland, as discussed in Accounting Principles Board Opinion No. 29, “Accounting for Nonmonetary Transactions” and part of a reverse spinoff as described in EITF 02-11, “Accounting for Reverse Spinoffs”. As a result, the transfer is accounted for using Markland’s recorded amount of the Technest common stock distributed rather than the fair value of that stock. At September 30, 2005, the Company recorded a dividend payable based on the estimated the number of Technest common shares that will be distributed using the most recent quoted price of Technest’s common stock. The final recorded amount of the dividend could differ from this amount.
4. AMORTIZATION OF INTANGIBLE ASSETS
Amortizable intangible assets consist of the following at September 30, 2005:
Amortizable intangibles - EOIR | $ | 11,755,000 | ||
Amortizable intangibles - Ergo | 400,000 | |||
Amortizable intangibles - STR | 1,551,944 | |||
Amortizable intangibles - Technest | 1,731,111 | |||
Total amortizable intangibles | 15,438,055 | |||
Accumulated amortization | (2,506,916 | ) | ||
Net amortizable intangibles | $ | 12,931,139 |
Amortization expense was $474,202 and $481,992 for the nine months ended September 30, 2005 and 2004, respectively.
5. LONG-TERM DEBT
Notes Payable - EOIR Acquisition
On June 29, 2004, EOIR issued notes guaranteed by Markland in the face amount of $11,000,000 in connection with the acquisition of EOIR's common stock. These notes accrue interest at 6% compounded monthly and are payable in quarterly installments over 60 months. The fair market value of these notes is $9,532,044 as determined by management based on a number of considerations including an independent valuation. The discount of $1,467,956 will be amortized to interest expense over the life of the note. During the three months ended September 30, 2005 and 2004, $73,399 and $73,398, respectively, were amortized to interest expense. The carrying value of the note and the unamortized discount at September 30, 2005 was $8,800,000 and $1,100,967, respectively.
Other Long-Term Bank Debt
EOIR's other long-term bank debt consists of the following as of September 30, 2005:
First Market Bank, secured by research equipment, dated October, 2002 with monthly payments of $3,715 including interest of LIBOR plus 2.75% (6.80% at September 30, 2005) | 34,518 | |||
First Market Bank, dated July, 2002 with monthly payments of $15,278 plus interest of LIBOR plus 2.75%, (6.80% at September 30, 2005) | 49,802 | |||
First Market Bank, secured by leasehold improvements, dated March 19, 2003 with monthly payments of $3,514 including interest of 5.05% | 11,588 | |||
American Honda Finance, secured by vehicle, dated March 24, 2003 with monthly payments of $406 including interest of 4.70% | 11,687 | |||
$ | 107,595 |
Convertible Notes and Warrant Purchase Agreements - September 21, 2004
On September 21, 2004, Markland Technologies, Inc. entered into a Purchase Agreement with DKR Soundshore Oasis Holding Fund, Ltd. and DKR Soundshore Strategic Holding Fund, Ltd. (together the "Investors") pursuant to which the Company sold warrants to purchase shares of common stock (the "Warrants") and secured convertible promissory notes (the "Convertible Notes") for the aggregate consideration of $4,000,000. The Convertible Notes are initially convertible into $5,200,000 of common stock at a price of $0.80 per share, subject to certain adjustments as defined in the Purchase Agreement. The Warrants entitle the Investors to purchase an aggregate of 6,500,000 shares of our Common Stock at an initial conversion price of $.80 at any time and from time to time through September 21, 2009.
The Purchase Agreement contains standard representations, covenants and events of default. Occurrence of an event of default allows the Investors to accelerate the payment of the Convertible Notes and/or exercise other legal remedies, including foreclosing on collateral.
The Convertible Notes are in the aggregate principal amount of five million two hundred thousand dollars ($5,200,000) and accrue interest daily at the rate of eight percent (8%) per year on the then outstanding and unconverted principal balance of the Convertible Notes. Under the terms of the Convertible Notes, $4,000,000 of the outstanding principal and interest is required to be prepaid by March 15, 2005. In the event the Investors do not receive such prepayment amount by March 15, 2005, then the Conversion Price shall automatically become the Adjusted Conversion Price which is the lower of $0.80 a share or 80% of the average of the Closing Prices during the five (5) Trading Days prior to the applicable Conversion Date. This shall not be an event of default. The Company did not make such prepayment by March 15, 2005. The remaining outstanding balance is due by September 21, 2005. At anytime, and at the option of the Investors, the outstanding principal and accrued interest of the Convertible Notes may be converted into shares of Markland's common stock at the lower of $0.80 per share or 80% of the average of the closing prices during the five trading days prior to the applicable conversion date.
On September 20, 2005, the due date of these Convertible Notes was extended to December 20, 2005.
The Company has granted a security interest in and a lien on substantially all of its assets to the Investors pursuant to the terms of a Security Agreement, dated September 21, 2004.
As part of this financing, James LLC, the largest holder of Series D Preferred Stock, agreed not to sell any of its holdings of Series D Preferred Stock until the earlier to occur of: (1) notice from the Company and the investors that the transactions contemplated in the Purchase Agreement had been terminated, or (2) March 15, 2005. However, pursuant to the terms of the lock-up agreement, James, LLC may still convert their Series D shares and sell the underlying shares of common stock in accordance with Rule 144 of the Securities Act of 1933, as amended. In exchange, Markland agreed that under certain conditions, if they did not redeem the Series D stock by January 15, 2005, they would issue to James LLC a warrant to purchase 1,088,160 shares of our common stock at $.80 per share. The Series D stock was not redeemed by January 15, 2005 and the warrant was subsequently issued.
In conjunction with this financing, the Company issued 833,333 shares of common stock to investors that participated in the Company's April 2, 2004 private placement in exchange for their waiver and release of certain rights.
On September 21, 2004, Markland estimated the fair value of the Warrants and allocated the gross proceeds of $4,000,000 on a relative fair value basis between the Convertible Notes and the Warrants. Based on this analysis, Markland estimated that the relative fair value of the Warrants and Convertible Notes were approximately $1,659,000 and $2,341,000, respectively. Based on the initial conversion price of $0.80 per share, Markland estimated that the Convertible Notes could convert into 6,500,000 shares of common stock and the effective conversion price was approximately $0.36 per share. Accordingly, Markland determined that there was a beneficial conversion feature of approximately $3,054,000. Since the beneficial conversion feature exceeded the carrying value of the Convertible Notes, the recognition of the beneficial conversion feature was limited to $2,341,000. As a result, the Convertible Notes were recorded net of the fair value of the Warrants and beneficial conversion feature at $0 and will be accreted to $5,200,000, the face value of the Convertible Notes, over the term of those notes. Non-cash interest expense related to the accretion of this discount was $133,657 for the three months ended September 30, 2005. The carrying value of the Convertible Notes and unamortized discount at September 30, 2005 was $1,095,000 and $0, respectively.
In conjunction with the issuance of these Convertible Notes and Warrants, Markland incurred cash financing costs of $766,628. These costs have been recorded in Other Assets as deferred financing costs and are being amortized to interest expense over the term of the Convertible Notes. Non-cash interest expense related to the amortization of deferred financing costs was $39,987 in the three months ended September 30, 2005.
Warrants to purchase 1,500,000 shares of common stock at an initial exercise price of $1.50 and three year term were issued as finders fees. The fair value of these warrants have been calculated at $887,374 and have been recorded as additional deferred financing costs and are being amortized to interest expense over the term of the Convertible Notes. Non-cash interest expense related to the amortization of these deferred financing costs was $46,284 in the three months ended September 30, 2005.
During the three months ended September 30, 2005, notes with a face value of $2,055,000 were converted into 55,118,491 shares of the Company’s common stock.
Extension of Convertible Notes
On September 20, 2005, Markland Technologies, Inc. entered into an agreement with DKR Soundshore Oasis Holding Fund, Ltd. and DKR Soundshore Strategic Holding Fund, Ltd. (the “DKR entities”), the holders of Markland’s currently outstanding September 21, 2004 Secured 8% Convertible Notes (the “Notes”), to extend the maturity date of the Notes for ninety (90) days. The Notes were due on September 21, 2005. The Notes are now due on December 20, 2005. As of September 30, 2005, the principal amount currently outstanding on these Notes was $1,095,000.
As consideration for the extension of the maturity date of the Notes, Markland agreed to issue to the DKR entities for no additional consideration secured convertible promissory notes identical in all respects to the Notes, but for the fact that the maturity date of such notes is January 20, 2006. The original principal amount for the note to DKR Soundshore Oasis Holding Fund, Ltd. is $224,700 and the original principal amount for the note to DKR Soundshore Strategic Holding Fund, Ltd. is $52,675 (collectively, the “New Notes”). The principal amount of the New Notes was recorded as a liability and charged to interest expense in the quarter ended September 30, 2005. The New Notes have all the rights and preferences of the Notes as set forth in the Securities Purchase Agreement, dated September 21, 2004, between Markland and the investors signatory thereto. Markland also agreed to prepare and file with the Securities and Exchange Commission a registration statement on Form SB-2 covering the resale of the shares of Markland common stock, $.0001 par value per share, issuable upon conversion of the New Notes (the “Underlying Stock”). The Underlying Stock is deemed Registrable Securities as defined in the Registration Rights Agreement, dated September 21, 2004, between Markland and the investors signatory thereto, and afforded all the rights and obligations of Registrable Securities, provided, however, that the Filing Date (as defined in the aforementioned Registration Rights Agreement) of the registration statement on Form SB-2 covering the resale of the Underlying Stock shall be no later than October 17, 2005. Based on the initial conversion price of $0.03 per share, Markland estimated that the New Notes could convert into 11,557,292 shares of common stock and the effective conversion price was approximately $0.024 per share. Accordingly, Markland determined that there was a beneficial conversion feature of $69,344 which was recorded as a discount on the New Note and will be amortized to interest expense over the term.
The carrying value of the New Notes and the unamortized discount at September 30, 2005 was $277,375 and $69,344 respectively.
Markland also entered into a stock pledge agreement with the DKR entities pursuant to which Markland pledged 3,000,000 shares of Technest common stock currently owned by Markland to secure Markland’s obligations under the New Notes.
Convertible Notes and Warrant Purchase Agreements - November 9, 2004
On November 9, 2004, the Company entered into a Securities Purchase Agreement (the "Securities Purchase Agreement") with Harborview Master Fund, LP and Southridge Partners, LP (the "November Investors") pursuant to which the Company sold warrants to purchase shares of common stock (the "November Warrants") and secured convertible promissory notes (the "November Convertible Notes") for the aggregate consideration of $1,350,000. The November Convertible Notes are initially convertible into $1,755,000 of common stock at a price of $0.80 per share, subject to certain adjustments as defined in the Purchase Agreement.
The November Warrants entitle the November Investors to purchase an aggregate of 2,531,250 shares of our common stock, at any time and from time to time, through November 9, 2009 at an initial exercise price of $1.50 per share. The November Convertible Notes are in the aggregate principal amount of $1,755,000 and accrue interest daily at the rate of eight percent (8%) per year on the then outstanding and unconverted principal balance of the notes. Under the terms of the November Convertible Notes $1,000,000 of the outstanding principal and interest is required to be prepaid by March 15, 2005. In the event the November Investors do not receive such prepayment amount by the prepayment date then the conversion price shall automatically become the adjusted conversion price which is the lower of $0.80 per share or 80% of the average of the closing prices during the five trading days prior to the applicable conversion date. This shall not be an event of default. The Company did not make such prepayment by March 31, 2005. The notes will mature on November 9, 2005. At any time, and at the option of the November Investors, the outstanding principal and accrued interest of the notes may be converted into shares of our common stock at the lower of $0.80 per share or 80% of the average of the closing prices during the five trading days prior to the applicable conversion date.
On November 9, 2004, Markland estimated the fair value of the November Warrants and allocated the gross proceeds of $1,350,000 on a relative fair value basis between the November Convertible Notes and the November Warrants. Based on this analysis, Markland estimated that the relative fair value of the November Warrants and November Convertible Notes were approximately $571,513 and $778,487, respectively. Based on the initial conversion price of $0.80 per share, Markland estimated that the November Convertible Notes could convert into 2,193,750 shares of common stock and the effective conversion price was approximately $0.36 per share. Accordingly, Markland determined that there was a beneficial conversion feature of approximately $713,263. As a result, the November Convertible Notes were recorded net of the fair value of the November Warrants and beneficial conversion feature at $65,224 and will be accreted to $1,755,000, the face value of the November Convertible Notes, over the term of those notes. Non-cash interest expense related to the accretion of this discount was $35,958 for the three months ended September 30, 2005. The carrying value of the November Convertible Notes and the unamortized discount at September 30, 2005 was $25,000 and $0, respectively.
In conjunction with the issuance of these November Convertible Notes and November Warrants, Markland incurred financing costs of $175,530. These costs have been recorded in Other Assets as deferred financing costs and are being amortized to interest expense over the term of the November Convertible Notes. Non-cash interest expense related to the amortization of deferred financing costs was $85,931 in the three months ended September 30, 2005.
The other terms of these notes and warrants are substantially the same as the Convertible Notes and Warrants Purchase agreement dated September 21, 2004 described above.
In the three months ended September 30, 2005, notes with a face value of $484,990 were converted into 8,126,071 shares of the Company’s common stock.
Accrued interest of $67,880 related to both the September 21, 2004 and November 9, 2004 convertible notes was paid through the issuance of 888,297 shares of common stock.
8. STOCKHOLDERS' EQUITY
Preferred Stock
The Company is authorized to issue 5,000,000 shares of preferred stock which may be issued in series with such designations, preferences, stated values, rights qualifications, or limitations as determined by the Board of Directors.
Series A Redeemable Convertible Preferred Stock
On June 30, 2003, Markland issued 30,000 shares of our Series A Non-Voting Redeemable Convertible Preferred Stock in satisfaction of our remaining obligations under a promissory note. The Series A Preferred Stock has no par value, is non-voting and has a stated value of $10 per share. The Preferred Stock is convertible at any time at the option of the Company, and cannot be converted by the holder. This stock is convertible at the rate of three shares of Series A Preferred Stock for each share of common stock. This conversion rate may be adjusted at any time by the Company as a result of either the sale of the Company or as a result of a stock split or stock dividend that is issued by the Company while these shares remain outstanding.
The Company shall have the right, but not the obligation to, at any time after the issuance of these shares to redeem all or any portion of the outstanding shares of Series A Preferred Stock from the holder in cash at the stated value of $10 per share by sending notice to the holder. The Series A Preferred Stock has a liquidation preference of $10 per share. This stock does not accrue dividends.
Series C 5% Cumulative Convertible Preferred Stock
The Series C Preferred Stock is non-voting and has a liquidation preference of $1,000 per share. The holders of the Series C Preferred Stock are entitled to receive dividends on each share of preferred stock, which shall accrue on a daily basis at the rate of 5% per annum on the sum of the liquidation preference plus all accumulated and unpaid dividends thereon. These dividends shall accrue whether or not they have been declared or there are legally available funds with which to pay them, and at the option of the holders are payable either in cash or in unrestricted common stock. The Series C Preferred Stock is redeemable at any time by Markland, and cannot be converted by the holders without written permission for a period of 6 months following the issuance of the shares and then only 10% may be converted per month thereafter. The Series C Preferred Stock is convertible at the option of the holder at a conversion price ranging from 65% to 80% of the common stock's market price at the time of the conversion.
At September 30, 2005, there were no shares of Series C Preferred Stock issued or outstanding.
Series D Convertible Preferred Stock
Shares of the Series D Convertible Preferred Stock have a liquidation preference of $1,000 per share, are non-voting, do not accrue dividends, are redeemable by Markland anytime and are convertible into shares of Markland's common stock at a conversion price ranging from 65% to 80% of the common stock's market price at the time of the conversion.
The Series D preferred stock is convertible at the option of the stockholder at any time. The number of shares of our common stock into which each share of Series D preferred is convertible is determined by dividing $1,000 by the discounted bid price. The "discounted" bid price is the average closing bid
price of our common stock during the five business days immediately preceding the conversion date multiplied by the applicable discount factor, as set forth below.
AVERAGE CLOSING BID PRICE (1) | DISCOUNT FACTOR | |||
$15.00 or less | 80 | % | ||
more than $15.00, but less than or equal to $30.00 | 75 | % | ||
more than $30.00, but less than or equal to $45.00 | 70 | % | ||
more than $45.00 | 65 | % | ||
The Series D preferred stock can be converted only to the extent that the Series D stockholder will not, as a result of the conversion, hold in excess of 9.999% of the total outstanding shares of our common stock.
On August 19, 2005, we entered into a definitive exchange agreement with the Deer Creek Fund LLC, pursuant to which we exchanged 114,942 shares of Technest Series B Preferred Stock (potentially convertible into 3,799,409 shares of Markland common stock based on the closing price of Markland’s common stock as of August 19, 2005) for 500 shares of Markland Series D Preferred Stock (convertible into 5,008,013 shares of Markland Common Stock as of August 19, 2005). The Company has determined that as of the date of issuance there was a beneficial conversion feature in the aggregate amount of $159,552. The accretion of the beneficial conversion features on the Series D Preferred Stock has been recorded as a deemed dividend. The deemed dividends increases the loss applicable to common shareholders in the calculation of basic and diluted net loss per common share.
During the three months ended September 30, 2005, 3,830 shares of Series D were converted into 45,840,657 common shares of the Company.
At September 30, 2005, there were 9,268 shares of Series D outstanding. Please see Note 15 for an issuance of Series D after September 30, 2005.
Common Stock Issuances
Markland has entered into compensation agreements with certain officers and a consultant (see Note 11) which provide for, among other things, certain performance-based stock grants. Markland did not issue any shares under these agreements in the three months ended September 30, 2005. Markland amortized stock compensation expense of $916,959 in this period.
During the three months ended September 30, 2005, Markland issued the following:
· | 45,840,657 shares of its common stock on conversion of 3,830 Series D shares. |
· | 5,589,299 shares of its common stock with a fair value of $626,503 issued as settlement of liquidated damages being charged to interest expense. |
· | 63,244,562 shares of its common stock on conversion of secured convertible notes. |
· | 888,297 shares of its common stock in satisfaction of accrued interest of $61,812 on secured convertible notes. |
Markland has established the following reserves for the future issuance of common stock as follows:
Reserve for the exercise of warrants | 29,000,000 | |||
Reserve for stock option plan | 50,000,000 | |||
Reserve for conversion of Series A Preferred Stock | 10,000 | |||
Reserve for conversion of Series D Preferred Stock | 386,000,000 | |||
Reserve for conversion of Technest Series B preferred stock | 7,000,000 | |||
Reserve for conversion of secured convertible notes | 98,000,000 | |||
Total reserves | 570,010,000 |
The Company is also obligated to issue certain shares under employment and consulting agreements. The potential shares issuable as of September 30, 2005 exceed the authorized share capital of Markland. The authorization to issue additional shares to satisfy these requirements is dependent on approval by a majority of Markland shareholders.
Technest Series B Convertible Preferred Stock
In conjunction with Markland’s acquisition of Technest and Technest’s acquisition of Genex (see Note 3), Technest issued, among other securites, 1,149,425 shares of Series B Convertible Preferred Stock (“Series B Preferred Stock”). The Series B Preferred Stock will be convertible into Markland common stock upon the earlier to occur of (a) February 14, 2006 or (b) a date which is the first trading day after the date on which Markland common stock has a closing bid price of $2.50 or more for five consecutive trading days. The number of shares to be issued will be determined by dividing the quotient of (a) $5,000,000 divided by the lower of (i) $0.60 and (ii) the market price (as defined in the Merger Agreement) by (b) 1,149,425. As of September 30, 2005, 747,124 shares of Series B Convertible Preferred Stock have been converted to 3,250 shares of Markland Series D preferred stock and subsequently retired.
At September 30, 2005, Technest has incurred liquidated damages of $530,000 which was charged to interest expense related to the Company’s failure to file a registration statement.
Minority Interest
As of September 30, 2005, the minority interest in Technest is comprised of the following:
Outside investment in Technest common and preferred stock | $ | 3,512,273 | |||||
Deemed dividends related to beneficial conversion features of Technest preferred stock | 2,174,858 | ||||||
Portion of outside investment converted into Markland Series D preferred stock | (401,780 | ) | |||||
Minority interest in net loss of Technest | (214,272 | ) | 1,558,806 | ||||
Minority interest | $ | 5,071,079 | |||||
9. OPTIONS AND WARRANTS
Options
In conjunction with the Company's acquisition of EOIR (see Note 3), the Company adopted the 2004 Stock Incentive Plan ("the Plan"). The Plan authorizes the Company to issue up to 25,000,000 of common shares in the form of options, stock awards, performance share awards or stock appreciation rights.
The Company also adopted the 2005 Stock Award Plan, which authorizes the Company to issue up to 25,000,000 shares of common stock in the form of stock awards.
On June 29, 2004, the Company issued options to eleven former minority owners of EOIR who have continued employment with the Company. These options have a ten year term and vest ratably over a five year period. Ten of these employees received options to purchase 9,345,737 shares of common stock at a price of $.3775. On the date of grant, the intrinsic value of these options, $3,528,016, was recorded as unearned stock-based compensation and additional paid in capital. This intrinsic value will be amortized to stock compensation over the five year vesting period.
One employee received five options, each of which allows for the purchase of a number of shares equal to .11799575 times a fraction of $1,600,000 divided by the fair value of the stock on the vesting date. One of these options vests each year for the next five years. The exercise price of these options will be one-half the fair value of the stock on the vesting date. The intrinsic value of these options based on the fair value of the stock on September 30, 2005 is $471,983. This intrinsic value has been recorded as unearned stock-based compensation and additional paid in capital. Due to the variable nature of the exercise price and number of shares to be issued under these options, the intrinsic value will be remeasured each period until the terms are fixed. The intrinsic value of each option will be amortized over the vesting periods. As of September 30, 2005, the maximum number of shares issuable under these options is 26,745,703.
For the three months ended September 30, 2005, the Company recorded $96,339 in amortization relating to the Plan options.
On May 18, 2005, the Company entered into a Restricted Stock Grant Agreement with Dr. Mackin, pursuant to which Dr. Mackin exchanged vested options to purchase 1,250,286 shares of the Company’s common stock at a price of $.3775 per share for 1,250,286 shares of Common Stock. Subject to the terms of the Restricted Stock Grant Agreement, the shares of Common Stock issued to Dr. Mackin are subject to forfeiture in the event that Dr. Mackin’s tenure with the Company is terminated before a registration statement covering the shares has been declared effective by the Securities and Exchange Commission. In addition, four other employees also exchanged options to purchase 231,750 shares of common stock at $.3775 per share for 231,750 shares of the Company’s common stock. The Company charged to operations $166,613 relating to these exchanges of equity instruments.
Markland has also agreed to grant options to purchase an additional 5,000,000 shares of common stock to employees of EOIR in the future. Markland expects that these options will vest over five years after the date of grant and will have an exercise price equal to the fair market value of the common stock on the date of grant.
In connection with the acquisition of Genex (see Note 3), Markland agreed to replace options to purchase 312,000 shares of Genex common stock with fully vested options for the purchase of the same number of shares of Markland common stock with an exercise price equal to the fair value of Markland’s common stock on the closing date of the Genex acquisition ($0.60).
There were no options issued in the three months ended September 30, 2005 and 5,222,790 were vested at September 30, 2005.
Warrants
At September 30, 2005, the Company had the following outstanding warrants:
Number of | ||||||||||
Shares | Exercise | Date of | ||||||||
Exercisable | Price | Expiration | ||||||||
Issued in conjunction with April 2, 2004 private placement | 3,333,333 | $ | 1.25 | April 2, 2007 | ||||||
333,333 | $ | 1.40 | April 2, 2007 | |||||||
Issued in conjunction with April 16, 2004 private placement | 2,500,000 | $ | 1.50 | April 16,2007 | ||||||
25,000 | $ | 2.00 | April 16,2007 | |||||||
Issued in conjunction with May 3, 2004 private placement | 7,098,750 | $ | 1.50 | May 3, 2007 | ||||||
529,800 | $ | 1.50 | May 3, 2007 | |||||||
Issued in conjunction with September 21, 2004 convertible note | 1,000,000 | $ | 0.60 | September 21, 2009 | ||||||
Issued in conjunction with November 9, 2004 convertible note | 337,500 | $ | 1.50 | November 9, 2007 | ||||||
Issued in conjunction with December 7, 2004 consulting agreement | 400,000 | $ | 0.60 | November 30, 2007 | ||||||
Issued in conjunction with September 21, 2004 lock up agreement | 1,088,160 | $ | 0.60 | January 5, 2009 | ||||||
Issued in conjunction with March 29, 2005 agreement | 8,443,750 | $ | 0.60 | March 8, 2010 | ||||||
Total | 25,089,626 |
Weighted average exercise price | $ | 1.00 | |||||
Weighted average remaining life | 2.75 years | ||||||
All warrant agreements contain anti-dilution provisions which, upon exercise, may cause the exercise price and number of shares of common stock issued to differ from those listed above.
At September 30, 2005, the Company does not have sufficient authorized common shares available to deliver upon exercise of the warrants listed above. As a result, in accordance with EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, the warrants have been reclassified from permanent equity to a liability. The Company estimated the fair value of the warrants on the date of the change in classification using the Black-Scholes option pricing model. Therefore, $155,000 was reclassified from permanent equity to accrued expenses and other current liabilities. A change in the fair value of the Company’s common stock by $0.01 per share would increase or decrease the fair value of the warrants by approximately $70,000. The Company will continue to remeasure the fair value of the warrants each period and record any change in the statement of loss as long as the warrants continue to be classified as liabilities.
10. | NET LOSS PER SHARE |
All securities that could potentially dilute basic earnings per share ("EPS") were not included in the computation of diluted EPS because to do so would have been anti-dilutive for the periods presented.
11. COMMITMENTS AND CONTINGENCIES
Compensation Agreements
In the three months ended September 30, 2005, Markland amortized stock compensation of $916,959 related to its compensation agreements.
Facility Rental
We have an administrative office in Providence, Rhode Island which is utilized under a monthly sublease comprising approximately 4,000 square feet and an administrative office in Boston, MA. The monthly lease amount for these facilities is approximately $12,000
EOIR, Technest's wholly owned subsidiary, holds a three-year lease for its executive and administrative offices of approximately 5,420 square feet in Woodbridge, Virginia. The lease expires on September 30, 2008. EOIR leases approximately 10,000 square feet in Spotsylvania, Virginia, where it houses its software development unit. The lease expires on October 31, 2009. EOIR also holds a five-year lease for 6,951 square feet in Spotsylvania, Virginia. The lease expires on October 15, 2010. EOIR also has several offices located in Fredericksburg, Virginia - one office with 1,200 square feet, with a two-year lease that expires on October 31, 2006, and one with 4,200 square feet, with a three-year lease that expires on June 30, 2007. Monthly lease amounts for these facilities total approximately $36,600.
Genex leases office space under the terms of a non-cancelable operating lease that expires in January 2006. The office space lease provides for annual increases of 3% to the base rent and requires the Company to reimburse the landlord for its pro rata share of the increases in annual operating expenses and real estate taxes. Monthly lease amounts for this facility total approximately $10,100.
Rent expense for the three months ended September 30, 2005 and 2004, was $144,717 and $72,965 respectively.
Income taxes
The Company expects that its net operating loss carryforwards will be sufficient to offset any taxable income. As a result, no provision for income taxes or any related penalties or interest has been recorded for the three months ended September 30, 2005 and 2004.
Government Contracts
The Company's billings related to certain U.S. Government contracts are based on provisional general & administrative and overhead rates which are subject to audit by the contracting government agency. During an audit conducted in November 2004 covering the fiscal year 2002, the Defense Contract Audit Agency (“DCAA”) discovered significant deficiencies in Genex’s accounting system that resulted in misclassified and unallowable costs. As a result of this audit, Genex could be prevented from completing certain previous contracts awarded by the Department of Defense and may be required to refund amounts overbilled to its customers. The Company has accrued $ 68,017 for overpayments for 2002 and has extended the analysis of misclassified and unallowed costs to September 30, 2005. At September 30, 2005, the company has determined that $102,228 is repayable to the government. This amount is included in accrued expenses at September 30, 2005.
12. INCOME TAXES
There was no provision for federal or state income taxes for the three months ended September 30, 2005 and 2004, due to the Company's operating losses and a full valuation reserve.
The Company's deferred tax asset before valuation allowance is approximately $16,000,000, and at September 30, 2005 consisted primarily of net operating loss carry forwards. The change in the valuation allowance for the year ended June 30, 2005 was approximately $6,000,000. The Company's net operating loss carry forwards of approximately $34,000,000 will expire in varying amounts through 2025. The use of the federal net operating loss carry forwards may be limited in future years as a result of ownership changes in the Company's common stock, as defined by section 382 of the Internal Revenue Code. The Company has not completed an analysis of these changes.
The Company has provided a full valuation reserve against the deferred tax asset because of the Company's loss history and significant uncertainty surrounding the Company's ability to utilize its net operating loss and tax credit carryforward.
13. RELATED PARTY TRANSACTIONS
Robert Tarini, our chief executive officer is also chief executive officer of SyQwest, Inc. SyQwest performs software and engineering development for the Company and provides approximately 4000 sq ft of office space to the Company in Providence, RI. During the three months ended September 30, 2005, $214,280 was paid to SyQwest for these services and there was no balance outstanding with SyQwest at September 30, 2005.
ipPartners, Inc. a corporation majority owned and controlled by Mr. Tarini, Markland's Chief Executive Officer and Chairman, participated in 12.5% of the February 14, 2005 investor financing related to the acquisition of Genex by Technest. This financing was negotiated on behalf of Markland by senior management of Markland, including Mr. Tarini. The Markland Investment was approved by a unanimous vote of the Board of Directors of Markland including, Mr. Mackin and Mr. Ducey, neither of whom has an interest in the transaction. ipPartners, Inc. is also a participant in the exchange agreement to exchange Markland Series D preferred stock for Technest Series B preferred stock.
The Company believes that all transactions described above were made on terms no less favorable to it than those obtainable from unaffiliated third parties. All future transactions, if any, with its executive officers, directors and affiliates will be on terms no less favorable to it than those that will be obtainable from unrelated third parties at the time such transactions are made.
14. LITIGATION
Charles Wainer
On June 28, 2004, Charles Wainer filed a civil suit against Markland in Florida state court alleging breach of a stock purchase agreement and breach of an employment agreement stemming from Wainer's sale of his business to a predecessor of Markland and his subsequent employment thereat. In the complaint, Wainer alleges Markland owes him $300,000 cash, some unspecified portion of $700,000 in stock, some unspecified portion of $86,000 cash for lease payments, and approximately $20,000 in back-pay. On August 11, 2004, Markland answered the complaint and denied any liability. In September 2005 the trial of this matter was concluded. As a result, Markland anticipates that judgment will be entered against Markland and in favor of Mr. Wainer in an amount of approximately $482,000. At June 30, 2005, the Company charged to Selling, General and Administrative expense $482,000 related to this matter.
Joseph R. Moulton
On or about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the Circuit Court of Spotsylvania County, Virginia, against the Company, EOIR, and our Chief Executive Officer and Director, Robert Tarini. Mr. Moulton was the largest single shareholder of EOIR prior to its acquisition by the Company, owning approximately 67% of the EOIR capital stock. Mr. Moulton received approximately $5,863,000 in cash and a promissory note of EOIR in the approximate principal amount of $6,967,000 for his shares of EOIR at the closing of the acquisition of EOIR by the Company. In his complaint Mr. Moulton asserts, among other things, that the Company breached its obligations under the Stock Purchase Agreement, dated June 29, 2004, pursuant to which the Company acquired EOIR, by terminating Mr. Moulton's employment with EOIR and removing him from the EOIR board of directors. Mr. Moulton is seeking damages allegedly suffered by his loss of employment, extreme emotional distress, and costs incurred to enforce his contractual rights. In addition, he is seeking certain other equitable relief including, the appointment of a receiver to oversee the management of EOIR until these promissory notes issued to former EOIR shareholders at the closing of the acquisition are paid in full and a declaratory judgment that the Company's actions constitute an event of default under these promissory notes allowing for the acceleration of all amounts (approximately $11,000,000) due thereunder. The Company is a guarantor of these notes. The Company believes that the allegations in this lawsuit are entirely without merit and expects to file an answer denying Mr. Moulton's allegations and opposing vigorously all equitable relief sought. The Company is considering bringing various claims against Mr. Moulton either by counterclaim or in a separate action.
Deer Creek
Markland and Technest were notified on July 21, 2005 by counsel for Deer Creek LLC, or Deer Creek, an investor in the February 15, 2005 transaction involving Technest, Markland and Genex, that Deer Creek filed an order to show cause requesting a temporary restraining order in the Supreme Court for New York County, naming Technest and Markland as defendants. Deer Creek is seeking to enjoin Markland from issuing its common stock upon conversion of certain shares of Markland's Series D Preferred Stock issued pursuant to certain exchange agreements dated June 20, 2005. Technest and Markland retained the firm of Pryor, Cashman, Sherman & Flynn LLP, 410 Park Avenue, 10th Floor, New York, New York 10022 to represent their interests in this matter. On July 25, 2005 Technest and Markland removed the matter to the United States District Court for the Southern District of New York. This matter was settled on August 19, 2005. Markland entered into an exchange agreement and a registration rights agreement with Deer Creek on August 19, 2005.
Greg and Mary Williams
Markland and EOIR were notified on July 11, 2005 by counsel for Greg and Mary Williams, former shareholders and employees of EOIR and, in the case of Mr. Williams, a former director of Markland, that the Williamses filed a lawsuit in the Commonwealth of Virginia, naming EOIR and Markland as a defendant, regarding a number of contractual disputes involving the registration of shares of Markland common stock underlying certain options issued to the Williamses in connection with the acquisition of EOIR by Markland and severance payments called for pursuant to severance agreements by and among the Williamses, EOIR and Markland. On August 3, 2005, EOIR and Markland filed an answer and a demurrer denying all liability.
H & H Acquisition Corp.
On July 23, 1998, H & H Acquisition Corp., individually and purportedly on behalf of Technest Holdings, commenced an action in federal court in the Southern District of New York against the Company, the founder and certain officers, among others. The complaint is an action to recover shares of common stock of the Company and unspecified damages. Management believes that the claims against the Company and certain officers are without merit and is vigorously defending the action. The Company cannot make any assurances about the litigation's outcome. However, the Company could be adversely affected if the plaintiff prevails.
In September 2002 the Company was served with a Summary Judgment Motion regarding H & H Acquisition Corp. and the Company answered the motion in November 2002. On January 3, 2005, the court denied the motion for summary judgment. Trial of this matter is scheduled to begin in January 2006.
Other
In addition, we are subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows
15. SUBSEQUENT EVENTS
Subsequent stock issuances
Subsequent to September 30, 2005, convertible promissory notes with a face value of $925,000 were converted into 37,809,372 shares of our common stock.
Subsequent to September 30, 2005, 275 shares of Series D Convertible Preferred Stock were converted into 12,001,099 shares of our common stock.
On October 4, 2005, we entered into exchange agreements with Southridge Partners, LP and Southshore Captial Fund, Ltd., pursuant to which we issued 1,750 shares of Series D preferred stock in exchange for 402,301 shares of Technest Series B preferred stock.
On October 4, 2005, we issued a warrant to purchase 750,000 shares of our common stock to Greenfield Capital Partners LLC. The warrants expire on February 10, 2010 and have an exercise price of $0.34 per share and are substantially in the form attached to our current report on Form 8-K filed on October 7, 2005 as Exhibit 10.5. These warrants are exercisable immediately.
The following discussion and analysis of our financial condition and results of operations for our financial quarter ending September 30, 2005 should be read together with our financial statements and related notes included elsewhere in this report.
Forward Looking Statements
The information in this discussion contains forward-looking statements. These forward-looking statements involve risks and uncertainties, including but not limited, to statements regarding Technest Holdings, Inc.’s capital needs, business strategy and expectations. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may”, “should”, “expect”, “plan”, “intend”, “anticipate”, “believe”, “estimate”, “predict”, “potential” or “continue”, the negative of such terms or other comparable terminology. Actual events or results may differ materially. In evaluating these statements, you should consider various factors, including the risks outlined in the Risk Factors section below, and, from time to time, in other reports we file with the Securities and Exchange Commission (the “SEC”). These factors may cause our actual results to differ materially from any forward-looking statement. Readers are cautioned not to place undue reliance on any forward looking statements contained in this report. We will not update these forward looking statements unless the securities laws and regulations require us to do so.
Business
Overview
Our business, as it exists today, consists of five business areas: intelligent surveillance, chemical and explosives detection, advanced technologies research and development, remote sensor systems and technologies, and border security. Our primary sources of operating revenue are from our indirect subsidiaries, EOIR and Genex.
Through EOIR and Genex, we offer remote sensing technology products and services, providing complete solutions for three-dimensional (3D) imaging and display, intelligent surveillance, and 3D facial recognition to the United States Department of Defense ("DOD") and various other United States intelligence agencies ("INTEL"), educational and medical institutions and private commercial entities. These acquisitions are a very important part of our ongoing business strategy of creating a world class integrated portfolio of solutions for the Homeland Security, DOD and INTEL marketplaces.
Genex offers products which include: (i) design and fabrication of customized remote sensor systems and platforms for DOD, INTEL and Homeland Security applications; (ii) design and fabrication of 3D facial recognition products tools for law enforcement; and (iii) design and fabrication of non-invasive 3D medical imaging tools. EOIR offers products and services which include: (i) design and fabrication of customized remote sensor systems and platforms for DOD, INTEL and Homeland Security applications; (ii) remote sensor data collection, data signal processing and data exploitation; and (iii) training in the use of remote sensor systems and data. These efforts of EOIR and Genex involve systems engineering, system integration, prototyping, manufacturing and field data collections as well as data analysis and processing.
Intelligent Surveillance
Genex’s intelligent surveillance portfolio is anchored by its real-time embedded image processing technology and its 3D facial recognition technology. Our products include OmniEye™ Wellcam, OmniEye™ Cerberus, Smart Optical Sensor (SOS), Smart Suite™ and Omnivision.
The OmniEye™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. The OmniEye™ Cerberus is a re-configurable multi-sensor system that is designed for long distance infrared and visible light detection. The OmniEye™ Cerberus delivers this flexibility while still maintaining seamless panoramic coverage up to 360 degrees.
The Smart Optical Sensor high speed image processing platform powers Genex’s Smart Suite™ algorithms, enhancing both new and existing sensor systems with capabilities including: reliable target detection, motion tracking, and object classification and recognition. Smart Suite™ algorithms by Genex are a portfolio of advanced video analysis and augmentation modules. The SOS is a powerful system that allows multiple cameras to be deployed easily in a distributed, scaleable network that provides autonomous surveillance.
OmniVision is a software platform for Genex’s wide range of security and surveillance camera products. Built as a modular system, OmniVision can operate as a standalone application or easily integrate into existing systems. The unique architecture of OmniVision puts next-generation capabilities within reach of traditional camera and digital video recorder systems. The system includes software application modules for many different end user needs.
Genex currently is engaged in programs to develop: disposable sensors for the U.S. Army Night Vision Lab; a miniature general purpose sensor processor for the U.S. Army Picatinny Arsenal; SmartMTI Motion Detection for the U.S. Army Armament Research, Development and Engineering Center; a weapon’s flash detection system for the U.S. Navy Office of Naval Research; and a smart object avoidance system for the U.S. Navy Naval Surface Warfare System.
Chemical and Explosive Detection
We are targeting key sensing technologies that are critical to both DOD and Homeland Security missions: Chemical/Biological (Chem/Bio) and Improvised Explosive Devices (IED) detection sensors. Our Chem/Bio and IED group concentrates on the research and development of technologies that can reliably detect the presence of chemical, biological, and explosive devices or components from a stand-off distance utilizing multi spectral electro optical sensing methods. Under a Phase 2 Small Business Innovation Research (“SBIR”) grant from the U.S. Army, Genex is developing a new and unique sensor that can remotely detect the presence of chemical and biological weapons. We intend to offer these standoff detection sensors in an integrated system solution approach which also includes point detection capability provided by the EOIR manufactured ACADA system. The ACADA system utilizes Ion Mobility Spectroscopy cell based point detection chemical sensor technology.
Advanced Technologies Research and Development
The Advanced Technologies Research and Development group of Genex is focused on developing our imaging technology portfolio via advanced research in 3D facial recognition, intelligent surveillance 3D imaging, and medical imaging. By integrating our marketing pursuits with our R&D efforts, we can bring to market technological advances that have enhanced customer value. Some of our targeted research areas include: (i) fully integrated Surematch™ suite of 3D facial recognition software application programs, (ii) intelligent surveillance using two- and three-dimensional image processing to support homeland security, military, and commercial applications; (iii) detection of concealment of intent using thermal and 3D imaging to support anti-terrorist efforts; (iv) early detection of cancer using non-invasive and non-radiological diffuse optical tomography; and (v) more effective and less risky radiation treatment for cancer by use of 3D imaging for patient positioning.
Currently we have eight funded SBIR ongoing programs. The R & D efforts include maintenance and capture of intellectual property in the form of patents and licensing agreements. Presently, we have a patent portfolio covering the areas of 3D imaging. Our strategy is to transform our captive intellectual property into proprietary products and services, which will create recurring revenue streams derived from our government customer base.
In some cases, our technologies and intellectual property have application in the commercial sector. With respect to the commercial sector, we are focused on finding markets which have: high fit of application with our technology; high revenue potential; economic value add for market to adopt our technology; and accessible customers and channels. Management plans to generate further commercial growth primarily through strategic partnerships with customers in markets passing the above screen to reduce technical risk while providing strong channels of distribution for market access. Efforts here are focused on our 3D FaceCam product and associated software. This product is utilized by our customers to create personalized products for customers based on a 3D image captured by our camera. The product is being marketed towards applications in digitized identification such as employee ID and motor vehicle licenses as well into the medical market place. Efforts are underway to reduce product costs to encourage broader market adoption, to improve channels of distribution for this product, and to establish commercial agreements for mass market deployment.
In addition, we are targeting manufacturers of products who would benefit strategically by adopting our technology to produce custom fitted products for their customers. We believe this strategy has the potential to generate a sustainable competitive advantage based on Genex’s ability to generate accurate 3D measurement data.
Remote Sensor Systems and Technologies for Military and Intelligence Applications
EOIR provides advanced remote sensing technology products and services to the DOD and to various other United States intelligence agencies. EOIR’s remote sensor systems are a very important core function in our ongoing business strategy of creating a world-class integrated portfolio of solutions for the Homeland Security, DOD and INTEL marketplaces.
EOIR's most significant source of revenues is an Omnibus Contract with the United States Army Night Vision and Electronic Sensors Directorate. The Omnibus Contract has an extensive and varied scope that requires us to provide a very broad range of products and technical services. For those products and technical services that EOIR does not possess in-house, we subcontract to our team members and other subcontractors as necessary. As a prime contractor, EOIR is responsible for the technical performance of all of its products and services delivered to the customer. Primary revenue streams are derived from the delivery of products and services which provide the customer with: advanced development product concepts; low volume produced prototypes; advanced signal processing algorithms and software; advanced systems integration; engineering and evaluation services; data collection and processing capabilities and other highly differentiated and proprietary products and services.
EOIR intellectual property lies in trade secrets and the experience and capabilities of its technical staff whom support these government contracts. We protect EOIR intellectual property and our competitive position through patent applications, non-disclosure agreements with our business partners, and non-compete agreements with our employees.
Products
EOIR develops and produces highly advanced remote sensing hardware and software system products for our government customer base. Our products extend the range of our remote sensor services, encompassing the full spectrum of sensor science, systems integration, and system support. Below is a list of our current products:
· | ACADA (Automatic Chemical Agent Detection and Alarm)- Man portable chemical agent point detector sensor system which utilizes Ion Mobility Spectroscopy technology to detect chemical agents such as Tabun, Sarin, and classic nerve agents. This unit has been mass produced and deployed throughout the US Navy. |
· | SERTS™ (Safety Evaluation Range Training System) -Audio and video recording system that allows instructors to instruct, review, and qualify trainees. SERTS is a minimally intrusive, multi-platform compatible, audio/video monitoring system that brings range evaluators to the action inside a host of live fire exercise vehicles. It transmits live audio and video from the exercise vehicle directly to a range tower for exercise monitoring, recording, and post exercise review. |
· | Embedded system that allows multiple sensors to be remotely controlled. USRD is designed to remotely control and retrieve data from multiple sensors and transfer data to a base station through wired and wireless communications. |
· | Pelco Camera Translators- Embedded system that allows non-Pelco cameras to be integrated into Pelco networks, that is, it allows non-Pelco cameras to be controlled by a standard Pelco control network. |
· | A thermal imaging display and analysis software based tool designed for viewing and analyzing thermal images. It offers a range of features including Fourier analysis, high and low pass filters, thermal image calibration, image statistics, and advanced digital display algorithms. |
· | An interferogram processing and analysis software based tool that permits analysis of interferograms from spectrometers. Designed for the analysis of remotely captured chemical emission spectral information, the analysis tool enables the recognition of targeted chemical signatures. |
· | A software based tool that can be used to keep accurate positioning information for multiple vehicles during field tests. |
· | A software based tool that assists predictive modeling of thermal targets and is used to calculate detection probabilities of targets at arbitrary angles and ranges. |
Services
EOIR has been providing highly differentiated services to government customers for nearly 20 years. Our scientific support spans a wide range of services, including the full spectrum of sensor sciences, systems integration, system support and software development, as more fully described below:
· | Sensor Science. Sensor science services at EOIR involve a multitude of spectral regions, ranging from visible to far infrared, developing, using and interpreting data from a number of different sensors including acoustic, radar, thermal, multi-spectral and hyper-spectral calibrated imagers. |
· | Systems Integration. EOIR has the electrical and mechanical engineering design experience necessary to integrate laboratory prototypes into existing military sensor systems. |
· | Technical Training. EOIR has the ability to develop classroom courses and computer-based and web-based trainers to satisfy unique customer requirements. EOIR is able to train on the use of sensor and detection equipment as well as teaching students how to interpret sensor signature data. |
· | Software Development. EOIR develops customized sensor and data collection software platforms to satisfy a variety of unique customer requirements. |
Border Security
We acquired the assets of Ergo Systems, Inc. in January 2003. This acquisition provided us with contracts with the Department of Homeland Security to maintain, integrate, and implement design enhancements to border security systems installed at U.S. ports of entry for the Dedicated Commuter Lane, which is part of a larger U.S. Customs and Immigration and Naturalization Service initiative to reduce wait times, improve data accuracy, and improve overall efficiencies at all border crossings for both freight and passengers.
The Dedicated Commuter Lane (DCL) integrates several important security checks. It employs automatic vehicle identification technology, which allows participants to pass through the border crossing more efficiently than without automatic screening. Participants run a card through a swipe card reader, which instantaneously sends patron information, including a photograph, to the inspector's screen for clearance. The gate rises and allows the patron through. The whole process takes about 30 seconds. The Dedicated Commuter Lane software also controls a variety of security subsystems, including video surveillance, gates, and tire shredders.
In conjunction with the DCL maintenance contract awarded by the Department of Homeland Security, we were also awarded a contract by Computer Sciences Corporation to perform border maintenance services in multiple ports of entry in the southern United States. During fiscal year 2005, our subsidiary, Ergo, recognized approximately $247,850 of revenue from these contracts.
During fiscal year 2004, we entered into a teaming agreement with Accenture, who was recently awarded the US VISIT contract. The purpose of this contract is to secure our borders and expedite the entry/exit process while enhancing the integrity of our immigration system and respecting the privacy of visitors to the United States. We have recently been appointed a subcontractor which may enable us to derive revenues from the US VISIT contract.
The US VISIT program is part of a larger Department of Homeland Security initiative to increase security, reduce wait times, improve data accuracy, and improve overall efficiencies at all border crossings for both freight and passengers by creating and implementing a "trusted traveler" concept of traffic flow. The "trusted traveler" concept is designed for frequent border crossers who are willing to undergo a background check and travel under some restrictions in exchange for the use of a commuter lane. This dedicated commuter lane substantially decreases the amount of time it takes to drive through the border. We believe that our experience in integrating solutions will be attractive to the Department of Homeland Security as it confronts the various issues of protecting our borders although there can be no assurances that the trusted traveler concept will result in an increase in sales or revenues.
Business History
Markland Technologies, Inc. is the successor to A. P. Sales Inc., a corporation incorporated in Colorado in 1995. In December 1998, A. P. Sales was dissolved as a Colorado corporation and re-domiciled in Florida under the name Quest Net Corporation ("Quest Net"). In March 2000, Quest Net acquired CWTel, Inc., a Florida corporation ("CWTel"). CWTel filed a voluntary bankruptcy petition in November 2001 and was issued a final decree in March 2002. In March 2001, Quest Net acquired all of the outstanding stock of Vidikron of America, Inc., a Delaware corporation ("Vidikron"). As a result, Vidikron's sole stockholder, Market LLC, a Cayman Islands limited liability company, became Quest Net's majority stockholder and Vidikron became a wholly-owned subsidiary of Quest Net. Quest Net subsequently changed its name to Markland Technologies, Inc. In order to cure a default in our obligations to Market LLC, we transferred all of our interest in Vidikron to Market LLC in June 2002. As a result, at the end of fiscal 2002, we had no active business operations.
In December 2002, we entered into a transaction with Eurotech, Ltd., ipPartners, Inc., Market LLC, and James LLC. Pursuant to this transaction the following took place:
· | We formed a subsidiary corporation called Security Technology, Inc. |
· | Eurotech transferred particular rights to its acoustic core technology relating to illicit material detection to our subsidiary. |
· | Crypto.com Inc. (a subsidiary of Eurotech) and ipPartners transferred particular rights to their cryptology technologies to our subsidiary. |
· | 90% of the shares of our common stock held by Market LLC and James LLC were retired. |
· | We issued 80% of our then issued and outstanding common stock to Eurotech and shares of common stock representing 10% of our then issued and outstanding shares of common stock to ipPartners. |
· | We issued $5,225,000 in stated value of our Series C 5% cumulative convertible preferred stock to Market LLC and James LLC in satisfaction of $5,225,000 of convertible notes held by Market LLC and James LLC and in exchange for their agreement to surrender 4,498,638 shares of our common stock. |
In January 2003, we acquired all the common stock of Ergo Systems, Inc., a company in the business of providing border security logistic support and product development services to the U.S. government. Ergo Systems Inc. has a contract with the Department of Homeland Security to maintain, integrate and implement design enhancements to border security systems. In consideration for this acquisition we agreed to pay $400,000 in cash, payable at milestones which are related to research efforts.
In March 2003, we entered into an agreement to acquire the intellectual property (including patents), equipment, and government contracts for some particular gas plasma antenna technology from ASI Technology Corporation. We closed this transaction in September 2003. We paid a purchase price of $150,000 in cash and 283,333 shares of our common stock valued at $850,000.
In October 2003, we acquired all of the common stock of Science and Technology Research Corporation, Inc. This company is the producer of the U.S. Navy's Shipboard Automatic Chemical Agent Detection and Alarm System. In consideration for this acquisition, we issued 1,539,779 shares of common stock valued at $5,100,000, paid $900,000 in cash and issued a promissory note for $375,000. We also entered into a consulting agreement with the former principal shareholder and employee.
On June 29, 2004, we acquired all of the outstanding stock of EOIR for $8,000,000 in cash and $11,000,000 in principal amount of five-year notes secured by the assets and stock of EOIR. EOIR is a provider of technology and services to the United States Army Night Vision and Electronic Sensors Directorate, as well as other United States Department of Defense and Intelligence Agencies. It has significant expertise in wide-area remote sensing using both electro-optic and infrared technologies.
On February 14, 2005, we acquired a controlling interest in Technest, a public company with no operations. In connection with this transaction, and, at the same time, Technest acquired all of the capital stock of Genex Technologies, Inc., a private company with expertise in imaging and surveillance whose primary customer is the U.S. Department of Defense. Technest financed the acquisition of Genex through the private placement of securities to sophisticated investors. We structured the acquisition of Genex in this manner to comply with covenants in our financing agreements and to facilitate the financing of the acquisition.
On August 17, 2005, pursuant to a stock purchase agreement with Technest Holdings, Inc., our majority owned subsidiary, we sold all of the outstanding stock of EOIR to Technest. As consideration for our stock of EOIR, Technest issued 12 million shares of its common stock to us, and, as a result, our ownership of Technest increased from 85% immediately prior to the transaction to approximately 98% on a primary basis and from 39% to approximately 82% on a fully diluted basis (assuming the conversion of all of Technest’s convertible securities and the exercise of all warrants to purchase Technest common stock). This reorganization did not result in a change of control for EOIR. We did not need stockholder consent in order to complete this reorganization. EOIR generated approximately 97% of our revenue for fiscal 2005.
RECENT EVENTS
Subsequent to September 30, 2005, convertible promissory notes with a face value of $900,000 were converted into 36,712,881 shares of our common stock.
Subsequent to September 30, 2005, 275 shares of Series D Convertible Preferred Stock were converted into 12,001,099 shares of our common stock.
On October 4, 2005, we entered into exchange agreements with Southridge Partners, LP and Southshore Captial Fund, Ltd., pursuant to which we issued 1,750 shares of Series D preferred stock in exchange for 402,301 shares of Technest Series B preferred stock.
On October 4, 2005, we issued a warrant to purchase 750,000 shares of our common stock to Greenfield Capital Partners LLC. The warrants expire on February 10, 2010 and have an exercise price of $0.34 per share and are substantially in the form attached to our current report on Form 8-K filed on October 7, 2005 as Exhibit 10.5. These warrants are exercisable immediately.
RESULTS OF OPERATIONS
REVENUE:
Revenue for the quarter ended September 30, 2005 increased by 20% to $18,996,341 compared to $15,769,851 for the same period in 2004, which was prior to our acquisition of Genex. Our EOIR subsidiary accounted for approximately 96% of these revenues in the three months ended September 30, 2005.
EOIR's most significant source of revenues is a contract with the United States Army Night Vision and Electronic Sensors Directorate. Approximately 89% of our revenues were received from this contract in the last quarter. We expect orders to continue at or above current levels under this contract, however, no assurance can be given that this will be the case.
COST OF REVENUES:
Cost of revenues for the quarter ended September 30, 2005 increased by 25% to $15,590,455, compared to $12,442,893 for the same period in 2004. Cost of revenues increased as a result of costs from our acquisition of Genex and a slight change in the mix of contract revenues.
Gross profits for the quarter ended September 30, 2005 increased by 2% to $3,405,886 compared to $3,326,958 for the same period in 2004.
Gross profit as a percentage of revenue for the quarter ended September 30, 2005 was approximately 18% compared to 21% for the same period in 2004. Most of our revenues for the quarter are from variable cost contracts which enjoy greater certainty of profit, compared to fixed price contracts but at lower margins. It is our intention to create a balanced portfolio of contracts and products as the Company matures.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Selling, general and administrative expense for the quarter ended September 30, 2005 increased by 35% to $4,860,132 compared to $3,593,619 in the same period in 2004. Selling, general and administrative expense was primarily composed of payroll, consultants, and legal and accounting fees. Included in this amount was a $916,959 charge for compensatory element of stock issuances for the quarter ended September 30, 2005, compared with $(19,143) for the same period in the previous year. This non cash charge accounted for 73% of the increase in selling, general and administrative expenses for the quarter. Costs related to Genex which were not present in the prior comparative period accounted for another 20% of the increase in selling, general and administrative expenses for the quarter ended September 30, 2005.
RESEARCH AND DEVELOPMENT:
During the quarter ended September 30, 2005, we spent $171,935 on research and development activities compared to no expenditure for the quarter September 30, 2004 as we begin to develop products from our intellectual property portfolio.
OPERATING LOSS:
Loss from operations for the quarter ended September 30, 2005 increased by 181% to $2,100,383 compared to $748,653 for the comparative period in 2004. The increase in the loss of $1,351,730 was accounted for by an increase in the non cash amortization of the compensatory element of stock issuances and costs incurred by Genex, our new subsidiary.
INTEREST EXPENSE:
Interest expense for the quarter ended September 30, 2005 increased to $2,003,724 compared to $503,215 for the quarter ended September 30, 2004. The non-cash element of these interest charges amounted to $1,383,974. In addition, we accrued $530,000 of interest in the quarter ended September 30, 2005 related to liquidated damages incurred by Technest. Interest and financing expense was from notes payable issued for bridge financing, and other financing costs. These charges represent the accretion of debt discount to the fair market value of the notes and amortization of deferred financing costs over the term of the convertible notes. We issued two convertible notes on September 21, 2004 and November 9, 2004. As this short-term financing has a term of one year, these charges are accreted over a relatively short period of time resulting in substantial non-cash interest charges. In connection with our acquisition of EOIR, EOIR issued, and we guaranteed, $11,000,000 in original principal amount of notes due to the former stockholders of EOIR. These notes bear interest at the rate of six (6%) percent per annum and must be repaid within the next five years. The carrying value of these notes is $8,800,000 at September 30, 2005. Also included in interest expense is $626,503 related to common stock issued in payment of liquidated damages to the holders of our convertible notes.
MINORITY INTEREST IN NET LOSS OF SUBSIDIARY AND PREFERRED STOCK DIVIDENDS:
The minority interest in the net loss of Technest was $23,266 for the quarter ended September 30, 2005.
Deemed preferred stock dividends for the quarter ended September 30, 2005 were $159,552. These deemed dividends resulted from the beneficial conversion features of Series D preferred stock stock issued by Markland in exchange for Series B preferred stock of Technest.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS:
Net loss applicable to common stockholders for the quarters ended September 30, 2005 and September 30, 2004 was $4,201,662 ($0.02 per share) and $1,246,021 ($0.03 per share), respectively. Our weighted average number of shares outstanding for the quarters ended September 30, 2005 and September 30, 2004 were 215,804,637 and 38,352,594, respectively.
The reduction in net loss per share from the prior period is due primarily to the significant increase in number of shares outstanding. Shares outstanding increased primarily as a result of our financing activities.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Working Capital
On September 30, 2005, Markland had a negative working capital balance of $5,332,741. Net cash used in operating activities was $1,560,182 for the three months ended September 30, 2005. Non-cash expenses included in the net loss of $3,528,010 totaled $2,884,317, while changes in the components of working capital used cash of $916,489. Most of this change in working capital was related to a reduction in trade payables and an increase in trade receivables.
Cash Used in Investing Activities
Markland used net cash of $55,409 for the acquisition of equipment
Cash Used in Financing Activities
In the three months ended September 30, 2005, $610,592 was used for loan repayments and $65,551 for the repurchase of common stock.
Sources of Liquidity
During the three months ended September 30, 2005, we have satisfied our cash requirements primarily through operating cash flows and our cash reserves.
OFF-BALANCE SHEET ARRANGEMENTS
We have issued letters of credit to banks in the amount of $290,000 related to our corporate credit cards which are collateralized by a restricted cash balance in the same amount. We have no other significant 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.
EFFECT OF INFLATION AND CHANGES IN PRICES
Management does not believe that inflation and changes in price will have a material effect on operations.
CRITICAL ACCOUNTING POLICIES
The preparation of Markland'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
Our consolidated financial statements include the accounts of Markland and its wholly-owned subsidiaries, Security Technology, Inc., Ergo Systems, Inc., Science and Technology Research Corporation, Inc, , and majority owned subsidiaries Technest Holdings, Inc., E-OIR Technologies, Inc., and Genex Technologies, Inc. We have eliminated all significant inter-company balances and transactions.
CONCENTRATIONS
Statement of Financial Accounting Standards ("SFAS") No. 105, "Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk," requires that we disclose any significant off-balance-sheet and credit risk 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. 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.
-39-
As of September 30, 2005, we had cash balances in banks in excess of the maximum amount insured by the FDIC. In addition, we derive substantially all of our contract revenue from contracts with Federal government agencies. Consequently, substantially all of our accounts receivable are due from Federal government agencies either directly or through other government contractors.
RESEARCH AND DEVELOPMENT
We charge research and development costs to expense as incurred. We capitalize costs related to acquired technologies that have achieved technological feasibility and have alternative uses. We expense as research and development costs the technologies we acquire if they are in process at the date of acquisition or have no alternative uses.
IMPAIRMENT OF GOODWILL AND AMORTIZABLE INTANGIBLES
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," we review goodwill and amortizable intangibles for impairment annually, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of our business enterprise below its carrying value. The impairment test requires us to estimate the fair value of our overall business enterprise down to the reporting unit level. We estimate fair value using either a discounted cash flows model, or an approach using market comparables, to determine fair value. Under the discounted cash flows method, we utilize estimated long-term revenue and cash flows forecasts developed as part of our planning process, together with an applicable discount rate, to determine fair value. Under the market approach, fair value is determined by comparing us to similar businesses (or guideline companies). Selection of guideline companies and market ratios require management's judgment. The use of different assumptions within our discounted cash flows model or within our market approach model when determining fair value could result in different valuations for goodwill.
ESTIMATED USEFUL LIVES OF AMORTIZABLE INTANGIBLE ASSETS
We amortize our amortizable intangible assets over the shorter of the contractual/legal life or the estimated economic life. We are amortizing the intangible assets acquired as of a result of the Ergo and ASI acquisitions over a three-year life commencing with the date of acquisition. With respect to the Science & Technology Research, Inc. and EOIR Technologies, Inc. acquisitions, consistent with independent business valuations, we are amortizing the intangible assets over ten years and nine years respectively.
Definite-lived intangible assets acquired from Genex represent costs of outside legal counsel related to obtaining new patents. Patent costs are amortized over the legal life of the patents, generally twenty 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.
Markland 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 based on an independent purchase price allocation analysis. These assets have an estimated useful life of five years.
IMPAIRMENT OF LONG-LIVED ASSETS
Pursuant to SFAS No. 144, we continually monitor events and changes in circumstances that could indicate carrying amounts of long-lived 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 the three months ended September 30, 2005 or 2004.
REVENUE RECOGNITION
We recognize revenue when the following criteria are met: (1) we have persuasive evidence of an arrangement, such as agreements, purchase orders or written requests, (2) we have completed delivery and no significant obligations remain, (3) our price to our customer is fixed or determinable, and (4) collection is probable. Revenues from time and materials contracts are recognized as costs are incurred. 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. 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 revision to cost and income and are recognized in the period in which the revisions are determined. Markland participates in teaming agreements where they are the primary contractor and they participate with other organizations to provide complex integrated remote sensor product and technology development services to the Federal government. Markland has managerial and oversight responsibility for all team members as well as the responsibility for the ultimate acceptability of all integrated technical performance criteria under the contracts for deliverable services and products. Markland as the prime contractor whom accepts risks for these customer funded tasks includes as revenues the amounts that they bill under the teaming arrangements and include as direct costs amounts that are reimbursable or paid to team members
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and Amends SFAS No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is not an alternative. SFAS No. 123(R) must be adopted no later than the first interim period for fiscal years beginning after December 15, 2005. We expect to adopt SFAS No. 123(R) on July 1, 2006.
SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods: a “modified prospective” approach or a “modified retrospective” approach. Under the modified prospective approach, compensation cost is recognized beginning with the effective date based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and the requirements of SFAS No. 123(R) for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date. The modified retrospective approach includes the requirements of the modified prospective approach but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either for all prior periods presented or prior interim periods of the year of adoption. We are evaluating which method to adopt.
As permitted by SFAS No. 123, we currently account for the share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. However, grants of stock to employees have always been recorded at fair value as required under existing accounting standards. We expect the adoption of SFAS No. 123(R) to have a material effect on its results of operations. Additionally, Our results of operations could be materially effected by share-based payments issued after the adoption of SFAS 123(R). The impact of the adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in Note 2 to our financial statements.
SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than an operating cash flow under current accounting literature. Since we do not have the benefit of tax deductions in excess of recognized compensation cost, because of our net operating loss position, the change will have no immediate impact on our consolidated financial statements.
RISK FACTORS
Any investment in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below, and all other information contained in this report, before you decide whether to purchase our common stock. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also become important factors that may harm our business. The occurrence of any of the following risks could harm our business. 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. In addition, our future operating results could differ materially from the results described in this report due to the risks and uncertainties related to our business, including those discussed below.
Risks Related to Markland’s Operating Losses
We have a history of operating losses, and there is no assurance that we will achieve profitability in the future. If we do not achieve profitability, our financial condition and our stock price could suffer.
We have a history of operating losses. We cannot predict when, or if, we will ever achieve profitability. Our current business operations began in 2002 and have resulted in losses in each fiscal year. Our accumulated deficit as of September 30, 2005 was $52,337,008. We will need to generate significantly greater revenues than we have in the past to achieve profitability. There can be no assurance that we will be able to do so. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. If we continue to experience operating losses, you may lose all or part of your investment.
Given our recent acquisitions, it is difficult to evaluate our business and future operating results.
We derive substantially all of our revenues from the operations of our indirect subsidiary, EOIR. Markland acquired this company on June 29, 2004. Our limited operating history makes it difficult to evaluate our business and expected results.
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. We incurred net losses applicable to our common stockholders of $4,201,662 and $1,246,021 for the quarters ended September 30, 2005 and 2004, respectively. Additionally, net cash used in our operating activities for the quarter ended September 30, 2005 was $1,560,182. We may be unable to obtain additional funds in a timely manner or on acceptable terms, which would 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.
Although we have been successful in the past in obtaining financing for working capital and acquisitions, 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.
We have grown quickly; if we cannot effectively manage our growth, our business may suffer.
We have rapidly and significantly expanded operations through the acquisitions of Science Technology Research Corporation ("STR") in October 2003, EOIR in June 2004 and Genex in February 2005. This growth has placed, and is expected to continue to place, a strain on our personnel, management, financial and other resources. Some of our officers have no prior senior management experience at public companies. Our new employees include a number of key managerial, technical and operations personnel who have not yet been fully integrated into our operations. To manage our growth effectively, we must, among other things:
· | upgrade and expand our manufacturing facilities and capacity in a timely manner; |
· | successfully attract, train, motivate and manage a larger number of employees for manufacturing, sales and customer support activities; |
· | control higher inventory and working capital requirements; and |
· | improve the efficiencies within our operating, administrative, financial and accounting systems, procedures and controls. |
To meet our growth objectives we must attract and retain highly skilled technical, operational, managerial and sales and marketing personnel. If we fail to attract and retain the necessary personnel, we may be unable to achieve our business objectives and may lose our competitive position, which could lead to a significant decline in net sales. We face significant competition for these skilled professionals from other companies, research and academic institutions, government entities and other organizations.
If we fail to manage our growth properly, we may incur unnecessary expenses and the efficiency of our operations may decline, adversely affecting our business and the price of our stock.
Future acquisitions of other companies, if any, may disrupt our business and additional expenses. As a result, our business could suffer.
We have completed the acquisitions of several companies. We plan to review potential acquisition candidates, and our business and our strategy may include building our business through acquisitions. However, acceptable acquisition candidates may not be available in the future or may not be available on terms and conditions acceptable to us.
Acquisitions involve numerous risks including among others, difficulties and expenses incurred in the consummation of acquisitions and assimilations of the operations, personnel, and services and products of the acquired companies. Additional risks associated with acquisitions include the difficulties of operating new businesses, the diversion of management's attention from other business concerns and the potential loss of key employees of the acquired company. If we do not successfully integrate the businesses we may acquire in the future, our business will suffer.
If we fail to realize some or all of the anticipated benefits from our acquisition of indirect subsidiary, EOIR, our business will suffer.
Our combined company may fail to realize some or all of the anticipated benefits and synergies of the transaction as a result of, among other things, lower than expected order rates from customers of EOIR, unanticipated costs, deterioration in the U.S. economy and other factors. There can be no assurance that we will receive new orders under EOIR’s existing contract with the United States Army Night Vision and Electronic Sensors Directorate.
Our current and future expected revenues are derived from a small number of customers within the U.S. government such that the loss of any one ultimate customer could materially reduce our revenues. As a result, our financial condition and our stock price would be adversely affected.
We currently derived substantially all of our revenue from contracts with the U.S. Government, including the DOD, Homeland Security and various INTEL within the U.S. Government. We have a contract with the United States Army Night Vision and Electronic Sensors Directorate that may provide for revenues of up to approximately $406,000,000 depending upon the U.S. Army's needs of which our indirect subsidiary, EOIR, recognized in excess of approximately $56.2 million in revenues for the year ended June 30, 2005. We expect this contract to account for a substantial majority of our revenues going forward.
The loss of this customer due to cutbacks, competition, or other reasons would materially reduce our revenue base. Annual or quarterly losses may occur if there are material gaps or delays in orders from one of our largest customers that are not replaced by other orders or other sources of income.
Many of our technologies are unproven and their success in the marketplace is unknown. If we do not successfully exploit these technologies, our business and our prospects would be adversely affected.
Although we currently sell automatic chemical detection and alarm systems, we do not know for how long the U.S. Navy will continue to buy this product, nor do we know if we will be able to sell this product or others like it to other customers. If we do not successfully exploit our technology, our financial condition, results of operations and business prospects would be adversely affected.
The development of our technology is subject to factors beyond our control, including the production of components by our suppliers. We do not have long term supply agreements. As a result, products incorporating our technology may not be successfully and timely produced by our original equipment manufacturers due to the inherent risk of technology development, new product introduction, limitations on financing, competition, obsolescence, loss of key technical personnel or other factors. The development and introduction of our technologies could be subject to additional delays. For instance, unanticipated technical obstacles can arise at any time and result in lengthy and costly delays or a determination that further exploitation is unfeasible.
Some of our competitors are much larger than we are, have better name recognition than we do and have far greater financial and other resources than we do. If we cannot effectively compete, our business may suffer and the price of our stock would decrease.
With the U.S. government's large appropriation of money for homeland security programs, many companies are competing for the same homeland security contracts and there can be no assurance that Markland will effectively compete with large companies who have more resources and funds than we do. Several companies have been working on issues relevant to the safety of the American people for the past several years. Because of the services and additional human and financial resources that these larger companies can provide, they may be more attractive to the U.S. government. Lockheed Martin and Northrop Grumman are providers of hardware engineering and systems engineering solutions. Computer Sciences Corporation and EDS provide computer and computer software solutions. Defense companies, such as General Dynamics, Boeing and Raytheon, are solutions providers that could easily expand their businesses into the homeland security business and are currently allocating resources to develop programs in this area.
Our success depends on the services of our chief executive officer and chief operating officer. The loss of key personnel or any inability to attract and retain additional personnel could affect our ability to successfully grow our business.
Our future success depends to a significant degree on the skills and efforts of Robert Tarini, our Chief Executive Officer and Dr. Joseph P. Mackin, our president and chief operating officer. If we lost the services of Mr. Tarini or Dr. Mackin, our business and operating results could be adversely affected. On December 30, 2004, we entered into a five year employment agreements with Mr. Tarini and Dr. Mackin, which were subsequently amended.
We also depend on the ability of our other executive officers and members of senior management to work effectively as a team. The loss of one or more of our executive officers or senior management members could impair our ability to manage our business effectively and could harm our business, prospects, financial condition and results of operations.
Our management will spend time on other activities with other entities. As a result, our business may suffer, adversely affecting the price of our common stock.
Robert Tarini, our chief executive officer, also serves as an officer and director of other entities. These entities include Technest Holdings, Inc., Syqwest, Inc., ipPartners, Inc., and Ocean Data Equipment Corporation. These entities may share similar investment objectives and policies. Dr. Mackin, our president and chief operating officer, serves as president of Technest and Genex and the president and chief executive officer of EOIR. Finally, Gino Pereira, our chief financial officer is also the chief financial officer of Technest and Genex. Mr. Tarini, Dr. Mackin and Mr. Pereira may disproportionately allocate their time and resources between these other entities and us. Neither our organizational documents nor our policies specify a minimum standard of time and attention that Mr. Tarini, Dr. Mackin and Mr. Pereira are required to devote to us.
Our largest customers are the DOD, Homeland Security, and various other INTEL whose operations are subject to unique political and budgetary constraints, involve competitive bidding, and our contacts with these customers may be subject to cancellation with or without penalty, which may produce volatility in our earnings and revenue.
Our largest customers are the DOD, Homeland Security, and various other INTEL. Due to political and budgetary processes and other scheduling delays that may frequently occur relating to the contract or bidding process, some government agency orders may be canceled or delayed, and the receipt of revenues or payments may be substantially delayed. This irregular and unpredictable revenue stream makes it difficult for our business to operate smoothly. Obtaining contracts from government agencies is challenging, and government contracts often include provisions that are not standard in private commercial transactions. For example, government contracts may:
· | include provisions that allow the government agency to terminate the contract without penalty under some circumstances; |
· | be subject to purchasing decisions of agencies that are subject to political influence; |
· | contain onerous procurement procedures; and |
· | be subject to cancellation if government funding becomes unavailable. |
In addition, federal government agencies routinely audit government contracts. These agencies review a contractor's performance on its contract, pricing practices, cost structure and compliance with applicable laws, regulations and standards. These audits may occur several years after completion of the audited work. An audit could result in a substantial adjustment to our revenues because we would not be reimbursed for any costs improperly allocated to a specific contract, and we would be forced to refund any improper costs already reimbursed. 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 federal government agencies. In addition, our reputation could be harmed if allegations of impropriety were made against us.
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 net sales.
The steps we have taken to protect our technology may be inadequate to prevent others from using what we regard as our technology to compete with us. Our patents could be challenged, invalidated or circumvented, in which case the rights we have under our patents could provide no competitive advantages. Existing trade secrets, copyright and trademark laws offer only limited protection. In addition, the laws of some foreign countries do not protect our proprietary technology to the same extent as the laws of the United States, which could increase the likelihood of misappropriation. Furthermore, other companies could independently develop similar or superior technology without violating our intellectual property rights.
If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome, disruptive and expensive, distract the attention of management, and there can be no assurance that we would prevail.
Claims by others that we infringe their intellectual property rights could increase our expenses and delay the development of our business. As a result, our business and financial condition could be harmed.
Our industries are characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. We cannot be certain that our products do not and will not infringe issued patents, patents that may be issued in the future, or other intellectual property rights of others.
We do not conduct exhaustive patent searches to determine whether the technology used in our products infringes patents held by third parties. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies.
We may face claims by third parties that our products or technology infringe their patents or other intellectual property rights. Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract the attention of our management. If any of our products are found to violate third-party proprietary rights, we may be required to pay substantial damages. In addition, we may be required to re-engineer our products or obtain licenses from third parties to continue to offer our products. Any efforts to re-engineer our products or obtain licenses on commercially reasonable terms may not be successful, which would prevent us from selling our products, and, in any case, could substantially increase our costs and have a material adverse effect on our business, financial condition and results of operations.
Fluctuations in our quarterly net sales 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 net sales 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:
· | timing of orders from our largest customers - the DOD, Homeland Security, various INTEL and the United States Night Vision and Electronic Sensors Directorate; |
· | our ability to 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 net sales 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 net sales could therefore significantly harm our operating results for a particular fiscal period.
Risks Related to the Dilutive Effect of Our Agreements with Investors and Other Arrangements
Our stock price could decline significantly if we issue substantial shares of our common stock (i) upon conversion of the outstanding Series D Preferred Stock, (ii) upon exercise of our warrants, (iii) upon conversion of our notes, or (iv) pursuant to our employment agreements, our consulting agreements, our equity compensation plans, and our private equity credit agreement.
We are obligated to issue a substantial number of shares of common stock pursuant to the terms of the arrangements described above. Should a significant number of these securities be issued, exercised or converted, the resulting increase in the amount of the common stock in the public market could have a substantial dilutive effect on our outstanding common stock. The conversion and exercise of a substantial amount of the aforementioned securities or the issuance of new shares of common stock may also adversely affect the terms under which we could obtain additional equity capital. The price, which we may receive for the shares of common stock, that are issuable upon conversion or exercise of such securities, may be less than the market price of the common stock at the time of such conversions or exercise.
We cannot predict the actual number of shares of common stock that will be issued pursuant to these arrangements, in part, because the conversion price of some of these securities will fluctuate based on prevailing market conditions and we have not determined the total amount of advances we intend to draw. Nonetheless, we can estimate the number of shares of common stock that will be required to issue using the certain assumptions including (1) the recent price of our common stock of $.0221 on November 15, 2005, (2) our recent average closing bid price of our common stock for the last five trading days ending November 15, 2005, and (3) the number of shares outstanding as of November 16, 2005.
· | As of November 16, 2005, the outstanding Series D Preferred Stock would convert into approximately 607,095,196 shares of our Common Stock, and our secured convertible promissory notes would convert into approximately 30,645,296 shares of our common stock. |
· | In addition, as provided in Section 2(b) of the Terms and Conditions of the September 21, 2004 and November 9, 2004 notes, interest payments may be made with shares in lieu of cash. As of November 16, 2005, we had issued 3,703,091 shares of our common stock as payment of interest accrued on the notes. As a result, existing investors will experience significant dilution, and may experience further dilution if the price of our stock continues to decline. |
Our stockholders will experience significant dilution upon the conversion of our Series D Preferred Stock because the Series D Preferred Stock converts at a discount to the market price of our common stock at the time of conversion.
Shares of Series D preferred stock are convertible at the option of the stockholder at any time. The number of shares of our common stock into which each share of Series D preferred is convertible is determined by dividing $1,000 by the discounted bid price. The "discounted" bid price is the average closing bid price of our common stock during the five business days immediately preceding the conversion date multiplied by the applicable discount factor, as set forth below.
Average Closing Bid Price (1) | Discount Factor | |||
$15.00 or less | 80 | % | ||
more than $15.00, but less than or equal to $30.00 | 75 | % | ||
more than $30.00, but less than or equal to $45.00 | 70 | % | ||
more than $45.00 | 65 | % |
__________
(1) After an adjustment for a 1-for-60 reverse stock split effective October 27, 2003.
The Series D preferred stock can be converted only to the extent that the Series D stockholder and its affiliates will not, as a result of the conversion, hold in excess of 9.999% of the total outstanding shares of our common stock.
There is an inverse relationship between our stock price and the number of shares issuable upon conversion or our Series D Preferred Stock. That is, as our stock price declines, we would be required to issue a greater number of shares upon conversion of the Series D Preferred Stock. The conversion price is based on the then-existing market price. This inverse relationship is demonstrated by the table set forth below, which shows the number of shares to be issued upon conversion of the Series D Preferred Stock at certain prices per share.
Average Closing Price of Common Stock for Five Preceding Trading Days | Conversion Price | Shares of Common Stock Issued upon Conversion of One Share of Series D Preferred Stock |
$0.04 | $0.032 | 31,250 |
$0.03 | $0.024 | 41,667 |
$0.02 | $0.016 | 62,500 |
$0.01 | $0.008 | 125,000 |
Our stockholders will experience significant dilution upon the conversion of our 8% convertible notes issued on September 21, 2004 because these notes convert at a discount to the market price of our common stock at the time of conversion.
All or any portion of the principal amount of the 8% convertible notes then outstanding together with any accrued and unpaid interest thereunder may be converted into shares of common stock at the conversion price, at the option of the holder of the notes, at any time and from time to time. The number of shares issuable upon any conversion will be equal the outstanding principal amount of the note to be converted, divided by the conversion price on the conversion date, plus (if indicated in the applicable conversion notice) the amount of any accrued but unpaid interest on the note through the conversion date, divided by the conversion price on the conversion date. As of March 15, 2005, the conversion price of the notes has been adjusted to the lower of (i) $0.80 and (ii) a floating rate equal to 80% of average closing price per share of our common stock for the five trading days preceding conversion. Due to the conversion mechanics of the note, decreases in the conversion price result in an increase in the total number of shares issuable upon conversion.
The number of shares to be acquired by each of the holders of the notes upon conversion cannot exceed the number of shares that, when combined with all other shares of common stock and securities then owned by each holder and its affiliates, would result in any one of them owning more than 9.999% of our outstanding common stock at any point in time. The holders of the notes may not waive this limitation.
There is an inverse relationship between our stock price and the number of shares issuable upon conversion or these convertible notes. That is, as our stock price declines, we would be required to issue a greater number of shares upon conversion of these notes. The conversion price is based on the then-existing market price. This inverse relationship is demonstrated by the table set forth below, which shows the number of shares to be issued upon conversion of the notes at certain prices per share.
Average Closing Price of Common Stock for Five Preceding Trading Days | Conversion Price | Shares of Common Stock Issued per $1,000 dollars of note principal converted |
$0.04 | $0.032 | 31,250 |
$0.03 | $0.024 | 41,667 |
$0.02 | $0.016 | 62,500 |
$0.01 | $0.008 | 125,000 |
Risk Related to Our Equity Line
Existing shareholders may experience significant dilution from the sale of shares under our private equity credit agreement with Brittany Capital Management.
Any sale of shares pursuant to our private equity credit agreement will have a dilutive effect on the percentage ownership of our existing stockholders. Based on the last reported sale price of our common stock of $.0207 on November 16, 2005, we would have to issue 259,726,768 shares of common stock to draw down the entire $5 million available to us under the private equity credit agreement. These shares would represent approximately 74% of our currently outstanding common stock upon issuance. Upon effectiveness of the registration statement registering 11,727,713 shares under the private equity credit agreement and assuming all 11,727,713 shares registered thereunder are resold in the public market, there will be an additional 11,727,713 shares of common stock outstanding.
The offering price of our common stock for any put under the private equity credit agreement is based on a discounted market price calculated at the time of the put. As a result, there is an inverse relationship between our stock price and the number of shares we may issue under this agreement. That is, any decline in the price of our common stock would require us to put additional shares for a given draw. The inverse relationship is demonstrated by the table set forth below, which shows the number of shares to be issued under the private equity credit agreement for a hypothetical $50,000 draw-down at hypothetical market prices of $0.05; $0.04; $0.03; $0.02 and $0.01 per share.
Price sensitivity of dilution resulting from Private Equity Credit Agreement
Hypothetical Draw Amount | Hypothetical Market Price | Discounted Market Price | Shares to be issued |
$50,000 | $0.05 | $0.0465 | 1,075,268 |
$50,000 | $0.04 | $0.0372 | 1,344,086 |
$50,000 | $0.03 | $0.0279 | 1,792,114 |
$50,000 | $0.02 | $0.0186 | 2,688,172 |
$50,000 | $0.01 | $0.0093 | 5,376,344 |
Subsequent sales of these shares in the open market by Brittany may also have the effect of lowering our stock price, thereby increasing the number of shares issuable under the equity line facility (should we choose to sell additional shares to Brittany) and consequently further diluting our outstanding shares. These sales could have an immediate adverse effect on the market price of the shares and result in dilution to the holders of our shares.
We believe that Brittany and other stockholders intend to sell their shares of common stock in the market, which sales may cause our stock price to decline.
Brittany may sell in the public market up to 11,727,713 shares of common stock upon the effectiveness of the registration statement covering the resale of those shares. Such sales may cause our stock price to decline. Specifically,
· | Existing stockholders will experience substantial dilution if we draw down the maximum amount of shares of common stock currently being registered under a separate registration statement (approximately 3.3% of our currently outstanding shares on November 16, 2005). This means that up to 11,727,713 shares of common stock may be sold. The perceived risk associated with the possible sale of a large number of shares issued under the equity line could cause some of our stockholders to sell their stock, thus causing the price of our stock to decline. |
· | Because Brittany is purchasing our shares at a discount, it will have an incentive to sell immediately so that it can realize a gain on the difference. If our common stock market price does decline, this could further accelerate sales of our common stock. |
· | To the extent Brittany sells its common stock, the common stock price may decrease due to the additional shares in the market. This could allow Brittany to sell greater amounts of common stock, the sales of which would further depress the stock price. |
· | Actual or anticipated downward pressure on our stock price due to actual or anticipated sales of stock under the private equity credit agreement could cause some institutions or individuals to engage in short sales of our common stock, which may itself cause the price of our stock to decline. |
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 under the private equity credit agreement 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.
Other Risks Related to Our Capital Structure and our Common Stock
If we default on any of our outstanding notes, some or all of our assets could be liquidated, our operations will be disrupted and you may lose all or part of your investment.
All of our assets are subject to security agreements. Our obligations under notes issued to the former stockholders of EOIR, are secured by all the assets of EOIR and are guaranteed by Markland, and our obligations under the notes issued to the investors in our September 21, 2004 private placements are secured by all of the assets of Markland and its subsidiaries - EOIR, Ergo Systems, Inc. and STR. As a result, if we default under the terms of any of these notes, the holders of the notes could foreclose under the security interest and liquidate some or all of our assets.
Future sales by our stockholders may adversely affect our stock price and our ability to raise funds in new stock offerings.
Future sales of our common stock in the public market could lower the market price of our common stock. Such sales may also make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that our management deems acceptable or at all. Some of our shareholders hold securities issued and sold in private transactions in reliance upon exemptions from the registration requirements of the Securities Act.
These securities may be resold in the public market only if the resale is registered or pursuant to an exemption from registration. As of November 16, 2005:
· | approximately 21,895,614 shares of our common stock are restricted securities; and |
· | we have four effective registration statements covering the resale of up to 362,453,983 shares of our common stock. |
We do not know when these shares will be sold since sales will depend upon the market price for our common stock, the circumstances, needs and decisions of the selling stockholders, and other factors.
The holders of our preferred stock have some rights and privileges that are senior to our common stockholders, and we may issue additional shares of preferred stock without stockholder approval that could adversely affect the price of our common stock.
Our board of directors has the authority to issue, without any further vote or action by you and the other common stockholders, a total of up to 5,000,000 shares of preferred stock and to fix the rights, preferences, privileges, and restrictions, including voting rights, of the preferred stock, which typically are senior to the rights of the common stockholders. As of November 16, 2005, we have outstanding 30,000 shares of our Series A non-voting redeemable convertible preferred stock, 10,918 shares of our Series D convertible preferred stock and may, from time to time in the future, issue additional preferred stock for financing or other purposes with rights, preferences or privileges senior to the common stock. Your rights will be subject to, and may be adversely affected by, the rights of the holders of the preferred stock that have been issued or might be issued in the future. Preferred stock also could make it more difficult for a third party to acquire a majority of our outstanding voting stock. This could delay, defer or prevent a change in control. Furthermore, holders of preferred stock may have other rights, including economic rights, senior to the holders of our common stock. As a result, the existence and issuance of preferred stock could have a material adverse effect on the market value of the common stock.
The issuance of preferred stock may entrench management or discourage a change of control.
Our Articles of Incorporation authorize the issuance of preferred stock that would have designations rights, and preferences determined from time to time by our Board of Directors. Accordingly, our Board of Directors is empowered, without stockholder approval, to issue preferred stock with dividends, liquidation, conversion, voting, or other rights that could adversely affect the voting power or other rights of the holders of our common stock.
In the event of issuance, the preferred stock could be used, under some circumstances, as a method of discouraging, delaying or preventing a change in control of the company or, alternatively, granting the holders of preferred stock such rights as to entrench management. Current members of our management that are large stockholders and members of our Board may have interests that are different from other stockholders. Therefore, conflicting interests of some members of management and our stockholders may lead to stockholders desiring to replace these individuals. In the event this occurs and the holders of our common stock desired to remove current management, it is possible that our Board of Directors could issue preferred stock and grant the holders thereof such rights and preferences so as to discourage or frustrate attempts by the common stockholders to remove current management. In doing so, management would be able to severely limit the rights of common stockholders to elect the Board of Directors. In addition, by issuing preferred stock, management could prevent other shareholders from receiving a premium price for their shares as part of a tender offer.
We have never paid cash dividends on our capital stock, and we do not anticipate paying cash dividends in the foreseeable future. Investors should not rely on an investment in our stock for the payment of cash dividends.
We have not paid cash dividends on any of our classes of capital stock to date, and we currently intend to retain our future earnings, if any, to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future. Pursuant to the Purchase Agreement between Markland, DKR Soundshore Oasis Holding Fund, Ltd. and DKR Soundshore Strategic Holding Fund, Ltd., dated September 21, 2004, we have covenanted that so long as any of the notes issued pursuant to such agreement are outstanding, we will not declare, pay or make any provision for any cash dividend or cash distribution with respect to our common stock or preferred stock, without first obtaining the approval of the investors who are parties to the agreement.
Issuance of shares of common stock upon conversion of our Series D Preferred Stock and our September 21, 2004 notes could have an adverse effect on our ability to make acquisitions with our common stock, thereby adversely affecting our business and future prospects.
Our strategy is to grow through organic means by increasing acceptance by our customers of our present products and services offerings and also through acquisitions of assets that provide products or services to Homeland Security, DOD, or INTEL. As we issue shares of common stock pursuant to our current obligations, we may not have sufficient shares of our common stock available to successfully attract and consummate future acquisitions. It may be necessary for our stockholders to approve an increase of our authorized common stock in order to have sufficient authorized shares available to issue as consideration for acquisitions. There can be no assurance that we will obtain shareholder approval to increase the number of authorized shares or that such approval will be timely.
We may have an insufficient number of authorized shares of common stock to allow for conversion of all of our secured convertible notes, which could cause us to restructure the notes or to pay cash at maturity — neither of which we may be able to accomplish.
We currently have 500 million shares of common stock authorized for issuance. As of November 16, 2005, approximately 350 million shares were outstanding.
If the holders of our secured convertible notes issued on September 21, 2004 and September 20, 2005 elect to convert the outstanding principal and interest of such notes for shares of our common stock, these conversions may result in an issuance of shares that exhausts the amount of shares currently authorized for issuance. At an annual or special stockholders meeting, we may include a proposal to increase our authorized common stock. However, absent receiving stockholder approval at a stockholder meeting, we may be required to otherwise restructure the then-outstanding notes prior to maturity or pay cash at maturity if, at the time of conversion, the amount of shares required for redemption of those notes exceeds our then-authorized shares. There can be no assurance that, in such an event, we will be successful in restructuring our obligations under the outstanding notes prior to maturity.
We have committed to issue more shares of our common stock than we are currently authorized to issue and we may be forced to redeem outstanding securities as a result. We may be required to seek an increase in the number of our authorized shares of common stock in order to avoid possible redemption of securities and to obtain any available future financing.
Through the issuance of convertible debt, convertible preferred stock, options, warrants and other securities, we have made commitments to reserve and issue shares of our common stock that exceed the number of shares we are authorized to issue under our certificate of incorporation. Many of the instruments related to our derivative securities include mandatory redemption provisions, triggered by our failure to reserve a certain number of shares of our common stock, to honor valid conversion or exchange requests or to comply with resale registration obligations. We may receive valid conversion, exchange and share issuance requests that we are unable to fulfill. There is no upper limit on the number of shares that we may be required to issue to satisfy our commitments.
In addition, the holders of our common stock are subject to the low-risk short selling strategies that may be adopted by third parties and that could contribute to the future decline of our stock price. A substantial number of our convertible and exchangeable securities are convertible or exchangeable at a price per share that is 20% to 25% less than the five-day average closing bid price of our common stock immediately prior to conversion or exchange. In addition, the terms of these derivative securities generally do not prohibit the holders of these securities from short selling our common stock. Short selling is the act of borrowing stock to sell with the expectation of the price dropping and the intent of buying the stock back at a cheaper price to replace the borrowed stock. As a result of these factors, holders of these derivative securities may decide to sell our common stock short in an effort to drive down the price of the common stock by creating an imbalance of sell-side interest. Such a strategy involves low risk to the holder of these derivative securities due to the discounted conversion or exchange prices they enjoy that provides a hedge against potential price increases. The use of such a strategy by one or more of the holders of these derivative securities could cause a significant reduction in the market price of our common stock.
In order to fulfill all of our commitments, our stockholders would need to approve an amendment to our certificate of incorporation to significantly increase the number of our authorized shares of common stock. We can give no assurance that any increase will occur. If approved, any further increase could lead to further dilution for our existing stockholders.
In addition, we may need to seek an increase in our authorized shares of common stock in order to obtain future financing, if such financing would be available to us on acceptable terms, or at all. Any additional financing involving our common stock or derivative securities convertible into our common stock could also lead to further dilution for our existing stockholders.
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 registered 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 Relating to Our Investment in Technest
Technest's lack of operating history on which investors may evaluate its operations, prospects and ability to produce a return on investment makes an investment in Markland highly speculative.
Prior to February 14, 2005, Technest did not have any operations on which a potential investor may base an evaluation of its prospects and ability to operate Genex profitably. If Technest is unable to sustain profitable operations, Markland's return on its investment in Technest may suffer and the price of Markland's common stock may decline.
Robert Tarini is the Chief Executive Officer and Chairman of the Board of Directors of Technest and Markland. In addition, Mr. Tarini, has an investment in Technest. Dr. Mackin and Mr. Pereira also serve as officers of Technest. Conflicts of interest could arise as a result of these overlapping positions.
Technest and Markland share similar investment objectives and policies. There may be instances where the business of these companies overlap or compete. Mr. Tarini, Dr. Mackin and Mr. Pereira may disproportionately allocate time and resources between these other entities and us. Neither our organizational documents nor our policies specify a minimum standard of time and attention that these officers and directors, as applicable, are required to devote to us. However, we do not believe that having the same board of directors or doing business in the same markets will present a conflict of interest. There can be no assurances that there will be no conflicts of interest. The board will endeavor to act in the best interests of each company.
In addition, Mr. Tarini, through his wholly-owned company ipPartners, Inc., is one of the investors that participated in the transactions pursuant to which Genex Technologies was acquired. On February 14, 2005, ipPartners, Inc. received 143,678 shares of Technest Series B preferred stock, 143,678 shares of Technest Series C preferred stock convertible into 143,678 shares of Technest common stock and warrants to purchase 143,678 Technest common stock in exchange for $625,000. On June 20, 2005, ipPartners, Inc. exchanged all of its Technest Series B preferred stock for 625 shares of Markland Series D preferred stock. On August 23, 2005, ipPartners converted its 625 shares of Markland Series D preferred stock into 6,510,417 shares of Markland common stock. The resale of these shares of common stock were registered pursuant to a registration statement on Form SB-2 that was effective on August 10, 2005.
It may be difficult for us to resell shares of common stock of Technest if an active market for Technest common stock does not develop.
Due to the current price of Technest common stock, many brokerage firms may not be willing to effect transactions in its 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 below $5.00). These disclosure requirements may have the effect of reducing the trading activity in the secondary market for Technest common stock as it is subject to these penny stock rules. These factors severely limit the liquidity, if any, of Technest common stock, and will likely continue to have a material adverse effect on its market price and on our ability to raise additional capital through selling Technest common stock we hold.
The common stock of Technest is not actively traded on a securities exchange and will not be able to cause its securities to be listed because Technest does not meet the initial listing criteria for any registered securities exchange or the Nasdaq National Market System. The common stock of Technest is quoted on the less recognized OTC Bulletin Board. This factor may further impair our ability to sell our shares when we want and/or could depress the stock price of Technest common stock. As a result, we may find it difficult to dispose of, or to obtain accurate quotations of the price of, Technest common stock because smaller quantities of shares could be bought and sold, transactions could be delayed and security analyst and news coverage of our Technest may be limited. These factors could result in lower prices and larger spreads in the bid and ask prices for shares of Technest common stock.
We cannot predict the extent to which investor interest in Technest common stock or a business combination, if any, will lead to an increase in its market price or the development of an active trading market or how liquid that market, if any, might become.
Markland may become an investment company if our controlling interest in Technest falls below 51%. If so, our compliance and registration costs will increase.
If Markland's ownership of Technest falls below 51%, Technest will no longer meet the definition of "majority-owned subsidiary" as contemplated by the Investment Company Act of 1940 (the "Investment Company Act") and Markland could be subject to regulation under the Investment Company Act. In such event, Markland may be required to register as an investment company, unless an exemption is available. We may incur significant registration and compliance costs and we may become subject to liability under the Investment Company Act, the Securities Act and the Exchange Act and rules and regulations adopted thereunder. Compliance with these rules could adversely affect Markland and Technest because it would require additional management and financial resources. On November 16, 2005, Markland was the beneficial owner of 13,954,023 shares of Technest common stock (after giving effect to Technest's reverse stock split), which represented approximately 91% of the shares of Technest common stock on a primary basis.
Risks Relating to Investing in a Controlled Company
Other business ventures of our chief executive officer may present demands on his time or possible conflicts of interest which could materially and adversely affect our business.
Robert Tarini, our chief executive officer and a director of our company is involved in other business activities and may, in the future, become involved in additional business opportunities. Mr. Tarini currently holds positions and is involved in the following activities.
· | Mr. Tarini is the founder and president of ipPartners, Inc., a firm specializing in the design and manufacture of acoustic remote sensing devices utilized in marine and land based applications. He is also the sole shareholder. |
· | Mr. Tarini is the chief executive officer, the chief operating officer and a minority shareholder of Syqwest, Inc., a company that specializes in the development of acoustic remote sensing devices. |
· | Since 1999, Mr. Tarini has served as the chief executive officer of Ocean Data Equipment Corporation, where he has overseen the design and development of a complete line of scientific instruments targeted for geophysical and hydrographic research, and developed a remote sensing technique, which is currently being developed for application in detecting illicit materials. He is also a minority shareholder. |
· | On February 14, 2005, Mr. Tarini was appointed chief executive officer and a director of Technest. |
Mr. Tarini may face a potential conflict of interest in how he allocates his available time to each company. We have not formally adopted a plan to resolve any potential or actual conflicts of interest that exist or that may arise related to this matter. There can be no assurance that we will have a policy in place to address potential conflicts of interests.
Risks Related to the Homeland Security and Defense Industries
The homeland security and defense industries are characterized by rapid technological change and evolving industry standards, and unless we keep pace with the changing technologies, we could lose customers and fail to win new customers.
Our future success will depend, in part, upon our ability to develop and introduce a variety of new products and services and enhancements to these new product and services in order to address the changing and sophisticated needs of the homeland security marketplace. Delays in introducing new products, services and enhancements, the failure to choose correctly among technical alternatives or the failure to offer innovative products and services at competitive prices may cause customers to forego purchases of our products and services and purchase those of our competitors. Frequently, technical development programs in the homeland security industry require assessments to be made of the future directions of technology and technology markets generally, which are inherently risky and difficult to predict.
We face intense competition, which could result in lower revenues and higher research and development expenditures and could adversely affect our results of operations.
Current political tensions throughout the world have heightened interest in the homeland security industry, and we expect competition in this field, which is already substantial, to intensify. If we do not develop new and enhanced products, or if we are not able to invest adequately in our research and development activities, our business, financial condition and results of operations could be negatively impacted. Many of our competitors have significantly more cash and resources than we have. Our competitors may introduce products that are competitively priced, have increased performance or functionality, or incorporate technological advances that we have not yet developed or implemented. To remain competitive, we must continue to develop, market and sell new and enhanced systems and products at competitive prices, which will require significant research and development expenditures.
We cannot assure you that we will be able to compete successfully against current and future competitors.
Risks Relating to New Corporate Governance Standards
We are not subject to the same corporate governance standards as listed companies. This may affect market confidence and company performance. As a result, our business could be harmed and the price of our stock could decrease.
Registered exchanges and the Nasdaq National Market have adopted enhanced corporate governance requirements that apply to issuers that list their securities on those markets. These standards deal with the rights and responsibilities of a company's management, its board, shareholders and various stakeholders. How well companies are run may affect market confidence as well as company performance. Our common stock is quoted on the OTC Bulletin Board, which does not have comparable requirements. As a result, our business and the price of our stock may be adversely affected.
For instance, we are not required to have any independent directors and we do not have independent directors. Therefore management has significant influence over decisions made by the Board on behalf of the stockholders.
In some circumstances, management may not have the same interests as the shareholders and conflicts of interest may arise. We do not have a policy to resolve conflicts of interest and we are not required to have one. Notwithstanding the exercise of their fiduciary duties as directors and executive officers and any other duties that they may have to us or our other stockholders in general, these persons may have interests different than yours.
Our administrative costs and expenses resulting from new regulations have increased, adversely affecting our financial condition and results of operations.
We face new corporate governance requirements under the Sarbanes-Oxley Act of 2002 and SEC rules adopted thereunder. These regulations increased our legal and financial compliance and made some activities more difficult, time-consuming and costly. Our expenses will continue to increase as we continue to implement these new regulations.
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 will make it more difficult and more expensive for us to obtain director and officer liability insurance. We may be required to accept reduced coverage or incur significantly higher costs to obtain coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve as members of our board of directors.
If we fail to maintain effective internal controls over financial reporting, the price of our common stock may be adversely affected.
We are required to establish and maintain appropriate internal controls over financial reporting. Our internal controls over financial reporting may have weaknesses and conditions that need to be addressed, the disclosure of which may have an adverse impact on the price of our common stock.
Failure to establish those controls, or any failure of those controls once established, could adversely impact Markland's 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.
Standards for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 are uncertain, and if we fail to comply in a timely manner, our business could be harmed and our stock price could decline.
Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of our internal control over financial reporting, and attestation of this assessment by our independent registered public accountant. We expect that this requirement will first apply to our annual report for the fiscal year ending June 30, 2007. The standards that must be met for management to assess the effectiveness of the internal control over financial reporting are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. We may encounter problems or delays in completing activities necessary to make an assessment of its internal control over financial reporting. In addition, we may encounter problems or delays in completing the implementation of any requested improvements and receiving an attestation of its assessment by our independent registered public accountants. If management cannot assess Markland's internal control over financial reporting as effective, or our independent registered public accounting firm is unable to issue an unqualified attestation report on such assessment, investor confidence and share value may be negatively impacted.
Risks Related to Investing in Illiquid and Low-Priced Securities
Our common stock is deemed to be "penny stock," which may make it more difficult for investors to sell these shares due to suitability and disclosure requirements.
Due to the current price of our common stock ($0.0207 on November 16, 2005), many brokerage firms may not be willing to effect transactions in our securities, particularly because low-priced securities are subject to SEC rules (referred to as the "penny stock 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 Markland common stock as it is subject to these penny stock rules. These rules severely limit the liquidity, if any, of our common stock, and will likely continue to have a material adverse effect on our market price and on our ability to raise additional capital through selling Markland common.
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 Commission, that: (a) contains a description of the nature and level of risk in the market for penny stocks in both public offerings and secondary trading; (b) contains a description of the broker's or dealer's duties to the customer and of the rights and remedies available to the customer with respect to a violation to such duties or other requirements of Securities' laws; (c) contains a brief, clear, narrative description of a dealer market, including bid and ask prices for penny stocks and the significance of the spread between the bid and ask price; (d) contains a toll-free telephone number for inquiries on disciplinary actions; (e) defines significant terms in the disclosure document or in the conduct of trading in penny stocks; and (f) contains such other information and is in such form, including language, type, size and format, as the SEC may require by rule or regulation.
In addition, the broker-dealer also must provide, prior to effecting any transaction in a penny stock, the customer with: (a) bid and ask quotations for the penny stock; (b) the compensation of the broker-dealer and its salesperson in the transaction; (c) the number of shares to which such bid and ask prices apply, or other comparable information relating to the depth and liquidity of the market for such stock; and (d) monthly account statements showing the market value of each penny stock held in the customer's account.
Finally, 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.
These requirements may reduce the potential market for our common stock by reducing the number of potential investors, brokers and traders. This may make it more difficult for investors in our common stock to sell shares to third parties or to otherwise dispose of them. This could cause our stock price to decline.
We cannot predict the extent to which investor interest in Technest common stock or a business combination, if any, will lead to an increase in its market price or the development of an active trading market or how liquid that market, if any, might become.
It may be difficult for you to resell your shares if an active and liquid 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.
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 an SEC rule that imposes additional sales requirements on broker-dealers who sell low-priced securities (generally defined as those having a per share price below $5.00).
These factors severely limit the liquidity of our common stock, and would likely have a material adverse effect on its market price and on our ability to raise additional capital. We cannot predict the extent to which investor interest in our stock, if any, will lead to an increase in its market price or the development of a more active trading market or how liquid that market might become.
The market price of our common stock may be volatile. As a result, you may not be able to sell our common stock in short time periods, or possibly at all.
Our stock price has been volatile. From July 1, 2003 to November 16, 2005, the trading price of our common stock ranged from a low price of $0.019 per share to a high price of $9.00 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.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
Based on our management's evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the "Exchange Act")) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. The limited size of our internal financial and controls staff did not permit a significant amount of time or expense on monitoring and oversight of our general administrative and financial functions. In the course of management's ongoing evaluation of our controls and procedures, management has concluded that, due to the limited amount of resources available for general administrative and financial matters, the Company: (i) had a less than desirable number of people performing a majority of the financial duties, (ii) lacked the desired internal financial and controls staff resources for a comprehensive internal audit function, and (iii) and in some cases had not been able to promptly accumulate and process all of our data and reports on a timely basis. Management believes that at this time, in light of existing newly instituted staff and controls, the risks associated with a lack of segregation of duties and limited staff have been largely mitigated. However, management will periodically reevaluate the situation, and as necessary, will put in place additional internal staff and controls to prevent a lack of discipline around policies and procedures in our administrative and financial matters.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING.
There is no change in our internal control over financial reporting during our quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
With the acquisition of Technest and Genex, we have integrated the accounting and controls for these two small companies into our group accounting function at EOIR in Virginia. The larger scale of this operation allows for more timely recording of transactions and greater separation of duties than would otherwise be possible.
Charles Wainer
On June 28, 2004, Charles Wainer filed a civil suit against Markland in Florida state court alleging breach of a stock purchase agreement and breach of an employment agreement stemming from Wainer's sale of his business to a predecessor of Markland and his subsequent employment thereat. In the complaint, Wainer alleges Markland owes him $300,000 cash, some unspecified portion of $700,000 in stock, some unspecified portion of $86,000 cash for lease payments, and approximately $20,000 in back-pay. On August 11, 2004, Markland answered the complaint and denied any liability. In September 2005 the trial of this matter was concluded. As a result, Markland anticipates that judgment will be entered against Markland and in favor of Mr. Wainer in an amount of approximately $482,000. At June 30, 2005, the Company has charged to Selling, General and Administrative expense $482,000 related to this matter.
Joseph R. Moulton
On or about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the Circuit Court of Spotsylvania County, Virginia, against the Company, EOIR, and our Chief Executive Officer and Director, Robert Tarini. Mr. Moulton was the largest single shareholder of EOIR prior to its acquisition by the Company, owning approximately 67% of the EOIR capital stock. Mr. Moulton received approximately $5,863,000 in cash and a promissory note of EOIR in the approximate principal amount of $6,967,000 for his shares of EOIR at the closing of the acquisition of EOIR by the Company. In his complaint Mr. Moulton asserts, among other things, that the Company breached its obligations under the Stock Purchase Agreement, dated June 29, 2004, pursuant to which the Company acquired EOIR, by terminating Mr. Moulton's employment with EOIR and removing him from the EOIR board of directors. Mr. Moulton is seeking damages allegedly suffered by his loss of employment, extreme emotional distress, and costs incurred to enforce his contractual rights. In addition, he is seeking certain other equitable relief including, the appointment of a receiver to oversee the management of EOIR until these promissory notes issued to former EOIR shareholders at the closing of the acquisition are paid in full and a declaratory judgment that the Company's actions constitute an event of default under these promissory notes allowing for the acceleration of all amounts (approximately $11,000,000) due thereunder. The Company is a guarantor of these notes. The Company believes that the allegations in this lawsuit are entirely without merit and expects to file an answer denying Mr. Moulton's allegations and opposing vigorously all equitable relief sought. The Company is considering bringing various claims against Mr. Moulton either by counterclaim or in a separate action.
Deer Creek
Markland and Technest were notified on July 21, 2005 by counsel for Deer Creek LLC, or Deer Creek, an investor in the February 15, 2005 transaction involving Technest, Markland and Genex, that Deer Creek filed an order to show cause requesting a temporary restraining order in the Supreme Court for New York County, naming Technest and Markland as defendants. Deer Creek is seeking to enjoin Markland from issuing its common stock upon conversion of certain shares of Markland's Series D Preferred Stock issued pursuant to certain exchange agreements dated June 20, 2005. Technest and Markland retained the firm of Pryor, Cashman, Sherman & Flynn LLP, 410 Park Avenue, 10th Floor, New York, New York 10022 to represent their interests in this matter. On July 25, 2005 Technest and Markland removed the matter to the United States District Court for the Southern District of New York. This matter was settled on August 19, 2005. Markland entered into an exchange agreement and a registration rights agreement with Deer Creek on August 19, 2005. Such agreements were filed as exhibits to our current report on Form 8-K filed on August 25, 2005.
Greg and Mary Williams
Markland and EOIR were notified on July 11, 2005 by counsel for Greg and Mary Williams, former shareholders and employees of EOIR and, in the case of Mr. Williams, a former director of Markland, that the Williamses filed a lawsuit in the Commonwealth of Virginia, naming EOIR and Markland as a defendant, regarding a number of contractual disputes involving the registration of shares of Markland common stock underlying certain options issued to the Williamses in connection with the acquisition of EOIR by Markland and severance payments called for pursuant to severance agreements by and among the Williamses, EOIR and Markland. On August 3, 2005, EOIR and Markland filed an answer and a demurrer denying all liability.
H & H Acquisition Corp.
On July 23, 1998, H & H Acquisition Corp., individually and purportedly on behalf of Technest Holdings, commenced an action in federal court in the Southern District of New York against the Company, the founder and certain officers, among others. The complaint is an action to recover shares of common stock of the Company and unspecified damages. Management believes that the claims against the Company and certain officers are without merit and is vigorously defending the action. The Company cannot make any assurances about the litigation's outcome. However, the Company could be adversely affected if the plaintiff prevails.
In September 2002 the Company was served with a Summary Judgment Motion regarding H & H Acquisition Corp. and the Company answered the motion in November 2002. On January 3, 2005, the court denied the motion for summary judgment. Trial of this matter is scheduled to begin in January 2006.
Other
In addition, we are subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows
During the quarter ending September 30, 2005, the holders of our Series D convertible preferred stock converted an aggregate of 3,830 shares of Series D convertible preferred stock into 45,840,657 shares of common stock. The following table lists each holder of Series D convertible preferred stock who effectuated such a conversion during the quarter ended September 30, 2005, the number of shares of Series D convertible preferred stock that were converted and the number of shares of common stock that were issued upon those conversions.
Holder | Number of Shares of Series D Convertible Preferred Stock Converted during quarter ended September 30, 2005 | Number of shares of Common Stock issued to Holder pursuant to conversions of Series D Convertible Preferred Stock during quarter ended September 30, 2005 |
James, LLC | 1,080 | 12,503,111 |
DKR Soundshore Oasis Holding Fund, Ltd. | 950 | 12,933,710 |
DKR Soundshore Strategic Holding Fund, Ltd. | 50 | 623,130 |
ipPartners, Inc. | 625 | 6,510,417 |
Verdi Consulting, Inc. | 1,125 | 13,270,289 |
The issuance of these securities was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, as a sale not involving a public offering.
During the quarter ending September 30, 2005, the holders of our outstanding Secured 8% Convertible Notes converted an aggregate of $2,539,990 of the outstanding principal on those notes into 63,244,562 shares of common stock. During the same period, we issued 888,297 shares of our common stock to the holders of our Secured 8% Convertible Notes in satisfaction of interest and an aggregate of 5,589,299 shares of our common stock in satisfaction of liquidated damages incurred pursuant to registration rights agreements dated September 21, 2004 and November 9, 2004. The following table lists each holder of our outstanding Secured 8% Convertible Notes who effectuated a conversion during the quarter ended September 30, 2005, the amount of principal that was converted, the number of shares of common stock that were issued as a result of those conversions, the number of shares of common stock issued to the holder in satisfaction of interest and the number of shares issued to the holder in satisfaction of liquidated damages.
Holder | Amount of Principal Converted | Number of shares of Common Stock issued to Holder pursuant to conversions of Secured 8% Convertible Notes during quarter ended September 30, 2005 | Number of Shares issued as interest payments on outstanding Secured 8% Convertible Notes during quarter ended September 30, 2005 | Number of shares issued in satisfaction of liquidated damages | |||||||||
DKR Soundshore Oasis Holding Fund, Ltd. | $ | 1,600,000 | 43,745,551 | 626,998 | 3,537,039 | ||||||||
DKR Soundshore Strategic Holding Fund, Ltd. | $ | 435,000 | 11,372,940 | 159,468 | 884,260 | ||||||||
Harborview Fund LLP | $ | 485,000 | 8,189,741 | 101,831 | 1,168,000 |
The issuance of these securities was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, as a sale not involving a public offering.
Exhibit No. | Description | Filed with this Quarterly Report | Incorporated by reference | |||
Form | Filing Date | Exhibit No. | ||||
10.1 | Stock Purchase Agreement between Technest Holdings, Inc. and Markland Technologies, Inc. dated August 17, 2005 | 8-K | August 18, 2005 | 10.1 | ||
10.2 | Exchange Agreement dated August 19, 2005 by and between Markland Technologies, Inc. and Deer Creek Fund LLC | 8-K | August 25, 2005 | 10.1 | ||
10.3 | Registration Rights Agreement dated August 25, 2005 between Markland Technologies, Inc. and Deer Creek Fund LLC | 8-K | August 25, 2005 | 10.2 | ||
10.4 | Agreement between Markland Technologies, Inc. and DKR Soundshore Oasis Holding Fund, Ltd. dated September 20, 2005 | 8-K | September 20, 2005 | 10.1 | ||
10.5 | Agreement between Markland Technologies, Inc. and DKR Soundshore Strategic Holding Fund, Ltd. dated September 20, 2005 | 8-K | September 20, 2005 | 10.2 | ||
10.6 | Stock Pledge Agreement by and among Markland Technologies, Inc., DKR Soundshore Oasis Holding Fund, Ltd. and DKR Soundshore Strategic Holdings Fund, Ltd. dated September 20, 2005 | 8-K | September 20, 2005 | 10.3 | ||
10.7 | Agreement relating to Certain Securities Issued by Markland Technologies, Inc. and Technest Holdings, Inc. dated October 4, 2005 by and among James LLC, Southridge Partners, LP, Southshore Capital Fund, Ltd., Greenfield Capital Partners LLC, Markland Technologies, Inc. and Technest Holdings, Inc. | 8-K | October 7, 2005 | 10.1 | ||
10.8 | Agreement to Terminate Leases dated October 4, 2005 by and among Markland Technologies, Inc., Technest Holdings, Inc. and Southridge Holdings LLC. | 8-K | October 7, 2005 | 10.2 | ||
10.9 | Form of Exchange Agreement dated October 4, 2005 between Markland Technologies, Inc. and Southridge Partners, LP. | 8-K | October 7, 2005 | 10.3 | ||
10.10 | Form of Exchange Agreement dated October 4, 2005 between Markland Technologies, Inc. and Southshore Capital Fund, Ltd. | 8-K | October 7, 2005 | 10.4 | ||
10.11 | Form of Warrant Issued to Greenfield Capital Partners LLC. | 8-K | October 7, 2005 | 10.5 | ||
10.12 | Private Equity Credit Agreement dated October 13, 2005 between Markland Technologies, Inc. and Brittany Capital Management, Ltd. | SB-2 (1) | October 14, 2005 | 10.92 | ||
10.13 | Registration Rights Agreement dated October 13, 2005 between Markland Technologies, Inc. and Brittany Capital Management, Ltd. | SB-2 (1) | October 14, 2005 | 10.93 | ||
31.1 | Certification by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a). | X | ||||
31.2 | Certification by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a). | X | ||||
32.1 | Certification by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section 1350 | X |
(1) SEC File # 333-129017
In accordance with the requirements of the Exchange Act, the registrant caused his report to be signed on its behalf by the undersigned, thereunto duly authorized.
MARKLAND TECHNOLOGIES, INC. | ||
| | |
Date: November 21, 2005 | By: | /s/ Robert Tarini |
Robert Tarini Chief Executive Officer | ||
-65-