10. OPTIONS, WARRANTS AND STOCK-BASED COMPENSATION

2011 Equity Incentive Plan

On March 4, 2011, the Board of Directors adopted the Technest Holdings, Inc. 2011 Equity Incentive Plan and reserved up to 50,000,000 shares of common stock for issuance to employees, directors and consultants, subject to stockholder approval by March 4, 2012. The plan also provides for automatic annual increases, subject to Board approval, on January 1st of each year (commencing on January 1, 2012 and ending on January 1, 2021), in the aggregate number of shares reserved equal to the lesser of (a) five percent of the total number of shares outstanding on December 31st of the preceding year or (b) 3,000,000 shares. Under the plan, the Board may grant stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance stock awards, performance cash awards and other stock awards.

Valuation and amortization method. The fair value of each stock award is estimated on the grant date using the Black-Scholes option-pricing model. The estimated fair value of employee stock options is amortized to expense using the straight-line method over the vesting period.

Volatility. The Company estimates volatility based on the Company’s historical volatility.

Risk-free interest rate. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant commensurate with the expected term assumption.

Expected term. The expected term of stock options granted is based on an estimate of when options will be exercised in the future. The Company applied the simplified method of estimating the expected term of the options, as described in the SEC’s Staff Accounting Bulletins 107 and 110, as the Company has had a significant change in its business operations as result of the reverse

acquisition and the historical experience is not indicative of the expected behavior in the future. The expected term, calculated under the simplified method, is applied to groups of stock options that have similar contractual terms. Using this method, the expected term is determined using the average of the vesting period and the contractual life of the stock options granted.

Forfeitures. Stock-based compensation expense is recorded only for those awards that are expected to vest. FASB ASC Topic 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term “forfeitures” is distinct from “cancellations” or “expirations” and represents only the unvested portion of the surrendered option. An annual forfeiture rate of 0% was applied to all unvested options as of December 31, 2011 which was management’s best estimate. This analysis will be re-evaluated semi-annually and the forfeiture rate will be adjusted as necessary. Ultimately, the actual expense recognized over the vesting period will be for only those shares that vest.

The following weighted average assumptions were used for grants:


	Six Months Ended December 31, 2011	Year Ended June 30, 2011
Risk-free interest rate	0.90% - 0.96%	1.76% - 2.28%
Expected dividend yield	—	—
Expected term	5.5 years	6 years
Forfeiture rate	0%	0%
Expected volatility	122.33% - 124.91%	128.99% - 136.20%

A summary of option activity as of December 31, 2011 and for the six months then ended is presented below:


Options	Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at July 1, 2011		43,100,000	$	0.065		9.78 years
Granted		2,620,000	$	0.017
Exercised		—	$	—
Forfeited or expired		—	$	—
Outstanding at December 31, 2011		45,720,000	$	0.062		9.31 years	$	—
Exercisable at December 31, 2011		416,670	$	0.015		9.96 years	$	—

On August 12, 2011, the Board of Directors granted stock options to purchase 120,000 shares of common stock at an exercise price of $0.05 per share. The weighted average fair value of the options on the date of the grant was estimated at $0.043 per share. These options vest over one year and have a term of 10 years.

On December 14, 2011, the Board of Directors granted stock options to purchase 2,500,000 shares of common stock at an exercise price of $0.015 per share. The weighted average fair value of the options on the date of the grant was estimated at $0.008 per share. These options vest monthly over 10 months and have a term of 10 years.

Stock-based compensation expense for the three and six months ended December 31, 2011 was $22,020 and $193,167, respectively. At December 31, 2011, unrecognized total compensation cost related to all unvested awards of $1,193,156 is expected to be recognized over a weighted average period of 2.23 years. At December 31,2011 there were 4,280,000 shares reserved for future grants.

Warrants

The outstanding Technest Holdings, Inc. warrants remain in place subsequent to the reverse acquisition. No warrants were issued, or exercised during the six months ended December 31, 2011. On July 17, 2011, warrants to purchase 200,000 shares at $1.89 per share expired. The Company has reserved shares of common stock for the exercise of 75,000 outstanding warrants exercisable at $5.85 per share which expire on August 3, 2013.

The weighted average remaining life of the warrants is 1.6 years. At December 31, 2011 all warrants are exercisable and there is no aggregate intrinsic value for the warrants outstanding.

Stock Award Plan

The Technest Holdings, Inc. 2006 Stock Award Plan, pursuant to which Holdings may award up to 2,000,000 shares of its common stock to employees, officers, directors, consultants and advisors, remains in place subsequent to the reverse acquisition.

Holdings has broad discretion in making grants under the Stock Award Plan and may make grants subject to such terms and conditions as determined by the Board of Directors. Stock awards under the Plan will be subject to the terms and conditions, including any applicable purchase price and any provisions pursuant to which the stock may be forfeited, set forth in the document making the award. As of December 31, 2011, the Company has 111,845 shares available for future grant under the Plan.