U.S.
SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
      One)x
            QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
      the quarterly period ended: December 31,
2009





OR





o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
      the transition period from ______________ to
  ______________








Commission
File Number 000-27023








TECHNEST
HOLDINGS, INC.


(Exact
name of registrant as specified in its charter)





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





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


(Address of principal executive
offices and zip code)





(301)
767-2810


(Registrant’s telephone number,
including area code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to filed such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes xNo o





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





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





Large
      accelerated filer     o
            Accelerated
      filer  oNon-accelerated
      filer       o
            Smaller
      reporting company  x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  Yes oNo x





As of
February 12, 2010, there were 32,272,091 shares of common stock, $0.001 par
value, of the registrant issued and outstanding.








TECHNEST
HOLDINGS, INC.





FORM
10-Q


TABLE
OF CONTENTS


DECEMBER
31, 2009





PagePART
      I.
            FINANCIAL
      INFORMATION:
            3Item
      1.
            Financial
      Statements (Unaudited)
            3Consolidated
      Balance Sheets at December 31, 2009 and June 30,
2009
            3-4Consolidated
      Statements of Operations for the Six Months Ended December 31, 2009 and
      2008
            5Consolidated
      Statements of Operations for the Three Months Ended December 31, 2009 and
      2008
            6Consolidated
      Statement of Changes in Stockholders’ Equity for the Six Months Ended
      December 31, 2009
            7-8Consolidated
      Statements of Cash Flows for the Six Months Ended December 31, 2009 and
      2008
            9Notes
      to Condensed Consolidated Financial Statements
            10Item
      2.
            Management’s
      Discussion and Analysis or Plan of Operation
            17Item
      4T.
            Controls
      and Procedures
            21PART
      II.
            OTHER
      INFORMATION
            22Item
      1.
            Legal
      Proceedings
            22Item
      1A.
            Risk
      Factors
            22Item
      6.
            Exhibits
            28Signatures
            
            30





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





2




PART
I. FINANCIAL INFORMATION





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
BALANCE SHEETS


DECEMBER
31, 2009 AND JUNE 30, 2009








December
      31,
              2009
            
            
            June
      30,
              2009(Unaudited)ASSETSCurrent
      AssetsCash
      and cash equivalents
            
            $
            13,643,560
            
            
            $
            5,567Accounts
      receivable
            
            
            134,700
            
            
            
            260,381Inventory
      and work in process
            
            
            41,161
            
            
            
            26,745Restricted
      cash
            
            
            15,000
            
            
            
            216,697Prepaid
      expenses and other current assets
            
            
            92,108
            
            
            
            750,013Assets
      related to discontinued operations
            
            
            4,846,366
            
            
            
            22,948,333Total
      Current Assets
            
            
            18,772,895
            
            
            
            24,207,736Property and Equipment–
      Net of accumulated depreciation $106,529 and $94,703
            
            
            26,314
            
            
            
            37,363Other
      AssetsDeposits
            
            
            28,525
            
            
            
            28,525Definite-lived
      intangible assets – Net of accumulated amortization $1,583,111 and
      $1,420,740
            
            
            189,757
            
            
            
            322,173Goodwill
            
            
            4,876,038
            
            
            
            4,876,038Total
      Other Assets
            
            
            5,094,320
            
            
            
            5,226,736Total
      Assets
            
            $
            23,893,529
            
            
            $
            29,471,835LIABILITIES,
      REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITYCurrent
      LiabilitiesAccounts
      payable
            
            $
            462,460
            
            
            $
            745,159Accrued
      expenses and other current liabilities
            
            
            342,001
            
            
            
            626,381Accrued
      state income taxes
            
            
            293,091
            
            
            
            293,091Dividend
      payable
            
            
            13,134,741
            
            
            
            -Liabilities
      related to discontinued operations
            
            
            1,061,405
            
            
            
            5,246,838Total
      Current Liabilities
            
            
            15,293,698
            
            
            
            6,911,469Total
      Liabilities
            
            
            15,293,698
            
            
            
            6,911,469








See notes
to condensed consolidated financial statements.


3





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
BALANCE SHEETS (concluded)





December
      31,
              2009
            
            
            June
      30,
              2009(Unaudited)Series
      D Redeemable, Convertible Preferred Stock - $.0001 par
    value;3,000
      shares authorized; -0- and 1,640 shares issued and outstanding at December
      31,2009
      and June 30, 2009, respectively
            
            
            -
            
            
            
            1,690,483Commitments
      and ContingenciesStockholders’
      EquitySeries
      A Convertible Preferred Stock - $.001 par value; 150 shares
      authorized;-0-
      and 64.325 shares issued and outstanding at December 31, 2009 and June 30,
      2009,respectively
            
            
            -
            
            
            
            -Series
      C Convertible Preferred Stock - $.001 par value; 1,149,425 shares
      authorized;-0-
      and 402,301 shares issued and outstanding at December 31, 2009 and June
      30, 2009,respectively
            
            
            -
            
            
            
            402Common
      stock - par value $.001 per share; 495,000,000 shares
      authorized;32,272,091
      and 20,676,211 shares issued and outstanding at December 31, 2009, andJune
      30, 2009,  respectively
            
            
            32,271
            
            
            
            20,675Additional
      paid-in capital
            
            
            25,852,329
            
            
            
            37,032,781Accumulated
      deficit
            
            
            (17,144,748
            )
            
            
            (16,183,975
            )Total
      Technest Holdings, Inc. Stockholders’ Equity
            
            
            8,739,852
            
            
            
            20,869,883Non
      controlling interest
            
            
            (140,021
            )
            
            
            -Total
      Stockholders’ Equity
            
            
            8,599,831
            
            
            
            20,869,883Total
      Liabilities, Redeemable Preferred Stock and Stockholders’
      Equity
            
            $
            23,893,529
            
            
            $
            29,471,835








See notes
to condensed consolidated financial statements.


4





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Unaudited)





2009
            
            
            2008Revenues
            
            $
            1,126,015
            
            
            $
            1,215,163Cost
      of Revenues
            
            
            554,484
            
            
            
            675,899Gross
      Profit
            
            
            571,531
            
            
            
            539,264Operating
      ExpensesSelling,
      general and administrative
            
            
            979,349
            
            
            
            1,157,068Research
      and development
            
            
            70,844
            
            
            
            111,935Amortization
      of intangible assets
            
            
            162,370
            
            
            
            162,370Total
      Operating Expenses
            
            
            1,212,563
            
            
            
            1,431,373Operating
      Loss from Continuing Operations
            
            
            (641,032
            )
            
            
            (892,109
            )Other
      Income (Expense), NetOther
      income (expense)
            
            
            6,921
            
            
            
            (3,267
            )Interest
      expense
            
            
            (34,731
            )
            
            
            -Interest
      income
            
            
            89,104
            
            
            
            -Total
      Other Income (Expense), Net
            
            
            61,294
            
            
            
            (3,267
            )Loss
      from Continuing Operations before Income Taxes
            
            
            (579,738
            )
            
            
            (895,376
            )Income
      tax benefit
            
            
            -
            
            
            
            237,600Net
      Loss from Continuing Operations
            
            
            (579,738
            )
            
            
            (657,776
            )Discontinued
      OperationsLoss
      on discontinued operations
            
            
            (521,056
            )
            
            
            -Net
      Loss from Discontinued Operations
            
            
            (521,056
            )
            
            
            -Net
      Loss
            
            
            (1,100,794
            )
            
            
            (657,776
            )Net
      Loss Attributable to Non-Controlling Interest
            
            
            140,021
            
            
            
            -Net
      Loss Attributable to Technest Holdings, Inc.
            
            
            (960,773
            )
            
            
            (657,776
            )Deemed
      Dividend to Preferred Stockholders - Series D
            
            
            (291,306
            )
            
            
            (1,121,431
            )Net
      Loss Applicable to Common Shareholders
            
            $
            (1,252,079
            )
            
            $
            (1,779,207
            )Basic
      and Diluted Loss Per Common ShareFrom
      continuing operations attributable to Technest Holdings,
    Inc.
            
            $
            (0.03
            )
            
            $
            (0.09
            )From
      discontinued operations attributable to Technest Holdings,
      Inc.
            
            $
            (0.02
            )
            
            $
            -Net
      Loss Per Share - Basic and Diluted
            
            $
            (0.05
            )
            
            $
            (0.09
            )Weighted
      Average Number of Common Shares OutstandingBasic
      and diluted
            
            
            22,370,400
            
            
            
            20,662,486








See notes
to condensed consolidated financial statements.


5





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


FOR
THE THREE MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Unaudited)





2009
            
            
            2008Revenues
            
            $
            540,076
            
            
            $
            767,959Cost
      of Revenues
            
            
            274,658
            
            
            
            401,359Gross
      Profit
            
            
            265,418
            
            
            
            366,600Operating
      ExpensesSelling,
      general and administrative
            
            
            490,846
            
            
            
            633,885Research
      and development
            
            
            40,594
            
            
            
            38,691Amortization
      of intangible assets
            
            
            81,185
            
            
            
            81,185Total
      Operating Expenses
            
            
            612,625
            
            
            
            753,761Operating
      Loss from Continuing Operations
            
            
            (347,207
            )
            
            
            (387,161
            )Other
      Income (Expense), NetOther
      income (expense)
            
            
            6,921
            
            
            
            (4,438
            )Interest
      expense
            
            
            (34,731
            )
            
            
            -Interest
      income
            
            
            30,881
            
            
            
            -Total
      Other Income (Expense), Net
            
            
            3,071
            
            
            
            (4,438
            )Loss
      from Continuing Operations before Income Taxes
            
            
            (344,136
            )
            
            
            (391,599
            )Income
      tax benefit
            
            
            -
            
            
            
            80,600Net
      Loss from Continuing Operations
            
            
            (344,136
            )
            
            
            (310,999
            )Discontinued
      OperationsLoss
      on discontinued operations
            
            
            (81,510
            )
            
            
            -Net
      Loss from Discontinued Operations
            
            
            (81,510
            )
            
            
            -Net
      Loss
            
            
            (425,646
            )
            
            
            (310,999
            )Net
      Loss Attributable to Non-Controlling Interest
            
            
            87,491
            
            
            
            -Net
      Loss Attributable to Technest Holdings, Inc.
            
            
            (338,155
            )
            
            
            (310,999
            )Deemed
      Dividend to Preferred Stockholders - Series D
            
            
            (12,184
            )
            
            
            (1,121,431
            )Net
      Loss Applicable to Common Shareholders
            
            $
            (350,339
            )
            
            $
            (1,432,430
            )Basic
      and Diluted Loss Per Common ShareFrom
      continuing operations attributable to Technest Holdings,
    Inc.
            
            $
            (0.01
            )
            
            $
            (0.07
            )From
      discontinued operations attributable to Technest Holdings,
      Inc.
            
            $
            (0.00
            )
            
            $
            -Net
      Loss Per Share - Basic and Diluted
            
            $
            (0.01
            )
            
            $
            (0.07
            )Weighted
      Average Number of Common Shares OutstandingBasic
      and diluted
            
            
            24,000,881
            
            
            
            20,676,211








See notes
to condensed consolidated financial statements.


6





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009


(Unaudited)








Series
      A
            
            
            Series
      CConvertible
            
            
            ConvertibleCommon
      stock
            
            
            Preferred
      stock
            
            
            Preferred
      stockShares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalance
      - June 30, 2009
            
            
            20,676,739
            
            
            $
            20,675
            
            
            
            64
            
            
            $
            -
            
            
            
            402,301
            
            
            $
            402Issuance
      of restricted stock aspayment for accrued expenses
            
            
            754,535
            
            
            
            755
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Accretion
      of Series D redeemableconvertible preferred stock to redemption
      value
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Beneficial
      conversion feature onSeries D redeemable convertible preferred
      stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Accretion
      of dividend on Series Dredeemable convertible preferred
      Stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Issuance
      of restricted stock uponconversion of Series A convertible
      preferred stock
            
            
            304,578
            
            
            
            305
            
            
            
            (64
            )
            
            
            -
            
            
            
            -
            
            
            
            -Issuance
      of restricted stock uponconversion of Series C convertible
      preferred stock
            
            
            402,294
            
            
            
            402
            
            
            
            -
            
            
            
            -
            
            
            
            (402,301
            )
            
            
            (402
            )Issuance
      of restricted stock uponconversion of Series D redeemable
      convertible preferred stock
            
            
            10,133,945
            
            
            
            10,134
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Dividend
      payable
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      Loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Balance
      - December 31, 2009
            
            
            32,272,091
            
            
            $
            32,271
            
            
            
            -
            
            
            $
            -
            
            
            
            -
            
            
            $
            -










See notes
to condensed consolidated financial statements.


7





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY


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


(Unaudited)





Additional
            
            
            
            
            
            Non-
            
            
            TotalPaid-In
            
            
            Accumulated
            
            
            Controlling
            
            
            Stockholders'Capital
            
            
            Deficit
            
            
            Interest
            
            
            EquityAmount
            
            
            Amount
            
            
            Amount
            
            
            AmountBalance
      - June 30, 2009
            
            $
            37,032,781
            
            
            $
            (16,183,975
            )
            
            $
            -
            
            
            $
            20,869,883Issuance
      of restricted stock aspayment for accrued expenses
            
            
            124,245
            
            
            
            -
            
            
            
            -
            
            
            
            125,000Accretion
      of Series D redeemableconvertible preferred stock to redemption
      value
            
            
            (255,000
            )
            
            
            -
            
            
            
            -
            
            
            
            (255,000
            )Beneficial
      conversion feature onSeries D redeemable convertible preferred
      stock
            
            
            105,000
            
            
            
            -
            
            
            
            -
            
            
            
            105,000Accretion
      of dividend on Series Dredeemable convertible preferred
      stock
            
            
            (36,306
            )
            
            
            -
            
            
            
            -
            
            
            
            (36,306
            )Issuance
      of restricted stock uponconversion of Series A convertible
      preferred stock
            
            
            (305
            )
            
            
            -
            
            
            
            -
            
            
            
            -Issuance
      of restricted stock uponconversion of Series C convertible
      preferred stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Issuance
      of restricted stock uponconversion of Series D redeemable
      convertible preferred  stock
            
            
            2,016,655
            
            
            
            -
            
            
            
            -
            
            
            
            2,026,789Dividend
      payable
            
            
            (13,134,741
            )
            
            
            -
            
            
            
            -
            
            
            
            (13,134,741
            )Net
      Loss
            
            
            -
            
            
            
            (960,773
            )
            
            
            (140,021
            )
            
            
            (1,100,794
            )Balance
      - December 31, 2009
            
            $
            25,852,329
            
            
            $
            (17,144,748
            )
            
            $
            (140,021
            )
            
            $
            8,599,831











See notes
to condensed consolidated financial statements


8




TECHNEST HOLDINGS,
INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Unaudited)





2009
            
            
            2008Cash
      Flows From Operating Activities:Net
      loss
            
            $
            (1,100,794
            )
            
            $
            (657,776
            )Adjustment
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization of property and equipment
            
            
            11,826
            
            
            
            18,091Amortization
      of intangible assets
            
            
            162,370
            
            
            
            162,370Non-cash
      interest income related to discount accretion
            
            
            (61,460
            )
            
            
            -Stock-based
      compensation to employees and directors
            
            
            -
            
            
            
            107,620Loss
      on sale of equipment
            
            
            -
            
            
            
            5,974Deferred
      income tax benefit
            
            
            -
            
            
            
            (237,600
            )Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            125,681
            
            
            
            328,781Unbilled
      receivables
            
            
            -
            
            
            
            23,888Inventory
      and work in process
            
            
            (14,416
            )
            
            
            (30,110
            )Restricted
      cash
            
            
            201,697
            
            
            
            18,630Deposits
      and prepaid expenses and other current assets
            
            
            (30,213
            )
            
            
            53,240Accounts
      payable
            
            
            (210,901
            )
            
            
            278,456Accrued
      expenses and other current liabilities
            
            
            56,621
            
            
            
            (677,360
            )Net
      Cash Used In Operating Activities
            
            
            (859,589
            )
            
            
            (605,796
            )Cash
      Flows From Investing Activities:Purchase
      of equipment
            
            
            (777
            )
            
            
            -Proceeds
      from sale of equipment
            
            
            -
            
            
            
            1,728Registration
      of new definitive lived intangible assets
            
            
            (29,954
            )
            
            
            (8,642
            )Net
      Cash Used In Investing Activities
            
            
            (30,731
            )
            
            
            (6,914
            )Cash
      Flows From Financing Activities:Proceeds
      from short term note
            
            
            150,000
            
            
            
            -Repayment
      of short term note
            
            
            (150,000
            )
            
            
            -Proceeds
      from issuance of Series D Redeemable, Convertible Preferred
      Stock
            
            
            150,000
            
            
            
            650,000Net
      Cash Provided by Financing Activities
            
            
            150,000
            
            
            
            650,000Net
      (Decrease) Increase in Cash and Cash Equivalents from Continuing
      Operations
            
            
            (740,320
            )
            
            
            37,290Cash
      Flows From Discontinued Operations:Operating
      activities – accounts payable and accrued expenses
            
            
            (3,333,887
            )
            
            
            -Investing
      activities – proceeds from settlement on sale of EOIR
            
            
            18,000,000
            
            
            
            -Net
      Increase in Cash and Cash Equivalents from  Discontinued
      Operations
            
            
            14,666,113
            
            
            
            -Net
      Increase in Cash and Cash Equivalents
            
            
            13,637,993
            
            
            
            37,290Cash
      and Cash Equivalents - Beginning of Period
            
            
            5,567
            
            
            
            76,761Cash
      and Cash Equivalents - End of Period
            
            $
            13,643,560
            
            
            $
            114,051




Supplemental
      Disclosures of Cash Flow Information:Cash
      paid during the periods for:Interest
            
            $
            30,000
            
            
            $
            -Taxes
            
            $
            -
            
            
            $
            -Non-Cash
      Investing and Financing Activities:Restricted
      stock issued as payment for accrued expenses
            
            $
            125,000
            
            
            $
            -Beneficial
      conversion on Series D Redeemable, Convertible Preferred
    Stock
            
            $
            105,000
            
            
            $
            455,000Accretion
      of Series D Redeemable, Convertible Preferred Stock to
      Redemption
              Value
            
            $
            255,000
            
            
            $
            1,105,000Accrued
      dividend on Series D Redeemable, Convertible Preferred Stock
              converted
      to Common Stock
            
            $
            36,306
            
            
            $
            16,431Series
      D Redeemable, Convertible Preferred Stock converted to Common
      Stock
            
            $
            2,026,789
            
            
            $
            -





See notes
to condensed consolidated financial statements.


9




TECHNEST
HOLDINGS INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Unaudited)








1.
            NATURE
      OF OPERATIONS





Business





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





Litigation Related to the
Sale of EOIR Technologies, Inc.





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





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





On
December 24, 2009, LLC paid Technest $18,000,000 and subsequently, the actions
pending between the parties were dismissed in accordance with the Settlement
Agreement.  The Company paid out of the proceeds received $3,333,887
of previously recorded liabilities related to the sale of EOIR and related
litigation. The Company recorded a $154,000 discount on the $5 million
contingent receivable as management anticipates collection of this amount by
September 2010. During the three and six months ended December 31, 2009,
the Company accreted into interest income a total of $30,827 and $61,460,
respectively, related to this discount.  Technest believes that the
collectability of the contingent receivable is determinable beyond a reasonable
doubt and as such does not believe any reserves are warranted at December 31,
2009.





2.
            BASIS
      OF PRESENTATION





Basis
of Presentation





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





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





10




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





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





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





Recent Accounting
Pronouncements





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





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





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





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




11




3.
            DISCONTINUED
      OPERATIONS





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





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





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





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





As a
result of the Settlement Agreement, Technest adjusted the related assets and
liabilities in the six months ended December 31, 2009 to reflect the terms of
the Settlement Agreement including netting the liability of $859,137 due to LLC
as a working capital adjustment on the sale of EOIR and the interest receivable
of $722,070 recorded previously in accordance with the arbitration ruling. The
Company has recorded a $154,000 discount on the $5 million contingent receivable
as management anticipates collection of this amount by September
2010.  During the three and six months ended December 31, 2009, the
Company accreted into interest income a total of $30,827 and $61,460,
respectively, related to this discount.  Technest believes that the
collectability of the contingent receivable is determinable beyond a reasonable
doubt and as such does not believe any reserves are warranted at December 31,
2009.





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





The loss
on discontinued operations for the three and six months ended December 31, 2009
was $81,510 and $521,056, respectively, which is primarily attributable to legal
expenses incurred in connection with the arbitration and settlement
process. The Company expects to incur only minor additional legal expenses
associated with this matter and these expenses will be charged to discontinued
operations as they are incurred.





4.
            TECHNEST,
      INC.





On
October 1, 2008, the Company formed and acquired a 49% interest in Technest,
Inc. (represented by 490 shares of issued common stock) in exchange for the
transfer of certain contracts and employees. Technest, Inc. conducts research
and development in the field of computer vision technology. The Company has the
right of first refusal to commercialize products resulting from this research
and development. The Company’s Chief Executive Officer beneficially owns 23% of
Technest, Inc. and a former employee of the Company and current employee of
Technest, Inc. owns an additional 23%.  The remaining 5% interest is held
by an unrelated third party. The Company has certain rights of first
refusal and repurchase rights at Fair Market Value, as defined in certain
restricted stock agreements, with respect to the shares of Technest, Inc. that
it does not own.  The Company allocates certain general and
administrative and overhead expenses to Technest, Inc. and in the three and six
months ended December 31, 2009, the Company allocated approximately $174,212 and
$352,916, respectively, of such expenses to Technest, Inc.




12




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





On July
1, 2009, the Company adopted new guidance in accordance with the Accounting
Standards Codification section 810-10 related to its non-controlling interest in
Technest, Inc.  The non-controlling interest in the net loss for the
three and six months ended December 31, 2009 was $87,491 and $140,021,
respectively.  In the three and six months ended December 31, 2009,
had the previous accounting guidance been applied, the Company’s net loss
applicable to common stockholders would have been $437,830 (or $0.02 per share)
and $1,392,100 (or $0.06 per share), respectively.





5.
            DEFINITE-LIVED
      INTANGIBLE ASSETS





Definite-lived
intangible assets consist of the following:





December
      2009
            
            Useful
      life (years)Patents
      - commercialized technology
            
            $
            440,000
            
            5Patents
      - other
            
            
            202,868
            
            15Customer
      relationships and contracts
            
            
            1,130,000
            
            5Accumulated
      amortization
            
            
            (1,583,111
            )Net
      definite-lived intangible asset
            
            $
            189,757





Amortization
expense was $162,370 for each of the six months ended December 31, 2009 and
2008.





6.
            AMERICAN
      ASSET FINANCING





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





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





7.
            SERIES
      D REDEEMABLE, CONVERTIBLE PREFERRED
STOCK





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





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





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





The
Company has determined that as of  the date of issuance there was a
beneficial conversion feature of $105,000 for the fiscal 2010
issuance. Since the Series D Preferred is redeemable upon collection of the
Contingent Purchase Price, the Company accreted the Series D Preferred to its
redemption value immediately upon issuance. This resulted in a deemed
dividend in the amount of $255,000 for the first six months of fiscal
2010.  The carrying value was further adjusted by additional dividends
earned in the six months ended December 31, 2009 (prior to
conversion).  Total dividends accrued on all outstanding Series D
Preferred during the six months ended December 31, 2009 amounted to
$36,305.  Cumulative accrued dividends on all outstanding Series D
Preferred immediately prior to conversion amounted to $86,789.





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





13




8.
            STOCKHOLDERS'
      EQUITY





Series A Convertible
Preferred Stock





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





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





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





Series C Convertible
Preferred Stock





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





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





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





Other Common Stock
Issuances





During
the six months ended December 31, 2009, the Company issued the following amounts
of common stock:




●
              754,535
      shares of its Common Stock with a fair value of $125,000 to five
      non-employee directors of the Company as compensation for service on the
      Company’s Board of Directors for the period July 1, 2008 to December 31,
      2009.




The
Company has established a reserve for the exercise of warrants of 649,286 shares
for the future issuance of common stock.





9.
            CAPITAL
      DISTRIBUTION





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




14




10.
            OPTIONS,
      WARRANTS AND STOCK-BASED
COMPENSATION





Options





No
options were granted pursuant to the Plan during the periods ended December 31,
2009 and 2008 and there are currently no options outstanding under the
Plan.





Warrants





No
warrants were issued, exercised or expired in the periods ended December 31,
2009 and 2008.





The
following table summarizes the Company's warrants outstanding at December 31,
2009:





Exercise
      price
            
            
            Number
            
            Expiration
      Date$
            6.50
            
            
            
            374,286
            
            02/14/2010$
            5.85
            
            
            
            75,000
            
            08/03/2013$
            1.89
            
            
            
            200,000
            
            07/17/2011649,286Weighted
      average remaining life
            
            1.0
      years





As of
December 31, 2009 all warrants are exercisable.  There is
no aggregate intrinsic value for warrants outstanding as of December
31, 2009.





Stock Award
Plan





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





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





Total
stock-based compensation related to shares that vested in the six months ended
December 31, 2009 and 2008 was $0 and $107,620, respectively.





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





As of
December 31, 2009, the Company has 621,115 shares available for future grant
under the Plan.





11.
            NET
      LOSS PER SHARE





Securities
that could potentially dilute basic earnings per share ("EPS") and that were not
included in the computation of diluted EPS because to do so would have been
anti-dilutive for the three and six months ended December 31, 2009 and 2008,
consist of the following:





Shares
      Potentially Issuable2009
            
            
            2008Series
      A Convertible Preferred Stock
            
            
            -
            
            
            
            306,047Series
      C Convertible Preferred Stock
            
            
            -
            
            
            
            402,294Series
      D Redeemable, Convertible, Preferred Stock
            
            
            -
            
            
            
            6,582,155Warrants
            
            
            649,286
            
            
            
            649,286Total
            
            
            649,286
            
            
            
            7,939,782




15




12.
            COMMITMENTS
      AND CONTINGENCIES





Facility
Rental





Technest
currently leases offices with approximately 6,848 square feet in Bethesda,
Maryland, pursuant to a five-year lease which expires March 31,
2011. Monthly lease amounts for this facility total approximately $15,585,
increasing annually by 3%.





Rent
expense for continuing operations in the three and six months ended December 31,
2009 was $46,755 and $93,510, respectively. Rent expense for continuing
operations in the three and six months ended December 31, 2008 was $55,550 and
$104,062, respectively.





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





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





13.
            INCOME
    TAXES





There was
no provision for federal or state income taxes for the three and six months
ended December 31, 2009 due to the Company's operating losses and a full
valuation reserve on deferred tax assets.





The
Company's deferred tax assets consist primarily of the tax effects of its net
operating loss carry forwards.  As of December 31, 2009, the Company
had a valuation allowance of $3,045,000.  The Company has recorded a
valuation allowance against deferred tax assets as management has determined
certain net operating loss carryforwards will not be available due to Internal
Revenue Code Section 382 ownership changes and the utilization of other net
operating loss carryforwards is uncertain. In the six months ended December
31, 2009, there was no change in the valuation allowance.   As of
December 31, 2009, the Company has net operating loss carryforwards not subject
to IRC Section 382 limitations of $4,202,000 which begin to expire in
2024.





The
benefit from federal and state income taxes related to continuing operations for
the six months ended December 31, 2008 was $237,600.





14.
            EMPLOYEE
      BENEFIT PLANS





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





Contributions
and other costs of this plan in the three and six months ended December 31, 2009
were $30,183 and $54,345, respectively. Contributions and other costs of
this plan in the three and six months ended December 31, 2008 were $21,746 and
$49,422, respectively.





15.
            LITIGATION





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





16.
            SUBSEQUENT
      EVENTS





Management
has evaluated subsequent events through February 16, 2010, which is the date the
financial statements were issued.





Capital
distribution





On
January 15, 2010, the Company paid a special cash dividend of $0.407 per share
of Common Stock amounting to $13,134,741, as previously declared by the Board of
Directors (see Note 9).





16





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





The
following discussion and analysis of our financial condition and results of
operations for our financial six months ending December 31, 2009 should be read
together with our financial statements and related notes included elsewhere in
this report.





FORWARD
LOOKING STATEMENTS





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





OVERVIEW





General





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





Our
products leverage several core technology platforms, including:





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





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





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





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





Defense
and Security - 3D-ID





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





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





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




17




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





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





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





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





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





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





Medical
Devices





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





Technest
Business Strategy





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





●
              Focus
      on commercialization of pipeline
products;




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




●
              Develop
      recurring revenue models where
possible;




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


●
              Continue
      to develop a robust intellectual property portfolio;
  and




●
              Seek
      strategic acquisitions.





18





RESULTS
OF OPERATIONS





Recent
Developments





Litigation
Related to the Sale of EOIR Technologies, Inc.





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





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





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





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





Three and six months ended
December 31, 2009 compared with the three and six months ended December 31,
2008





Revenues





Technest
had $540,076 in revenues during the three months ended December 31, 2009
compared with $767,959 during the three months ended December 31, 2008. These
revenues were largely generated by Small Business Innovative Research grants
(SBIR’s) in the field of 3-dimensional imaging and intelligent surveillance. We
use the revenue from these grants to develop future potential products for our
business. By their nature these revenues do not consistently accrue from quarter
to quarter. At December 31, 2009, the Company’s backlog of funded contracts was
approximately $2.1 million. The revenue for the three months ended December 31,
2008 included the sale of 21 WellCam units. There were no sales of these units
in the three months ended December 31, 2009 which is the main reason for the
decrease in revenue for the quarter.





Technest
had $1,126,015 in revenues during the six months ended December 31, 2009
compared with $1,215,163 during the six months ended December 31,
2008.





Gross
profit





The gross
profit for the three months ended December 31, 2009 was $265,418 or 49% of
revenues. The gross profit for the three months ended December 31, 2008 was
$366,600 or 48% of revenues.  Technest expects to expand its revenue
base to include commercial product revenues and, accordingly, gross profit on
future revenues may differ.





The gross
profit for the six months ended December 31, 2009 was $571,531 or 51% of
revenues. The gross profit from continuing operations for the six months ended
December 31, 2008 was $539,264 or 44% of revenues. The six months ended December
31, 2008 included certain firm fixed price contracts that had a lower than
average gross profit due to cost overruns.





Selling,
general and administrative expenses





Selling,
general and administrative expenses for the three months and six months ended
December 31, 2009 were $490,846 and $979,349, respectively, and consisted
primarily of payroll related expenses, professional fees and
rent.  Selling, general and administrative expenses for the three
months and six months ended December 31, 2008 were $633,885 and $1,157,068,
respectively, and consisted primarily of payroll related expenses and
professional fees. The Company continues to reduce operating costs where
appropriate.




19


Research
and Development





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





In the
three months and six months ended December, 31, 2008 the Company incurred
$38,691 and $111,935, respectively, in development expenses associated with its
EARCAD, 3D scanner and SketchArtist products.





Amortization
of intangible assets





Amortization
of intangible assets for the three months and six months ended December
31 was $81,185 and $162,370, respectively, for both 2009 and 2008. The
majority of amortization expense relates to the definite-lived intangible assets
acquired in conjunction with Genex Technologies.





Operating
loss





The
operating loss before taxes from continuing operations for the three months
ended December 31, 2009 was $347,207 compared with $387,161 for the three months
ended December 31, 2008.





The
operating loss before taxes from continuing operations for the six months ended
December 31, 2009 was $641,032 compared with $892,109 for the six months ended
December 31, 2008.





Discontinued
Operations





The net
loss from discontinued operations for the three months and six months ended
December 31, 2009 was $81,510 and $521,056. This was entirely attributable to
costs incurred with the arbitration against, and the subsequent settlement with,
EOIR Holdings LLC.





Net
Loss applicable to common shareholders





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





The net
loss attributable to common shareholders for the three months and six months
ended December 31, 2008 was $1,432,430 and $1,779,207, respectively. Included in
both periods is a non-cash deemed dividend of $1,121,431 related to the issuance
of Series D Redeemable, Convertible Preferred Stock.





Liquidity
and Capital Resources





Cash
and Working Capital





On
December 31, 2009, Technest had a positive working capital balance of $3,479,197
due primarily to the receipt of $18,000,000 from the sale of EOIR and
related Settlement Agreement and the remaining amount due under the Settlement
Agreement. Our primary source of operating cash flows was payments from our
customers. Payments from customers is based on the amount and timing of
work performed by us or the number of units delivered.  Our primary
ongoing uses of operating cash relate to payments to subcontractors and vendors,
salaries and related expenses and professional fees. The timing of such payments
is generally even throughout the year.  Our vendors and subcontractors
generally provide us with normal trade payment terms.  Net cash used
in operating activities for the six months ended December 31, 2009 was $859,589
compared with net cash used in operating activities of $605,796 for the six
months ended December 31, 2008 as the Company considerably reduced its accounts
payable and accruals.





Cash
Used in Investing Activities





In the
six months ended December 31, 2009, Technest used cash of $29,954 for the
acquisition of new definite lived intangible assets representing costs
associated with filing for new patents.  Technest also used $777 for
purchase of new equipment.





Cash
Provided by Financing Activities





In the
six months ended December 31, 2009, the Company received $150,000 related to the
issuance of its Series D Preferred Stock. These proceeds were used primarily for
legal expenses as well as for working capital purposes. The Company also
received and repaid a short term loan of $150,000 which was used for the payment
of past due professional fees.




20




Cash
Provided from Discontinued Operations





On
December 24, 2009, the Company received $18,000,000 from the sale of EOIR and
related settlement agreement. From that amount, the Company paid $3,333,887
directly relating to contractual obligations from the sale of EOIR and costs
associated with the subsequent arbitration and settlement
agreement.





Sources
of Liquidity





During
the six months ended December 31, 2009, we satisfied our operating and investing
cash requirements from cash reserves and from the sale of Series D Redeemable
Convertible Preferred Stock, a short term loan and the receipt of $18,000,000
from the settlement agreement with EOIR Holdings, Inc.





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





Off
Balance Sheet Arrangements





We
have no off-balance sheet arrangements that have or are reasonably likely to
have a current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that is material to stockholders. As of
December 31, 2009, Technest had warrants outstanding for the purchase of 649,286
shares of common stock. However, due to the net share settlement provisions of
these warrants, Technest does not expect any material cash proceeds upon
exercise.





Effect
of inflation and changes in prices





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





Critical
Accounting Policies and Estimates





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





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





Item
4T. Controls and Procedures





Evaluation
of Disclosure Controls and Procedures.





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





Changes
in Internal Control Over Financial Reporting.





There was
no change in our internal control over financial reporting during the quarter
ended December 31, 2009 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.




21


PART
II. OTHER INFORMATION





ITEM
1. Legal Proceedings.





Litigation
Related to the Sale of EOIR Technologies, Inc.





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





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





ITEM
1A. Risk Factors.





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





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





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





Technest
has had net operating losses each year since its inception. As of December 31,
2009, our accumulated deficit was approximately $17 million. If Technest
continues to suffer losses as it has in the past, investors may not receive any
return on their investment and may lose their entire investment.





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





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





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




22




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





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





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





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





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





●
            retaining
      key employees.





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





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





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





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





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





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





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





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





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





23





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





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





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





●
            our
      success in winning competitions for
orders;





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





●
            the
      mix of products we sell;





●
            competitive
      pricing pressures; and





●
            general
      economic climate.





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





Risks
Related to Contracting with the United States Government





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





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





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





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





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





●
            changes
      in Government programs or
requirements;





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





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





24




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





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





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





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





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





Risks
Related To “Controlled Companies”





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





Currently,
Southridge Partners LP owns 56.57% of the shares of Technest Common Stock, with
a total of 18,223,156 shares of Technest Common Stock. Aberdeen Avenue LLC
beneficially owns 15.77% of the shares of Technest Common Stock, with a total of
5,089,421 shares of Technest Common Stock. Southshore Capital Fund Ltd.
beneficially owns 3.32% of the shares of Technest Common Stock, with a total of
1,072,257 shares of Technest Common Stock. Stephen Hicks, one of our directors,
is deemed to beneficially own the shares of Technest Common Stock beneficially
owned by Southridge Partners LP, Aberdeen Avenue LLC, Southshore Capital Fund
Ltd. and Garth LLC. Including the shares of Technest Common Stock beneficially
owned by these entities, along with those shares directly owned by Mr. Hicks and
the shares owned by Trillium Partners, LP, Mr. Hicks is deemed to beneficially
own 78.45% of the shares of Technest Common Stock, with a total of 25,317,455
shares of Technest Common Stock. Mr. Hicks disclaims beneficial ownership of
such shares other than those issued to Mr. Hicks as a director of
Technest.





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





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





A very
small number of investors collectively owned approximately 78.45% of Technest’s
outstanding common stock on a primary basis.  As a result, those investors
have the ability to control all matters submitted to the stockholders of
Technest for approval (including the election and removal of
directors).  A significant change to the composition of our board
could lead to a change in management and our business plan. Any such transition
could lead to, among other things, a decline in service levels, disruption in
our operations and departures of key personnel, which could in turn harm our
business.





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





25




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





Risks
Related To Capital Structure





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





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





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





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





Risks
Related To Investing In Low- Priced Stock





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





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





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





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





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





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





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





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





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





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





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





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





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





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




26




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





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





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





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





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





Our stock
price has been volatile. From January 2006 to December 2009, the trading price
of our common stock ranged from a low price of $0.05 per share to a high price
of $11.35 per share. Many factors may cause the market price of our common stock
to fluctuate, including:





●
            variations
      in our quarterly results of
operations;





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





●
            acquisitions
      or strategic alliances involving us or our
  competitors;





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





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





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





Risks
Relating to New Corporate Governance Standards





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





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





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





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





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





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





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





27




ITEM
4.  Submission of Matters to a Vote of Security Holders.





Amendments
to Series A Convertible Preferred Stock and Series C Convertible Preferred Stock
Certificates of Designation





On
December 10, 2009, all of the Board of Directors of Technest Holdings, Inc.
(“Technest”) and all of the holders of the outstanding Technest Series A
Convertible Preferred Stock (“Series A”) and Technest Series C Convertible
Preferred Stock (“Series C”) approved amendments to each of the Series A
Certificate of Designation and the Series C Certificate of Designation (the
“Amendments”), respectively. The Certificates of Designation for the Series A
and Series C provided that a holder of such preferred stock could not convert
its preferred stock if upon such conversion, that holder, together with its
affiliates, would beneficially own more than 4.99% of the outstanding shares of
Technest Common Stock, subject to certain waiver requirements.  The
Series C Certificate of Designation further restricted a holder’s ability to
convert its preferred stock if such holder, together with its affiliates, would
beneficially own more than 9.99% of the outstanding shares of Technest Common
Stock and such restriction could not be waived.  The Amendments
removed these restrictions.





The
foregoing summary of the Certificates of Designation and the Amendments is
qualified in its entirety by reference to the full text of (i) the Series A
Certificate of Designation, which was filed as Exhibit 4.1 to a current report
on Form 8-K filed on February 14, 2005 and is incorporated by reference herein,
(ii) the Series C Certificate of Designation, which was filed as Exhibit 4.8 to
a current report on Form 8-K filed on February 15, 2005 and is incorporated by
reference herein, and (iii) the Amendments to the Series A Certificate of
Designation and the Series C Certificate of Designation, which were filed as
Exhibits 4.4 and 4.5 to a current report on Form 8-K filed on December 14, 2009
and are incorporated by reference herein.








ITEM
6.  Exhibits





Exhibit
              No.
            Description
            Filed
      with this Quarterly
              Report
            Incorporated
      by referenceForm
            Filing
      Date
            Exhibit
      No.4.1
            Technest
      Series A Convertible Preferred Stock Certificate of Designation, filed
      with the Secretary of State of Nevada on February 8, 2005.
            
            8-K
            February
      14, 2005
            4.14.2
            Technest
      Series C Convertible Preferred Stock Certificate of Designation filed with
      the Secretary of State of Nevada on February 14, 2005.
            
            8-K
            February
      15, 2005
            4.84.3
            Technest
      Series D 5% Convertible Preferred Stock Certificate of Designation filed
      with the Secretary of State of Nevada on October
    1, 2008.
            
            10-KSB
            October
      2, 2008
            4.184.4
            Amendments
      to Technest Series A Convertible Preferred Stock Certificate of
      Designation, filed with the Secretary of State of Nevada on December 10,
      2009.
            
            8-K
            December
      14, 2009
            4.44.5
            Amendments
      to Technest Series C Convertible Preferred Stock Certificate of
      Designation, filed with the Secretary of State of Nevada on December 10,
      2009.
            
            8-K
            December
      14, 2009
            4.510.1
            Settlement
      Agreement among Technest Holdings, Inc., EOIR Holdings, LLC and EOIR
      Technologies, Inc. dated October 26, 2009.
            
            8-K
            October
      29, 2009
            10.110.2
            Form
      of Non-Employee Director Restricted Stock Grant Agreement entered into by
      each non-employee director and Technest Holdings, Inc. dated December
      2009.
            
            8-K
            December
      14, 2009
            10.131.1
            Certification
      by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X31.2
            Certification
      by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X32.1
            Certification
      by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
      1350.
            X




28





Exhibit
              No.
            Description
            Filed
      withthis
      Quarterly
              Report
            Incorporated
      by referenceForm
            Filing
      Date
            Exhibit
      No.4.1
            Technest
      Series A Convertible Preferred Stock Certificate of Designation, filed
      with the Secretary of State of Nevada on February 8, 2005.
            
            8-K
            February
      14, 2005
            4.14.2
            Technest
      Series C Convertible Preferred Stock Certificate of Designation filed with
      the Secretary of State of Nevada on February 14, 2005.
            
            8-K
            February
      15, 2005
            4.84.3
            Technest
      Series D 5% Convertible Preferred Stock Certificate of Designation filed
      with the Secretary of State of Nevada on October
    1, 2008.
            
            10-KSB
            October
      2, 2008
            4.184.4
            Amendments
      to Technest Series A Convertible Preferred Stock Certificate of
      Designation, filed with the Secretary of State of Nevada on December 10,
      2009.
            
            8-K
            December
      14, 2009
            4.44.5
            Amendments
      to Technest Series C Convertible Preferred Stock Certificate of
      Designation, filed with the Secretary of State of Nevada on December 10,
      2009.
            
            8-K
            December
      14, 2009
            4.510.1
            Settlement
      Agreement among Technest Holdings, Inc., EOIR Holdings, LLC and EOIR
      Technologies, Inc. dated October 26, 2009.
            
            8-K
            October
      29, 2009
            10.110.2
            Form
      of Non-Employee Director Restricted Stock Grant Agreement entered into by
      each non-employee director and Technest Holdings, Inc. dated December
      2009.
            
            8-K
            December
      14, 2009
            10.131.1
            Certification
      by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X31.2
            Certification
      by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X32.1
            Certification
      by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
      1350.
            X











29





SIGNATURES





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





TECHNEST
      HOLDINGS, INC.Date: February
      16, 2010
              By:
              /s/ Gino
      M. PereiraGino
      M. PereiraChief
      Executive Officer and PresidentDate: February
      16, 2010
              By:
              /s/ Nitin
      V. KotakNitin
      V. KotakChief
      Financial Officer













30