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: September 30,
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 ofincorporation or
      organization)
            (IRS EmployerIdentification
      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 o No x




As of
November 13, 2009, there were 21,327,441 shares of common stock, $0.001 par
value, of the registrant issued and outstanding.










TECHNEST
HOLDINGS, INC.





FORM
10-Q


TABLE
OF CONTENTS


SEPTEMBER
30, 2009








PagePART
      I.
            FINANCIAL
      INFORMATION:
            3Item
      1.
            Financial
      Statements (Unaudited)
            3Consolidated
      Balance Sheets at September 30, 2009 and June 30, 2009
            3-4Consolidated
      Statements of Operations for the Three Months Ended September 30, 2009 and
      2008
            5Consolidated
      Statement of Changes in Stockholders’ Equity for the Three Months Ended
      September 30, 2009
            6Consolidated
      Statements of Cash Flows for the Three Months Ended September 30, 2009 and
      2008
            7Notes
      to Condensed Consolidated Financial Statements
            8Item
      2.
            Management’s
      Discussion and Analysis or Plan of Operation
            15Item
      4T.
            Controls
      and Procedures
            20PART
      II.
            OTHER
      INFORMATION
            20Item
      1.
            Legal
      Proceedings
            20Item
      1A.
            Risk
      Factors
            21Item
      6.
            Exhibits
            28Signatures
            
            29





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





2




PART I.
FINANCIAL INFORMATION






TECHNEST
HOLDINGS, INC.
 CONSOLIDATED
BALANCE SHEETS
 SEPTEMBER
30, 2009 AND JUNE 30, 2009


September
      30,
              2009
            
            
            June
      30,
              2009(Unaudited)ASSETSCurrent
      AssetsCash
      and cash equivalents
            
            $
            219,642
            
            
            $
            5,567Accounts
      receivable
            
            
            194,527
            
            
            
            260,381Inventory
      and work in process
            
            
            29,110
            
            
            
            26,745Restricted
      cash
            
            
            15,000
            
            
            
            216,697Prepaid
      expenses and other current assets
            
            
            40,388
            
            
            
            750,013Assets
      related to discontinued operations
            
            
            22,846,366
            
            
            
            22,948,333Total
      Current Assets
            
            
            23,345,033
            
            
            
            24,207,736Property and Equipment–
      Net of accumulated depreciation $100,833 and $94,703
            
            
            31,233
            
            
            
            37,363Other
      AssetsDeposits
            
            
            28,525
            
            
            
            28,525Definite-lived
      intangible assets – Net of accumulated amortization $1,501,925 and
      $1,420,740
            
            
            240,988
            
            
            
            322,173Goodwill
            
            
            4,876,038
            
            
            
            4,876,038Total
      Other Assets
            
            
            5,145,551
            
            
            
            5,226,736Total
      Assets
            
            $
            28,521,817
            
            
            $
            29,471,835LIABILITIES,
      REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITYCurrent
      LiabilitiesAccounts
      payable
            
            $
            837,740
            
            
            $
            745,159Accrued
      expenses and other current liabilities
            
            
            572,677
            
            
            
            626,381Liabilities
      related to discontinued operations
            
            
            4,683,091
            
            
            
            5,246,838Accrued
      income taxes
            
            
            293,091
            
            
            
            293,091Total
      Current Liabilities
            
            
            6,386,599
            
            
            
            6,911,469Total
      Liabilities
            
            
            6,386,599
            
            
            
            6,911,469








See notes
to condensed consolidated financial statements.




3





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
BALANCE SHEETS (concluded)






September
      30,
              2009
            
            
            June
      30,
              2009(Unaudited)Series
      D Redeemable, Convertible Preferred Stock - $.0001 par
    value;3,000
      shares authorized; 1,940 and 1,640 shares issued and outstanding at
      September 30,2009
      and June 30, 2009 (preference in liquidation of $2,014,605 at September
      30, 2009)
            
            
            2,014,605
            
            
            
            1,690,483Commitments
      and ContingenciesStockholders’
      EquitySeries
      A Convertible Preferred Stock - $.001 par value; 150 shares
      authorized;64.325
      shares issued and outstanding (preference in liquidation
of$64,325
      at September 30, 2009)
            
            
            -
            
            
            
            -Series
      C Convertible Preferred Stock - $.001 par value; 1,149,425
      sharesauthorized;
      402,301 issued and outstanding (preference in liquidationof
      $875,005 at September 30, 2009)
            
            
            402
            
            
            
            402Common
      stock - par value $.001 per share; 495,000,000 shares
      authorized;21,327,441
      and 20,676,211 shares issued and outstanding
            
            
            21,326
            
            
            
            20,675Additional
      paid-in capital
            
            
            36,958,008
            
            
            
            37,032,781Accumulated
      deficit
            
            
            (16,806,593
            )
            
            
            (16,183,975
            )Total
      Technest Holdings, Inc. Stockholders’ Equity
            
            
            20,173,143
            
            
            
            20,869,883Non-Controlling
      Interest
            
            
            (52,530
            )
            
            
            -Total
      Stockholders’ Equity
            
            
            20,120,613
            
            
            
            20,869,883Total
      Liabilities, Redeemable Preferred Stock and Stockholders’
      Equity
            
            $
            28,521,817
            
            
            $
            29,471,835








See notes
to condensed consolidated financial statements.




4





TECHNEST
HOLDINGS, INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 FOR
THE THREE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
 (Unaudited)




2009
            
            
            2008Revenues
            
            $
            585,939
            
            
            $
            447,204Cost
      of Revenues
            
            
            279,826
            
            
            
            274,540Gross
      Profit
            
            
            306,113
            
            
            
            172,664Operating
      ExpensesSelling,
      general and administrative
            
            
            488,503
            
            
            
            523,183Research
      and development
            
            
            30,250
            
            
            
            73,244Amortization
      of intangible assets
            
            
            81,185
            
            
            
            81,185Total
      Operating Expenses
            
            
            599,938
            
            
            
            677,612Operating
      Loss from Continuing Operations
            
            
            (293,825
            )
            
            
            (504,948
            )Other
      Income, NetInterest
      income
            
            
            58,223
            
            
            
            -Other
      income
            
            
            -
            
            
            
            1,171Total
      Other Income, Net
            
            
            58,223
            
            
            
            1,171Loss
      from Continuing Operations before Income Taxes
            
            
            (235,602
            )
            
            
            (503,777
            )Income
      tax benefit
            
            
            -
            
            
            
            157,000Net
      Loss from Continuing Operations
            
            
            (235,602
            )
            
            
            (346,777
            )Discontinued
      OperationsLoss
      on discontinued operations
            
            
            (439,546
            )
            
            
            -Net
      Loss from Discontinued Operations
            
            
            (439,546
            )
            
            
            -Net
      Loss
            
            
            (675,148
            )
            
            
            (346,777
            )Net
      Loss Attributable to Non-Controlling Interest
            
            
            52,530
            
            
            
            -Net
      Loss Attributable to Technest Holdings, Inc.
            
            
            (622,618
            )
            
            
            (346,777
            )Deemed
      Dividend to Preferred Stockholders - Series D
            
            
            (279,122
            )
            
            
            -Net
      Loss Applicable to Common Shareholders
            
            $
            (901,740
            )
            
            $
            (346,777
            )Basic
      and Diluted Loss Per Common ShareFrom
      continuing operations attributable to Technest Holdings,
    Inc.
            
            $
            (0.02
            )
            
            $
            (0.02
            )From
      discontinued operations attributable to Technest Holdings,
      Inc.
            
            $
            (0.02
            )
            
            $
            -Net
      Loss Per Share - Basic and Diluted
            
            $
            (0.04
            )
            
            $
            (0.02
            )Weighted
      Average Number of Common Shares OutstandingBasic
      and diluted
            
            
            20,739,918
            
            
            
            20,621,760




See notes
to condensed consolidated financial statements.
  5





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY


FOR
THE THREE MONTHS ENDED SEPTEMBER 30, 2009


(Unaudited)








Series
      A
            
            
            Series
      CConvertible
            
            
            ConvertibleCommon
      stock
            
            
            Preferred
      stock
            
            
            Preferred
      stockShares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalance
      - June 30, 2009
            
            
            20,676,211
            
            
            $
            20,675
            
            
            
            64
            
            
            $
            -
            
            
            
            402,301
            
            
            $
            402Issuance
      of restricted stock aspayment for accrued expenses
            
            
            651,230
            
            
            
            651
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -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
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      Loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Balance
      - September 30, 2009
            
            
            21,327,441
            
            
            $
            21,326
            
            
            
            64
            
            
            $
            -
            
            
            
            402,301
            
            
            $
            402





Additional
              Paid-In
            
            
            Accumulated
            
            
            Non-Controlling
            
            
            Total
      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
            
            
            99,349
            
            
            
            -
            
            
            
            -
            
            
            
            100,000Accretion
      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
            
            
            (24,122
            )
            
            
            -
            
            
            
            -
            
            
            
            (24,122
            )Net
      Loss
            
            
            -
            
            
            
            (622,618
            )
            
            
            (52,530
            )
            
            
            (675,148
            )Balance
      - September 30, 2009
            
            $
            36,958,008
            
            
            $
            (16,806,593
            )
            
            $
            (52,530
            )
            
            $
            20,120,613








See notes
to condensed consolidated financial statements.




6





TECHNEST
HOLDINGS, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 FOR THE THREE
MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
 (Unaudited)





2009
            
            
            2008Cash
      Flows From Operating Activities:Net
      loss
            
            $
            (675,148
            )
            
            $
            (346,777
            )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization of property and equipment
            
            
            6,130
            
            
            
            9,569Amortization
      of intangible assets
            
            
            81,185
            
            
            
            81,185Non-cash
      interest income related to discount accretion
            
            
            (30,633
            )
            
            
            -Stock-based
      compensation to employees and directors
            
            
            -
            
            
            
            92,349Deferred
      income tax expense (benefit)
            
            
            -
            
            
            
            (157,000
            )Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            65,854
            
            
            
            433,736Unbilled
      receivables
            
            
            -
            
            
            
            (11,858
            )Inventory
      and work in process
            
            
            (2,365
            )
            
            
            (29,790
            )Restricted
      cash
            
            
            201,697
            
            
            
            (922
            )Deposits
      and prepaid expenses and other current assets
            
            
            (9,320
            )
            
            
            (491
            )Accounts
      payable
            
            
            164,380
            
            
            
            (8,672
            )Unearned
      revenue
            
            
            -
            
            
            
            35,000Accrued
      expenses and other current liabilities
            
            
            262,295
            
            
            
            (116,581
            )Net
      Cash Provided by (Used In) Operating Activities
            
            
            64,075
            
            
            
            (20,252
            )Cash
      Flows From Investing Activities:Registration
      of new definite lived intangible assets
            
            
            -
            
            
            
            (8,642
            )Net
      Cash Provided by (Used In) Investing Activities
            
            
            -
            
            
            
            (8,642
            )Cash
      Flows From Financing Activities:Proceeds
      from issue of Series D Redeemable, Convertible Preferred
    Stock
            
            
            150,000
            
            
            
            -Net
      Cash Provided by (Used In) Financing Activities
            
            
            150,000
            
            
            
            -Net
      Increase (Decrease) In Cash
            
            
            214,075
            
            
            
            (28,894
            )Cash
      and Cash Equivalents - Beginning of Period
            
            
            5,567
            
            
            
            76,761Cash
      and Cash Equivalents - End of Period
            
            $
            219,642
            
            
            $
            47,867Supplemental
      Disclosures of Cash Flow Information:Cash
      paid during the periods for:Interest
            
            $
            -
            
            
            $
            -Taxes
            
            $
            -
            
            
            $
            -Non-Cash
      Investing and Financing Activities:Restricted
      stock issued as payment for accrued expenses
            
            $
            100,000
            
            
            $
            -Beneficial
      conversion on Series D Redeemable, Convertible PreferredStock
            
            $
            105,000
            
            
            $
            -Accretion
      of Series D Redeemable, Convertible Preferred Stock toRedemption
      Value
            
            $
            255,000
            
            
            $
            -Accrued
      Dividend on Series D Redeemable, Convertible Preferred
    Stock
            
            $
            24,122
            
            
            $
            -





See notes
to condensed consolidated financial statements.
  7
  TECHNEST
HOLDINGS INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE MONTHS ENDED SEPTEMBER 30, 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.





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 the period ended September 30, 2009.




8




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 months ended September 30, 2009 are not
necessarily indicative of the result 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.
 
 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.




9








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 quarter ended September 30, 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 quarter ended September 30, 2009, the Company
accreted into interest income a total of $30,633 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 September 30, 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
decisions to hold the related asset.





The loss
on discontinued operations for the three months ended September 30, 2009 was
$439,546 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 months
ended September 30, 2009, the Company allocated approximately $178,704 of such
expenses to Technest, Inc.





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




On July
1, 2009, the Company adopted new guidance in accordance with the Accounting
Standards Codification section 810-10 related to its non-controlling interest in
Technest, Inc.  The non-controlling interest in the net loss for the
three months ended September 30, 2009 was $52,530.  In the quarter
ended September 30, 2009, had the previous accounting guidance been applied, the
Company’s net loss applicable to common stockholders would have been $954,270,
or $0.05 per share.





5.DEFINITE-LIVED INTANGIBLE
ASSETS





Definite-lived
intangible assets consist of the following:





September
      2009
            
            Useful
      life (years)Patents
      - commercialized technology
            
            $
            440,000
            
            5Patents
      - other
            
            
            172,913
            
            15Customer
      relationships and contracts
            
            
            1,130,000
            
            5Accumulated
      amortization
            
            
            (1,501,925
            )Net
      definite-lived intangible asset
            
            $
            240,988





Amortization
expense was $81,185 for each of the three months ended September 30, 2009 and
2008.





10





6.SERIES D REDEEMABLE,
CONVERTIBLE PREFERRED STOCK





On
October 1, 2008, the Company’s Board of Directors approved the designation of
3,000 shares of Series D Redeemable, Convertible Preferred Stock (“Series D
Preferred”).  The Series D Preferred 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 7).  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 each 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 quarter of
fiscal 2010.  The carrying value in future periods is adjusted by
additional dividends earned and expected to be paid upon
redemption.  Total dividends accrued on the Series D Preferred amount
to $24,122 during the three month period ended September 30, 2009.





At September 30, 2009, the Company had
1,940 shares of Series D Preferred issued and outstanding which has a
liquidation preference of $2,014,605.





7.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 4.999% 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.





At
September 30, 2009 there were 64.325 shares of Series A Preferred Stock issued
and outstanding.




11





Series C Convertible
Preferred Stock





The
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. The Series C Conversion
Price is currently $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.





At
September 30, 2009, the Company had 402,301 shares of Series C Preferred Stock
issued and outstanding.





Common Stock
Issuances





During
the three months ended September 30, 2009, the Company issued the following
amounts of common stock:





●
            651,230
      shares of its Common Stock with a fair value of $100,000 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 June 30,
      2009.





The
Company has established the following reserves for the future issuance of common
stock as follows:





Reserve
      for the exercise of warrants
            
            
            649,286Reserve
      for conversion of Series A Convertible Preferred
    Stock
            
            
            306,047Reserve
      for conversion of Series C Convertible Preferred
    Stock
            
            
            402,301Reserve
      for conversion of Series D Redeemable, Convertible Preferred
      Stock
            
            
            15,109,542Total
      common stock reserves
            
            
            16,467,176





8.OPTIONS, WARRANTS AND
STOCK-BASED COMPENSATION





Options





No
options were granted pursuant to the Plan during the periods ended September 30,
2009 and 2008 and there are currently no options outstanding under the
Plan.





Warrants





No
warrants were issued, exercised or expired in the quarters ended September 30,
2009 and 2008.





The
following table summarizes the Company's warrants outstanding at September 30,
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
            1.2
      years





As of
September 30, 2009 all warrants are exercisable.  There is
no aggregate intrinsic value for warrants outstanding as of September
30, 2009.





12




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 three months ended
September 30, 2009 and 2008 was $0 and $92,349, 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
September 30, 2009, the Company has 621,115 shares available for future grant
under the Plan.





9.NET (LOSS) INCOME 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 months ended September, 2009 and 2008, consist of
the following:





Shares
      Potentially Issuable2009
            
            
            2008Series
      A Convertible Preferred Stock
            
            
            306,047
            
            
            
            306,047Series
      C Convertible Preferred Stock
            
            
            402,301
            
            
            
            402,301Series
      D Redeemable, Convertible, Preferred Stock
            
            
            10,073,028
            
            
            
            -Warrants
            
            
            649,286
            
            
            
            649,286Total
            
            
            11,430,662
            
            
            
            1,357,634





10.COMMITMENTS AND
CONTINGENCIES





Facility
Rental





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





Rent
expense for continuing operations in the three months ended September 30, 2009
and 2008 was $46,755 and $48,512, 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





11.INCOME TAXES





There was
no provision for federal or state income taxes for the three months ended
September 30, 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 September 30, 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 three months ended
September 30, 2009, there was no change in the valuation
allowance.   As of September 30, 2009, the Company has net
operating loss carryforwards not subject to IRC Section 382 limitations of
$4,038,000 which begin to expire in 2024.





The
benefit from federal and state income taxes related to continuing operations for
the three months ended September 30, 2008 was $157,000.





12.EMPLOYEE BENEFIT
PLANS





Technest
has adopted a 401(k) plan for the benefit of employees. Essentially all Technest
employees are eligible to participate. The Company also contributes to the plan
under a safe harbor plan requiring a 3% contribution for all eligible
participants. In addition, the Company may contribute a 3% elective match. 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 months ended September 30, 2009 and
2008 were $24,161 and $26,260, respectively.





13.LITIGATION





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





14.SUBSEQUENT
EVENTS





Management has evaluated subsequent
events through November 16, 2009, which is the date the financial statements
were issued.





American Asset
Financing





On
November 3, 2009, the Company received $150,000 from American Asset Finance LLC
(“AAF”) for general working capital purposes. AAF is to be repaid in the
following manner immediately on receipt of the EOIR settlement funds: $180,000
if payment is made on or before February 2, 2010, $198,000 if payment is made
after February 2, 2010 and on or before May 2, 2010, $216,000 if payment is made
after May 2, 2010 and on or before August 2, 2010.  If payment is made
after August 2, 2010 AAF will be entitled to receive $216,000 plus an additional
$7,500 per month or part thereof until payment in full has been
made.





14





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





The
following discussion and analysis of our financial condition and results of
operations for our financial quarter ending September 30, 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.





15




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





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




16


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.








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 this
receivable.





As
previously announced, upon receipt of $18,000,000, Technest intends to
distribute to its shareholders a minimum of 90% of the net proceeds after
setting aside reserves for payment of existing obligations.





Three months ended September
30, 2009 compared with the three months ended September 30,
2008





Revenues





Technest
had $585,939 in revenues during the three months ended September 30, 2009
compared with $447,204 during the three months ended September 30, 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 September 30, 2009, the Company’s backlog of funded contracts was
approximately $2.6 million, an increase of 127% over the last
quarter.




17


Gross
profit





The gross
profit for the three months ended September 30, 2009 was $306,113 or 52% of
revenues. The gross profit for the three months ended September 30, 2008 was
$172,664 or 39% of revenues.  Technest expects to expand its revenue
base to include commercial product revenues and, accordingly, gross profit on
future revenues may differ.





Selling,
general and administrative expenses





Selling,
general and administrative expenses for the three months ended September 30,
2009 were $488,503, and consisted primarily of payroll related
expenses.





Selling,
general and administrative expenses for the three months ended September 30,
2008 were $523,183, and consisted primarily of payroll related
expenses.





Research
and Development





In the
three months ended September, 30, 2009 the Company incurred $30,250 in
development expenses associated with its three dimensional camera
products.





In the
three months ended September, 30, 2008 the Company incurred $73,244 in
development expenses associated with its EARCAD and SketchArtist
products.





Amortization
of intangible assets





Amortization
of intangible assets for the three months ended September 30, 2009 and
2008 was $81,185. 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 September 30, 2009 was $293,825 compared with $504,948 for the three
months ended September 30, 2008 due to cost saving measures instituted by
management.





Discontinued
Operations





The net
loss from discontinued operations for the three months ended September 30, 2009
was $439,546. 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 ended September 30,
2009 was $901,740. Included in the net loss for three months ended September 30,
2009 is a non-cash deemed dividend of $279,122 related to Series D
Redeemable, Convertible Preferred Stock.





The net
loss attributable to common shareholders for the three months ended September
30, 2008 was $346,777.





Liquidity
and Capital Resources





Cash
and Working Capital





On
September 30, 2009, Technest had a positive working capital balance of
$16,958,434 due primarily to the  receivable from the sale of EOIR and
related Settlement Agreement. Our primary source of operating cash flows was
payments from our customers as well as the release of certain restriction on
cash accounts.  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 as well as non
recurring legal expenses in connection the Settlement Agreement in relation to
the sale of EOIR.  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 generated by operating
activities for the three months ended September 30, 2009 was $64,075 compared
with net cash used in operating activities of ($20,252) for the three months
ended September 30, 2008.




18




Cash
Used in Investing Activities





In the
three months ended September 30, 2008, Technest used cash of $8,642 for the
acquisition of new definite lived intangible assets representing costs
associated with filing for new patents.





Cash
Provided by Financing Activities





In the
three months ended September 30, 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.





Sources of
Liquidity





During
the three months ended September 30, 2009, we satisfied our operating and
investing cash requirements from cash reserves and from the sale of Series D
Redeemable Convertible Preferred Stock.





Subsequent
to September 30, 2009 we received a bridge loan in the amount of $150,000 from
American Asset Finance LLC for general working capital purposes.





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
Company is also expanding 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 officers are deferring a
portion of their remuneration. 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
September 30, 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.





19




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 September 30, 2009 that has materially affected, or is reasonably likely
to materially affect, our internal control over financial
reporting.





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.




20


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





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 entered into by the parties.  If the
settlement proceeds are not paid, Technest’s financial condition will be
significantly harmed.





On
October 26, 2009, Technest Holdings, Inc.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 EOIR Holdings 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. If, however, the settlement
proceeds were not paid, Technest’s financial condition would be significantly
harmed.





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 September 30,
2009, our accumulated deficit was approximately $16.8 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.




21


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 Companyto
      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.





22




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;





23




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





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





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





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





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





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





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





Risks
Related To “Controlled Companies”





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





According
to the stock records of Technest, as of November 11, 2009, Southridge
Partners LP, together with its affiliates, were the largest stockholders of
Technest, owning approximately 62.89% of Technest’s outstanding common stock as
the record holders of 13,412,865 shares. In addition, Southridge Partners,
LP and its affiliates have the right to acquire additional shares of common
stock through conversion of their shares of Technest preferred stock.  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.





24





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





A very
small number of investors collectively owned approximately 62.89% of Technest’s
outstanding common stock on a primary basis.  As a result, those investors
have the ability to control all matters submitted to the stockholders of
Technest for approval (including the election and removal of
directors).  A significant change to the composition of our board
could lead to a change in management and our business plan. Any such transition
could lead to, among other things, a decline in service levels, disruption in
our operations and departures of key personnel, which could in turn harm our
business.





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





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





Risks
Related To Capital Structure





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





We are
obligated to register shares held by Markland Technologies, Inc. or any of its
transferees as well as shares  held by other holders. Our common stock
is thinly traded. The registration of these shares for public resale may result
in a greater number of shares being available for trading than the market can
absorb. This may cause the market price of our common stock to decrease.





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





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





Risks
Related To Investing In Low- Priced Stock





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





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





25




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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





Our stock
price has been volatile. From January 2006 to October 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;





26




●
            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 6. 
Exhibits





Exhibit
      No.
            Description
            Filed
      with this Quarterly Report
            Incorporated
      by referenceForm
            Filing
      Date
            Exhibit
      No.10.1
            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
            Technest
      Holdings, Inc. 2006 Stock Award Plan, As amended  September 21,
      2009
            X31.1
            Certification
      by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X31.2
            Certification
      by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X32.1
            Certification
      by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
      1350.
            X





28





SIGNATURES





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







TECHNEST
      HOLDINGS, INC.Date: November
      16, 2009
            By:
            /s/ Gino M.
      PereiraGino
      M. Pereira
              Chief Executive Officer and
      PresidentDate: November
      16, 2009
            By:
            /s/ Nitin
      V. KotakNitin
      V. Kotak
              Chief
      Financial Officer





29





EXHIBIT
INDEX








Exhibit
      No.
              Description
              Filed
      with this Quarterly Report
              Incorporated
      by referenceForm
              Filing
      Date
              Exhibit
      No.10.1
              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
              Technest
      Holdings, Inc. 2006 Stock Award Plan, As amended  September 21,
      2009
              X31.1
              Certification
      by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
              X31.2
              Certification
      by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
              X32.1
              Certification
      by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
      1350.
              X
 
 30