UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K





x
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the Fiscal Year Ended June 30, 2009.o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





Commission
File Number 000-27023





Technest Holdings,
Inc.


(Exact name of Registrant as
specified in its Charter)





Nevada
              (State or other
      jurisdiction
              of incorporation or
      organization)
            88-0357272
              (I.R.S. Employer Identification
      No.)10411 Motor City Drive, Suite 650, Bethesda,
      MD
              (Address of principal executive
      offices)
            20817
              (Zip
      Code)10411 Motor City Drive, Suite 650, Bethesda,
      MD
              (Mailing
      Address)





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





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





Title
      of Class
            
            Name
      of each exchange on which registeredNone
            
            Not
      Applicable





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





Common Stock, par value
$0.001 per share


(Title or
Class)





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.   o  Yes 
xNo





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





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





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





Indicate
by check mark if  disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. o









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





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





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  o  Yes  x
 No





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates* computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of
December 31, 2008 (See definition of affiliate in Rule 12b-2 of the Exchange
Act.) was: $716,999


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




APPLICABLE
ONLY TO CORPORATE REGISTRANTS





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




21,327,
441 shares as of October 13, 2009, all of one class of common stock, $0.001 par
value.





DOCUMENTS
INCORPORATED BY REFERENCE





Documents
Incorporated by reference:  None











TECHNEST
HOLDINGS, INC.


FORM
10-K


TABLE
OF CONTENTS


June 30, 2009





Part
      IItem
      1.
            Business
            1Item
      2.
            Property
            6Item
      3.
            Legal
      Proceedings
            7Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            7Part
      IIItem
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            8Item
      7.
            Management’s
      Discussion and Analysis
            8Item
      8.
            Financial
      Statements
            F-1Item
      9.
            Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure
            25Item
      9A(T).
            Controls
      and Procedures
            25Item
      9B.
            Other
      Information
            26Part
      IIIItem
      10.
            Directors,
      Executive Officers and Corporate Governance
            26Item
      11.
            Executive
      Compensation
            28Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            32Item
      13.
            Certain
      Relationships and Related Transactions and Director
      Independence.
            34Item
      14.
            Principal
      Accounting Fees and Services
            36Part
      IVItem
      15.
            Exhibits
            36Signatures
            40




-i-





NOTE
REGARDING FORWARD-LOOKING STATEMENTS





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





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





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





-ii-





PART
I




Item 1. Description of Business





Recent
Developments





Sale
of EOIR Technologies, Inc.





In
connection with the sale of EOIR Technologies, Inc. (“EOIR”) and the dispute
over the related contingent consideration, 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.  Technest had filed a demand for
arbitration on September 24, 2008 against EOIR Holdings LLC (“LLC”), a portfolio
company of The White Oak Guggenheim Aerospace and Defense Fund L.P., for breach
of the Stock Purchase Agreement (“SPA”) which the parties entered into on
September 10, 2007 to effectuate the sale of EOIR, in exchange for approximately
$34 million. Technest alleged in its demand that LLC breached the SPA when
it failed to pay to Technest approximately $23 million of the purchase price,
which became due upon the successful award to EOIR of the follow-on of an
existing contract with the U.S. Army’s Night Vision and Electronic Sensors
Directorate (“NVESD”).  LLC alleged that the amount was not due
because the award of the contract to EOIR did not meet the requirements for
payment under the SPA.  However, the arbitration panel unanimously
agreed with Technest and ruled that LLC breached the SPA and must pay the
remainder of the purchase price, including interest, in the amount of
$23,778,403 plus interest from the date of the award through date of
payment.





On August
24, 2009, Technest filed a motion to confirm the arbitration award and for entry
of judgment in the U.S. District Court for the Eastern District of
Virginia.  On September 4, 2009, LLC filed an objection to Technest’s
motion to confirm the award and for entry of judgment and entered a motion to
stay the proceeding until the resolution of the motion it filed to vacate the
award in the U.S. District Court for the District of Columbia on September 8,
2009.  On September 11, 2009, at a hearing for LLC’s motion to stay
the proceeding, the U.S. District Court for the Eastern District of Virginia
ordered that in the interest of judicial economy, Technest’s motion to confirm
the award and for entry of judgment be transferred to the U.S. District Court
for the District of Columbia to be heard before the same judge that is to hear
LLC’s motion to vacate the award.  On September 20, 2009, LLC filed a
superseding petition to vacate the arbitration award in the U.S. District Court
for the District of Columbia.  On September 21, 2009, Technest filed
its opposition to LLC's motion to vacate the award. As detailed in Technest's
opposition, the bases for vacating an arbitration award are extremely
limited.On October 5,
2009, Technest filed its opposition to LLC's superseding petition to vacate the
arbitration award.





On
February 17, 2009, LLC filed a complaint against Technest in the U.S. District
Court for the District of Delaware.  The complaint alleges that
Technest breached the SPA when it did not pay a Net Working Capital Adjustment
to the Closing Date Purchase Price under the Agreement.  In its answer
and concurrently filed motion to stay the proceedings, Technest maintains that
the Net Working Capital Adjustment is not due because  LLC had
previously breached the SPA by failing to pay to Technest the full purchase
price for EOIR.  On April 21, 2009, the Court granted Technest's
motion to stay the proceedings pending completion of arbitration regarding the
Contingent Purchase Price issue but ordered the parties to complete their
initial disclosures to include limited discovery regarding the calculated amount
of the Net Working Capital Adjustment.  The parties submitted their
initial disclosures with the requested discovery information on July 2, 2009. On
September 30, 2009,  LLC filed another complaint against Technest in
the U.S. District Court for the District of Delaware.  The second complaint
alleges that Technest breached the SPA by violating various representations,
warranties, and covenants that governed the conditions of the sale of EOIR
Technologies, Inc.





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





Small
Business Status





On
June 26, 2008, the Small Business Administration (“SBA”) concluded a formal size
determination on Technest. The SBA found that although Technest met the
definition of a small business, the composition of its stock ownership
disqualified the Company from participating in the Small Business Innovation
Research (“SBIR”) program. As of that date, the Company was permitted to
complete SBIR contracts awarded previously but was precluded from applying for
new SBIR contracts.  Excluding revenues from EOIR, this has been the
major source of revenue, although not of profit, for Technest. On July 28, 2008,
the Board of Directors of Technest voted to authorize the transfer
of certain government contracts and employees and license certain
assets to a newly formed company in which Technest retains a 49% interest and
meets the ownership eligibility for SBIRs. Technest will retain the right of
first refusal on all commercial applications that are developed by this
company.  The transfer took place on October 1,
2008.  Management believes that this does not detract from the stated
goal of Technest to develop revenues from commercialization of its intellectual
property portfolio.




-1-


General





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




Our
products leverage several core technology platforms, including:





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





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





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





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





Defense
and Security - 3D-ID





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





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





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





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.




-2-




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





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





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





Medical Devices





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





Technest
Business Strategy





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





·
            Focus
      on commercialization of pipeline
products;





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





·
            Develop
      recurring revenue models where
possible;





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





·
            Continue
      to develop a robust intellectual property portfolio;
  and





·
            Seek
      strategic acquisitions.





Technest
History





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





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





-3-




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




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





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





Sale of EOIR Technologies,
Inc.On September 10, 2007, Technest Holdings, Inc. (the
“Company” or “Technest”) and its wholly owned subsidiary, EOIR Technologies,
Inc. (“EOIR”), entered into a Stock Purchase Agreement with EOIR Holdings LLC, a
Delaware limited liability company (“LLC”), pursuant to which
Technest agreed to sell EOIR to LLC.  LLC is an entity
formed on August 9, 2007 by The White Oak Guggenheim Defense and Aerospace Funds
for the purposes of facilitating this transaction.





The sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which is payable upon
the successful re-award to EOIR of the contract with the U.S. Army's Night
Vision and Electronics Sensors Directorate (“NVESD”). This transaction closed on
December 31, 2007. On August 4, 2008, EOIR was awarded the NVESD contract with a
funding ceiling of $495 million. The Contingent Purchase Price of $23 million
was due as of August 21, 2008 in accordance with the Stock Purchase Agreement.
LLC alleged that the amount was not due because the award of the contract to
EOIR did not meet the requirements for payment under the
SPA.  However, following a seven-day Arbitration hearing that ended on
June 30, 2009, the arbitration panel unanimously agreed with Technest and on
August 21, 2009 ruled that LLC breached the SPA and must pay the remainder of
the purchase price, including interest of $830,070, of  $23,778,403
plus interest from the date of the Award through date of payment at
3.25%.  LLC filed a petition to vacate the arbitration award in the
U.S. District Court for the District of Columbia.  On September 21,
2009, Technest filed its opposition to  LLC's motion to vacate the
award. As detailed in Technest's opposition, the bases for vacating an
arbitration award are extremely limited.  On October 5, 2009, Technest
filed its opposition to  LLC's superseding petition to vacate the
arbitration award.





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




-4-


Competition





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





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





Intellectual
Property





Our
ability to compete effectively depends to a significant extent on our ability to
protect our proprietary information. We rely primarily on patents and trade
secret laws and confidentiality procedures to protect our intellectual property
rights. We own 18 U.S. patents and have 14 patents pending. We enter into
confidentiality agreements with our consultants and key employees, and maintain
controls over access to and distribution of our technology, software and other
proprietary information. The steps we have taken to protect our technology may
be inadequate to prevent others from using what we regard as our technology to
compete with us.





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





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





Dependence
on U.S. Government Contracts





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





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





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





-5-




Government
Regulation





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




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





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





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





Sales
and Marketing





We
currently divide the marketing efforts of our products and services into three
areas: (1) directly to federal or local government agencies; (2) to commercial
security applications; and (3) to commercial healthcare applications. These
marketing duties are divided among senior management.





Manufacturing





Our
primary manufacturing facilities are located in Bethesda, Maryland.





Employees





As of
September 24, 2009, Technest had a total of 17 employees. We believe our future
success will depend upon the continued service of our key technical and senior
management personnel and upon our continued ability to attract and retain highly
qualified technical and managerial personnel. None of our employees is
represented by a labor union. We have never experienced a work stoppage and
consider our relationship with our employees to be good.





Item
2. Description of Property





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





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




-6-


Item 3. Legal Proceedings





The
White Oak Group





In
connection with the sale of EOIR Technologies, Inc. (“EOIR”) and the dispute
over the related contingent consideration, 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.    Technest had filed a
demand for arbitration on September 24, 2008 against EOIR
Holdings  LLC (“LLC”), a portfolio company of The White Oak Guggenheim
Aerospace and Defense Fund, L.P., for breach of the Stock Purchase Agreement
(“SPA”) which the parties entered into on September 10, 2007 to effectuate the
sale of EOIR, in exchange for approximately $34 million.  Technest
alleged in its demand that  LLC breached the SPA when it failed to pay
to Technest approximately $23 million of the purchase price, which became due
upon the successful award to EOIR of the follow-on of an existing contract with
the U.S. Army’s Night Vision and Electronic Sensors Directorate
(“NVESD”).   LLC alleged that the amount was not due because the
award of the contract to EOIR did not meet the requirements for payment under
the SPA.  However, the arbitration panel unanimously agreed with
Technest and ruled that  LLC breached the SPA and must pay the
remainder of the purchase price, including interest, in the amount of
$23,778,403 plus additional interest from the date of the award through date of
payment.




On August
24, 2009, Technest filed a motion to confirm the arbitration award and for entry
of judgment in the U.S. District Court for the Eastern District of
Virginia.  On September 4, 2009,  LLC filed an objection to
Technest’s motion to confirm the award and for entry of judgment and entered a
motion to stay the proceeding until the resolution of the motion it filed to
vacate the award in the U.S. District Court for the District of Columbia on
September 8, 2009.  On September 11, 2009, at a hearing
for  LLC’s motion to stay the proceeding, the U.S. District Court for
the Eastern District of Virginia ordered that in the interest of judicial
economy, Technest’s motion to confirm the award and for entry of judgment be
transferred to the U.S. District Court for the District of Columbia to be heard
before the same judge that is to hear  LLC’s motion to vacate the
award.  On September 20, 2009,  LLC filed a superseding
petition to vacate the arbitration award in the U.S. District Court for the
District of Columbia.  On September 21, 2009, Technest filed its
opposition to  LLC's motion to vacate the award. As detailed in
Technest's opposition, the bases for vacating an arbitration award are extremely
limited.  On October 5, 2009, Technest filed its opposition
to  LLC's superseding petition to vacate the arbitration
award.





On
February 17, 2009,  LLC filed a complaint against Technest in the U.S.
District Court for the District of Delaware.  The complaint alleges
that Technest breached the SPA when it did not pay a Net Working Capital
Adjustment to the Closing Date Purchase Price under the Agreement.  In
its answer and concurrently filed motion to stay the proceedings, Technest
maintains that the Net Working Capital Adjustment is not due
because  LLC had previously breached the SPA by failing to pay to
Technest the full purchase price for EOIR.  On April 21, 2009, the
Court granted Technest's motion to stay the proceedings pending completion of
arbitration regarding the Contingent Purchase Price issue but ordered the
parties to complete their initial disclosures to include limited discovery
regarding the calculated amount of the Net Working Capital
Adjustment.  The parties submitted their initial disclosures with the
requested discovery information on July 2, 2009.  On September 30,
2009,  LLC filed another complaint against Technest in the U.S.
District Court for the District of Delaware.  The second complaint
alleges that Technest breached the SPA by violating various representations,
warranties, and covenants that governed the conditions of the sale of EOIR
Technologies, Inc.





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





We did
not submit any matters to a vote of security holders during the three months
ended June 30, 2009, which is the fourth quarter of our fiscal
year.





-7-





PART
II





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





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





Calendar
      Year
            
            High
            
            
            Low2007First
      Quarter
            
            $
            2.10
            
            
            $
            1.31Second
      Quarter
            
            $
            1.50
            
            
            $
            0.31Third
      Quarter
            
            $
            0.53
            
            
            $
            0.31Fourth
      Quarter
            
            $
            0.65
            
            
            $
            0.322008First
      Quarter
            
            $
            0.62
            
            
            $
            0.31Second
      Quarter
            
            $
            0.51
            
            
            $
            0.31Third
      Quarter
            
            $
            0.45
            
            
            $
            0.24Fourth
      Quarter
            
            $
            0.25
            
            
            $
            0.052009First
      Quarter
            
            $
            0.30
            
            
            $
            0.05Second
      Quarter
            
            $
            0.20
            
            
            $
            0.10





The above
quotations reflect inter-dealer prices, without retail mark-up, markdown or
commission. These quotes are not necessarily representative of actual
transactions or of the value of our common stock, and are in all likelihood not
based upon any recognized criteria of securities valuation as used in the
investment banking community. As of September 23, 2009, there were approximately
317 record holders of our common stock.





We have
not paid any cash dividends on our common stock in the past. The payment of any
cash dividends will be at the discretion of the board of directors and will be
dependent upon our results of operations, financial condition, capital
requirements, contractual restrictions and other factors deemed relevant by the
board.





On
September 21, 2009, the Company issued 651,230 shares of its Common Stock to its
non-employee directors under its 2006 Stock Award Plan as compensation for their
services as directors during the fiscal year ended June 30, 2009.  The
issuance and sale of the securities were not registered under the Securities Act
of 1933, but were made in reliance upon the exemptions from the registration
requirements of the Securities Act set forth in Section 4(2)
thereof.





Issuer
Purchases of Equity Securities





We did
not make any purchases of our common stock during the three months ended June
30, 2009, which is the fourth quarter of our fiscal year.





Item
7.  Management’s Discussion and Analysis





The
following discussion and analysis of our financial condition and results of
operations for the years ending June 30, 2009 and 2008 should be read together
with our financial statements and related notes included elsewhere in this
annual report on Form 10-K.





-8-




When
reviewing the discussion below, you should keep in mind the substantial risks
and uncertainties that characterize our business. In particular, we encourage
you to review the risks and uncertainties described in the section entitled
"Risk Factors” beginning on page 18
of this annual report on Form 10-K. These risks and uncertainties could cause
actual results to differ materially from those forecasted in forward-looking
statements or implied by past results and trends. Forward-looking statements are
statements that attempt to project or anticipate future developments in our
business; we encourage you to review the examples of forward-looking statements
under "Note Regarding Forward-Looking Statements." These statements, like all
statements in this annual report on Form 10-K, speak only as of June 30, 2009
and we undertake no obligation to update or revise the statements in light of
future developments.





Recent
Developments





Litigation
Related to the Sale of EOIR Technologies, Inc.





In
connection with the sale of EOIR Technologies, Inc. (“EOIR”) and the dispute
over the related contingent consideration, 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.    Technest had filed a
demand for arbitration on September 24, 2008 against EOIR Holdings LLC (“LLC”),
a portfolio company of The White Oak Guggenheim Aerospace and Defense Fund,
L.P., for breach of the Stock Purchase Agreement (“SPA”) which the parties
entered into on September 10, 2007 to effectuate the sale of EOIR, in exchange
for approximately $34 million.  Technest alleged in its demand
that  LLC breached the SPA when it failed to pay to Technest
approximately $23 million of the purchase price, which became due upon the
successful award to EOIR of the follow-on of an existing contract with the U.S.
Army’s Night Vision and Electronic Sensors Directorate
(“NVESD”).   LLC alleged that the amount was not due because the
award of the contract to EOIR did not meet the requirements for payment under
the SPA.  However, the arbitration panel unanimously agreed with
Technest and ruled that LLC breached the SPA and must pay the remainder of the
purchase price, including interest, in the amount of $23,778,403 plus additional
interest from the date of the award through date of payment.





On August
24, 2009, Technest filed a motion to confirm the arbitration award and for entry
of judgment in the U.S. District Court for the Eastern District of
Virginia.  On September 4, 2009, LLC filed an objection to Technest’s
motion to confirm the award and for entry of judgment and entered a motion to
stay the proceeding until the resolution of the motion it filed to vacate the
award in the U.S. District Court for the District of Columbia on September 8,
2009.  On September 11, 2009, at a hearing for LLC’s motion to stay
the proceeding, the U.S. District Court for the Eastern District of Virginia
ordered that in the interest of judicial economy, Technest’s motion to confirm
the award and for entry of judgment be transferred to the U.S. District Court
for the District of Columbia to be heard before the same judge that is to hear
LLC’s motion to vacate the award.  On September 20, 2009, LLC filed a
superseding petition to vacate the arbitration award in the U.S. District Court
for the District of Columbia.  On September 21, 2009, Technest filed
its opposition to LLC’s motion to vacate the award. As detailed in Technest's
opposition, the bases for vacating an arbitration award are extremely
limited.  On October 5, 2009, Technest filed its opposition to LLC’s
superseding petition to vacate the arbitration award.





On
February 17, 2009, LLC filed a complaint against Technest in the U.S. District
Court for the District of Delaware.  The complaint alleges that
Technest breached the SPA when it did not pay a Net Working Capital Adjustment
to the Closing Date Purchase Price under the Agreement.  In its answer
and concurrently filed motion to stay the proceedings, Technest maintains that
the Net Working Capital Adjustment is not due because  LLC had
previously breached the SPA by failing to pay to Technest the full purchase
price for EOIR.  On April 21, 2009, the Court granted Technest's
motion to stay the proceedings pending completion of arbitration regarding the
Contingent Purchase Price issue but ordered the parties to complete their
initial disclosures to include limited discovery regarding the calculated amount
of the Net Working Capital Adjustment.  The parties submitted their
initial disclosures with the requested discovery information on July 2,
2009.  On September 30, 2009, LLC filed another complaint against
Technest in the U.S. District Court for the District of Delaware.  The
second complaint alleges that Technest breached the SPA by violating various
representations, warranties, and covenants that governed the conditions of the
sale of EOIR Technologies, Inc.





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




-9-


Goodwill
Impairment Analysis





Technest
tests its goodwill for impairment annually in its fourth quarter. Accounting
principles generally accepted in the U.S. require additional testing if events
or circumstances indicate that impairment may exist. As a result of the very
light trading volume in the Company’s common stock, inefficiencies in investor
research of small capitalization companies and the relatively small amount of
shares in the public float, the Company’s book value exceeds its market
capitalization. Technest performed an impairment test of the goodwill as of
June 30, 2009. Based upon the impairment test performed, there was no
impairment indicated for Technest’s goodwill as of June 30,
2009.  The fair value of the reporting unit containing the goodwill
was determined utilizing a discounted cash flow valuation
approach.





Year
ended June 30, 2009 compared with the year ended June 30, 2008





Revenues





Technest
had $2,482,726 in revenues from continuing operations during the year ended June
30, 2009 compared with $2,469,085 during the year ended June 30, 2008. These
revenues were largely generated by Small Business Innovation Research
Grants in the field of 3-dimensional imaging. We use the revenue from these
grants to develop future potential products for our business. At June 30, 2009,
the Company’s backlog of funded contracts was approximately $1.1 million.
However, since then, the Company has been awarded further funded contracts
totaling $2.0 million which represents 123% of all contracts awarded in the
fiscal year ended June 30, 2009.





Gross
profit





The gross
profit for the year ended June 30, 2009 was $1,148,830 or 46% of revenues. The
gross profit from continuing operations for the year ended June 30, 2008 was
$1,078,558 or 44% of revenues. Technest expects to expand its revenue base to
include commercial product revenues and, accordingly, gross profit on future
revenues may differ.  In the quarter ended June 30, 2008, as a result
of the conclusion of a DCAA audit, the Company determined that it had under
billed on a contract completed in 2005.  As a result, the Company
recorded revenue in the quarter ended June 30, 2008 of approximately $70,000
related to the final settlement of this contract increasing gross profit for the
year 7% and the gross profit margin from approximately 41% to 44%.





Selling,
general and administrative expenses





Selling,
general and administrative expenses for the year ended June 30, 2009 were
$2,142,630 and consisted primarily of payroll related expenses and professional
fees.





Selling,
general and administrative expenses for the year ended June 30, 2008 were
$4,868,657, and consisted primarily of legal and professional fees, including
settlement of the Deer Creek matter of approximately
$1,113,546, amortization of stock-based compensation amounting to $300,949,
and a $1,380,000 charge related to the fair value of stock issued in connection
with the termination of certain sections of a stockholders’ agreement and a
licensing agreement both dated March 13, 2007.





The
decrease of $2,726,027 in selling, general and administrative expenses for the
year ended June 30, 2009 over the year ended June 30, 2008 was primarily due to
unusual 2008 expenses of approximately $850,000 in legal fees and settlement of
the Deer Creek judgment, and the $1,380,000 charge related to the fair value of
stock issued in connection with the termination of certain sections of a
stockholder agreement and a licensing agreement as noted above. In addition, in
fiscal year 2009, the Company implemented a program of overhead
reduction.





Certain
general and administrative expenses of the Company that are associated with EOIR
totaling approximately $2,723,747 and $5,746,501 in the years ended June 30,
2009 and 2008, respectively, have been included in the net gain (loss) from
discontinued operations.  In the year ended June 30, 2009, the
expenses included legal and other costs associated with the EOIR arbitration
hearing.





Research
and development





In the
years ended June 30, 2009 and 2008, the Company incurred $192,349 and $46,002,
respectively, in development expenses associated with its EARCAD, 3D scanner and
SketchArtist products.





Amortization
of intangible assets





Amortization
of intangible assets for each of the years ended June 30, 2009 and 2008 was
$324,741. Amortization expense relates to the definite-lived intangible assets
acquired in conjunction with Genex Technologies.




-10-




Operating
loss





The
operating loss for the year ended June 30, 2009 was $1,510,890. The operating
loss for the year ended June 30, 2008 was $4,160,842.





Other
(expenses) income





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





In the
year ended June 30, 2008, Technest charged to interest expense $11,329. Interest
expense attributable to loans that were paid off at the closing of the sale of
EOIR has been included in the gain (loss) on discontinued
operations.





Discontinued
Operations





The net
loss from discontinued operations was $2,209,506 in the year ended June 30, 2009
compared with a net gain of $8,997,149 in the year ended June 30, 2008. This
loss was attributable to costs incurred with the arbitration against EOIR
Holdings LLC offset by a tax benefit resulting from the Company incurring
additional expenses in the year related to the EOIR arbitration hearing that are
expected to reduce the taxable gain from the sale of EOIR. The net gain for the
year ended June 30, 2008 included costs of $5,746,501 incurred by Technest that
are associated with the discontinued operations.





The gain
from discontinued operations for the year ended June 30, 2008 includes a gain on
disposal of $14,801,367 on the sale of EOIR.





Net
income (loss) applicable to common shareholders





The net
loss applicable to common stockholders for the year ended June 30, 2009 was
($4,389,466). Included in the net loss for 2009 is a non-cash deemed dividend
of $1,386,484 related to Series D Redeemable, Convertible Preferred
Stock.





The net
income applicable to common stockholders for the year ended June 30, 2008 was
$6,843,642.





Liquidity
and Capital Resources





Cash
and Working Capital





On June
30, 2009, Technest had a positive working capital balance of $17,296,267 due
primarily to the receivable from the sale of EOIR. Our primary source of
operating cash flows was payments from our customers.  The timing of
such payments is based on the amount and timing of work performed by us or the
number of units delivered.  Our primary ongoing uses of operating cash
relate to payments to subcontractors and vendors, salaries and related expenses
and professional fees.  The timing of such payments is generally even
throughout the year.  Our vendors and subcontractors generally provide
us with normal trade payment terms.  Net cash used in operating
activities for the year ended June 30, 2009 was $881,118 compared with
$1,505,637 for the year ended June 30, 2008. Net cash used in the year ended
June 30, 2009 includes a non recurring legal settlement of $600,000. The main
drivers of working capital changes were: improvements in the collection of
receivables in the amount of $340,000 and an increase in the amounts due to
vendors and accruals of $2,442,166 which was primarily related to legal
costs incurred in connection with the arbitration hearing.





Cash
Used in Investing Activities





In the
year ended June 30, 2009, Technest used cash of $11,803 for the acquisition of
new definite-lived intangible assets representing costs associated with filing
for new patents.  The Company also sold certain of their equipment for
proceeds of $1,727 resulting in a loss on the sale of $7,531.





Cash
Used in Financing Activities





In the
year ended June 30, 2009, the Company received $820,000 related to the issuance
of its Series D Preferred Stock. These proceeds were used primarily for legal
expenses, including the Deer Creek settlement, as well as for working capital
purposes.




-11-




Sources
of Liquidity





During
the year ended June 30, 2009,the Company satisfied its
operating and investing cash requirements primarily from cash reserves and
proceeds received upon the issuance of our Series D Redeemable, Convertible
Preferred Stock.





A further
$23 million is a receivable due to the Company from the sale of EOIR in fiscal
2008. On August 21, 2009, an American Arbitration Association Panel of three
arbitrators unanimously 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.   The arbitration panel unanimously agreed with
Technest and ruled that EOIR Holdings LLC (“LLC”) breached the Purchase and Sale
Agreement and must pay the remainder of the purchase price. On August 24, 2009,
Technest filed a motion to confirm the arbitration award and for entry of
judgment in the U.S. District Court for the Eastern District of Virginia. On
September 4, 2009, LLC filed an objection to Technest’s motion to confirm the
award and for entry of judgment and entered a motion to stay the proceeding
until the resolution of the motion it filed to vacate the award in the U.S.
District Court for the District of Columbia on September 8, 2009. On September
11, 2009, at a hearing for LLC’s motion to stay the proceeding, the U.S.
District Court for the Eastern District of Virginia ordered that in the interest
of judicial economy, Technest’s motion to confirm the award and for entry of
judgment be transferred to the U.S. District Court for the District of Columbia
to be heard before the same judge that is to hear LLC’s motion to vacate the
award.  On September 20, 2009, LLC filed a superseding petition to
vacate the arbitration award in the U.S. District Court for the District of
Columbia. On September 21, 2009, Technest filed its opposition to LLC's motion
to vacate the award. As detailed in Technest's opposition, the bases for
vacating an arbitration award are extremely limited. On October 5, 2009,
Technest filed its opposition to  LLC's superseding petition to vacate
the arbitration award.




The
Company is aggressively moving forward towards the collection of this award and
expects resolution before June 30, 2010.




In
addition the Company is actively seeking to raise additional capital through a
bridge financing to finance its obligations should the contingent purchase price
not be received during the current fiscal year.




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.





Commitments
and Contingencies





Facilities





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





Legal





EOIR
Holdings LLC





In
connection with the sale of EOIR Technologies, Inc. (“EOIR”) and the dispute
over the related contingent consideration, 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.    Technest had filed a
demand for arbitration on September 24, 2008 against EOIR
Holdings  LLC (“LLC”), a portfolio company of The White Oak Guggenheim
Aerospace and Defense Fund, L.P., for breach of the Stock Purchase Agreement
(“SPA”) which the parties entered into on September 10, 2007 to effectuate the
sale of EOIR, in exchange for approximately $34 million.  Technest
alleged in its demand that  LLC breached the SPA when it failed to pay
to Technest approximately $23 million of the purchase price, which became due
upon the successful award to EOIR of the follow-on of an existing contract with
the U.S. Army’s Night Vision and Electronic Sensors Directorate
(“NVESD”).   LLC alleged that the amount was not due because the
award of the contract to EOIR did not meet the requirements for payment under
the SPA.  However, the arbitration panel unanimously agreed with
Technest and ruled that LLC breached the SPA and must pay the remainder of the
purchase price, including interest, in the amount of $23,778,403 plus additional
interest from the date of the award through date of payment.




-12-


On August
24, 2009, Technest filed a motion to confirm the arbitration award and for entry
of judgment in the U.S. District Court for the Eastern District of
Virginia.  On September 4, 2009,  LLC filed an objection to
Technest’s motion to confirm the award and for entry of judgment and entered a
motion to stay the proceeding until the resolution of the motion it filed to
vacate the award in the U.S. District Court for the District of Columbia on
September 8, 2009.  On September 11, 2009, at a hearing
for  LLC’s motion to stay the proceeding, the U.S. District Court for
the Eastern District of Virginia ordered that in the interest of judicial
economy, Technest’s motion to confirm the award and for entry of judgment be
transferred to the U.S. District Court for the District of Columbia to be heard
before the same judge that is to hear  LLC’s motion to vacate the
award.  On September 20, 2009, LLC filed a superseding petition to
vacate the arbitration award in the U.S. District Court for the District of
Columbia.  On September 21, 2009, Technest filed its opposition
to  LLC's motion to vacate the award. As detailed in Technest's
opposition, the bases for vacating an arbitration award are extremely
limited.  On October 5, 2009, Technest filed its opposition
to  LLC's superseding petition to vacate the arbitration
award.





On
February 17, 2009,  LLC filed a complaint against Technest in the U.S.
District Court for the District of Delaware.  The complaint alleges
that Technest breached the SPA when it did not pay a Net Working Capital
Adjustment to the Closing Date Purchase Price under the Agreement.  In
its answer and concurrently filed motion to stay the proceedings, Technest
maintains that the Net Working Capital Adjustment is not due
because  LLC had previously breached the SPA by failing to pay to
Technest the full purchase price for EOIR.  On April 21, 2009, the
Court granted Technest's motion to stay the proceedings pending completion of
arbitration regarding the Contingent Purchase Price issue but ordered the
parties to complete their initial disclosures to include limited discovery
regarding the calculated amount of the Net Working Capital
Adjustment.  The parties submitted their initial disclosures with the
requested discovery information on July 2, 2009.  On September 30,
2009,  LLC filed another complaint against Technest in the U.S.
District Court for the District of Delaware.  The second complaint
alleges that Technest breached the SPA by violating various representations,
warranties, and covenants that governed the conditions of the sale of EOIR
Technologies, Inc.





Off
Balance Sheet Arrangements





We have
no off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that is material to stockholders. As of June
30, 2009, Technest had warrants outstanding for the purchase of 649,286 shares
of common stock. However, due to the net share settlement provisions of these
warrants, Technest does not expect any material cash proceeds upon
exercise.





Effect
of inflation and changes in prices





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





Critical
Accounting Policies





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





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





Principles
of Consolidation and Discontinued Operation





The
consolidated financial statements include the accounts of Technest and its
wholly-owned subsidiary, Genex Technologies, Inc. Also included in the
consolidation are the results of Technest’s 49% owned subsidiary Technest, Inc.
Technest, Inc. conducts research and development in the field of computer vision
technology and Technest Holdings has the right of first refusal to commercialize
products resulting from this research and development.  The Company’s
Chief Executive Officer beneficially owns 23% of Technest, Inc. and a
former employee of the Company and current employee of Technest, Inc. owns
an additional 23%.  The remaining 5% interest is held by an unrelated third
party.  Technest, Inc. is considered a variable interest entity (VIE) for
which Technest Holdings, Inc. is the primary beneficiary.  The equity
of the non-controlling shareholders in the capital and retained earnings of
Technest, Inc. are shown separately on the liability side of the consolidated
balance sheet, between liabilities and stockholders' equity.  This
non-controlling interest is adjusted for the non-controlling shareholders'
proportionate share of Technest, Inc.’s net income and losses.  In the
event that the non-controlling interest’s portion of net losses exceeds the
carrying value of the non-controlling interest, the carrying amount will not be
reduced below zero and the Company will recognize all of the excess
losses.  Upon the return to profitable operations, net income
attributable to the Company’s interest would not be reduced for the
non-controlling interest until the Company has fully recovered the losses that
were attributable to, but not recognized for, the non-controlling interest
during the loss period.  All significant inter-company balances and
transactions have been eliminated in consolidation.




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




-13-




Concentrations





We are
subject to concentrations of credit risk because the majority of our revenues
and accounts receivable are derived from the U.S. government, including the
Department of Defense, who is not required to provide collateral for amounts
owed to us. We do not believe that we are subject to any unusual credit risks,
other than the normal level of risk attendant to operating our
business.





From time
to time we have cash balances in banks in excess of the maximum amount insured
by the FDIC.  In addition, we derive substantially all of our contract
revenue from contracts with Federal government agencies. Consequently,
substantially all of our accounts receivable are due from Federal government
agencies either directly or through other government contractors.





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





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





Impairment
of Goodwill





Goodwill consists of the excess of the
purchase price over the fair value of tangible and identifiable intangible net
assets acquired in business combinations. Statement of Financial Accounting
Standards ("SFAS") No. 142 requires us to test goodwill for impairment at
least annually at the reporting unit level in lieu of being amortized. SFAS
No. 142 requires a two-step impairment test for goodwill and intangible
assets with indefinite lives. The first step is to compare the carrying amount
of the reporting unit's net assets to the fair value of the reporting unit. If
the fair value exceeds the carrying value, no further work is required and no
impairment loss is recognized. If the carrying amount exceeds the fair value,
then the second step is required to be completed, which involves allocating the
fair value of the reporting unit to each asset and liability, with the excess
being implied goodwill. An impairment loss occurs if the amount of the recorded
goodwill exceeds the implied goodwill.





To estimate the fair value of our
reporting unit, the Company utilizes a discounted cash flow model. Other
valuation methods, such as a comparable company analysis are used to corroborate
the discounted cash flow analysis performed at the reporting unit.  In
estimating fair value, significant estimates include, but not limited to, future
revenue growth by product/service line, operating profit margins, perpetual
growth rates, weighted-average cost of capital, and market data and analysis,
including market capitalization.





The Company estimated a growth rate for
its government contract business based on historical growth rates, current
contract backlog and anticipated future contracts.  As this work
generally has low operating profit margins, the Company’s fair value estimate is
not sensitive to changes in the estimated growth rate of the government contract
business.  To estimate the growth in the Company’s 3D SketchArtist
product, the Company prepared a bottom up revenue forecast including estimates
of the number of customers acquired, quantities purchased per customer and sales
price per unit.  The Company’s revenue forecast assumes three years of
customer acquisitions with the number of customers remaining level after
that.  Sales price per unit is forecast to decline slightly each year
as customers require volume discounts and as competitive products
emerge.  If the Company’s estimate of the number of customers acquired
(and therefore quantity of units sold) or selling price per unit is decreased by
50%, the estimated fair value of the reporting unit would still exceed the
carrying value of the net assets.





Estimated
Useful Lives of Amortizable Intangible Assets





We
amortize our amortizable intangible assets over the shorter of the
contractual/legal life or the estimated economic life.





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





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




-14-




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





Impairment
of Long-Lived Assets





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





Revenue
Recognition





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





Revenues
from time and materials contracts are recognized as costs are incurred and
billed. Revenues from firm fixed price contracts are recognized on the
percentage-of-completion method, either measured based on the proportion of
costs recorded to date on the contract to total estimated contract costs or
measured based on the proportion of labor hours expended to date on the contract
to total estimated contract labor hours, as specified in the contract. Revenues
from firm fixed price contracts with payments tied to milestones are recognized
when all milestone requirements have been achieved and all other revenue
recognition criteria have been met.   Costs incurred on firm fixed
price contracts with milestone payments are recorded as work in process until
all milestone requirements have been achieved. During the year ended June 30,
2009, approximately 23% of our revenue has come from firm fixed price
contracts.




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





Receivable
from Sale of EOIR





In
connection with the sale of EOIR Technologies, Inc. (“EOIR”) and the dispute
over the related contingent consideration, 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.    Technest had filed a
demand for arbitration on September 24, 2008 against  EOIR Holdings
LLC (“LLC”), a portfolio company of The White Oak Guggenheim Aerospace and
Defense Fund, L.P., for breach of the Stock Purchase Agreement (“SPA”) which the
parties entered into on September 10, 2007 to effectuate the sale of EOIR, in
exchange for approximately $34 million.  Technest alleged in its
demand that  LLC breached the SPA when it failed to pay to Technest
approximately $23 million of the purchase price, which became due upon the
successful award to EOIR of the follow-on of an existing contract with the U.S.
Army’s Night Vision and Electronic Sensors Directorate
(“NVESD”).   LLC alleged that the amount was not due because the
award of the contract to EOIR did not meet the requirements for payment under
the SPA.  However, the arbitration panel unanimously agreed with
Technest and ruled that LLC breached the SPA and must pay the remainder of the
purchase price, including interest, in the amount of $23,778,403 plus additional
interest from the date of the award through date of payment.





On August
24, 2009, Technest filed a motion to confirm the arbitration award and for entry
of judgment in the U.S. District Court for the Eastern District of
Virginia.  On September 4, 2009,  LLC filed an objection to
Technest’s motion to confirm the award and for entry of judgment and entered a
motion to stay the proceeding until the resolution of the motion it filed to
vacate the award in the U.S. District Court for the District of Columbia on
September 8, 2009.  On September 11, 2009, at a hearing
for  LLC’s motion to stay the proceeding, the U.S. District Court for
the Eastern District of Virginia ordered that in the interest of judicial
economy, Technest’s motion to confirm the award and for entry of judgment be
transferred to the U.S. District Court for the District of Columbia to be heard
before the same judge that is to hear  LLC’s motion to vacate the
award.  On September 20, 2009,  LLC filed a superseding
petition to vacate the arbitration award in the U.S. District Court for the
District of Columbia.  On September 21, 2009, Technest filed its
opposition to  LLC's motion to vacate the award. As detailed in
Technest's opposition, the bases for vacating an arbitration award are extremely
limited.  On October 5, 2009, Technest filed its opposition
to  LLC's superseding petition to vacate the arbitration
award.




-15-




On
February 17, 2009,  LLC filed a complaint against Technest in the U.S.
District Court for the District of Delaware.  The complaint alleges
that Technest breached the SPA when it did not pay a Net Working Capital
Adjustment to the Closing Date Purchase Price under the Agreement.  In
its answer and concurrently filed motion to stay the proceedings, Technest
maintains that the Net Working Capital Adjustment is not due
because  LLC had previously breached the SPA by failing to pay to
Technest the full purchase price for EOIR.  On April 21, 2009, the
Court granted Technest's motion to stay the proceedings pending completion of
arbitration regarding the Contingent Purchase Price issue but ordered the
parties to complete their initial disclosures to include limited discovery
regarding the calculated amount of the Net Working Capital
Adjustment.  The parties submitted their initial disclosures with the
requested discovery information on July 2, 2009.  On September 30,
2009,  LLC filed another complaint against Technest in the U.S.
District Court for the District of Delaware.  The second complaint
alleges that Technest breached the SPA by violating various representations,
warranties, and covenants that governed the conditions of the sale of EOIR
Technologies, Inc.





The
Company recorded the $23 million of contingent consideration in the quarter
ended March 31, 2008 as, at that time, the Company determined that the outcome
of the contingency was determinable beyond a reasonable doubt based on having
received notification of award of the NVESD contract pending review by the Small
Business Administration.  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 accrued interest income on the
$23 million receivable is recorded as an asset and income from continuing
operations as the interest does not impact the result of the gain or loss at the
date of disposal but rather represents the consequences of management's
subsequent decisions to hold or sell the asset.





Impact
of Recently Issued Accounting Standards





In
June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles, which establishes the FASB Accounting Standards
Codification as the single source of authoritative GAAP. The Codification will
supersede all existing non-SEC accounting and reporting standards.  As a
result, upon adoption, all references to accounting literature in our SEC
filings will conform to the appropriate reference within the Codification. This
statement is effective for financial statements issued for interim and annual
periods ending after September 15, 2009.  The Company is required to
adopt SFAS No. 168 on September 30, 2009, and it does not expect the adoption of
this standard to have an impact on its financial position or results of
operations.





In April
2009, the FASB issued Staff Position No. FAS 107-1 and APB 28-1, Interim Disclosures About Fair Value
of Financial Instruments, (“FSP 107-1 and APB 28-1”), which amends FASB
SFAS No.107, Disclosures about
Fair Value of Financial Instruments, to require disclosures about fair
value of financial instruments for interim reporting periods of publicly traded
companies as well as in annual financial statements.  This FSP also
amends APB Opinion No. 28, Interim Financial Reporting,
to require these disclosures in summarized financial information for interim
reporting periods. This FSP was effective for interim and annual periods ending
after June 15, 2009.  The adoption of FSP FAS 107-1 and APB 28-1 did
not have a material impact on the Company’s consolidated financial
statements.





In June
2008, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 07-5
(“EITF 07-5”), Determining
Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity's Own
Stock.  EITF 07-5 provides that an entity should use a two-step
approach to evaluate whether an equity-linked financial instrument (or embedded
feature) is indexed to its own stock, including evaluating the instrument's
contingent exercise and settlement provisions.   EITF 07-5 is effective for
fiscal years beginning after December 15, 2008.  The consensus must be
applied to outstanding instruments as of the beginning of the fiscal year in
which the consensus is adopted and should be treated as a cumulative-effect
adjustment to the opening balance of retained earnings.  Early
adoption is not permitted.  The Company does not expect the adoption
of EITF 07-5 to have a material impact on the Company’s consolidated financial
statements.





In
April 2008, the FASB issued FASB Staff Position Financial Accounting
Standard 142-3 (“FSP FAS 142-3”), Determination of the Useful Life of
Intangible Assets.  FSP FAS 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS
No. 142, Goodwill and
Other Intangible Assets.  The intent of this FSP is to improve
the consistency between the useful life of a recognized intangible asset under
SFAS No. 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141 (revised 2007), Business Combinations, and
other GAAP.  This statement is effective for fiscal years beginning on
or after December 15, 2008, and interim periods within those
years.  Early application is not permitted.  The Company
does not expect the adoption of this standard to have a material impact on its
consolidated results of operations and financial condition.





In April
2008, the FASB issued FSP Accounting Principles Board 14-1 (“FSP APB 14-1”),
Accounting for Convertible
Debt Instruments That May be Settled in Cash upon Conversion (Including Partial
Settlement).  FSP APB 14-1 requires the issuer of certain
convertible debt instruments that may be settled in cash (or other assets) on
conversion to separately account for the liability (debt) and equity (conversion
option) components of the instrument in a manner that reflects the issuer’s
nonconvertible debt borrowing rate.  FSP APB 14-1 is effective for
fiscal years beginning after December 15, 2008, and on a retroactive
basis.  The Company is evaluating the potential impact, if any, of the
adoption of FSP APB 14-1 on its consolidated results of operations and financial
condition.





-16-




In March
2008, the FASB issued SFAS No. 161,Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB statement No. 133
(SFAS No. 161).  SFAS No. 161 requires enhanced
disclosures regarding an entity’s derivative instruments and related hedging
activities.  These enhanced disclosures include information regarding how
and why an entity uses derivative instruments; how derivative instruments and
related hedge items are accounted for under SFAS No. 133,Accounting for Derivative
Instruments and Hedging Activities, and its related interpretations;
and how derivative instruments and related hedge items affect an entity’s
financial position, financial performance, and cash flows.  SFAS
No. 161 is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008.  The adoption of
SFAS No. 161 will not have a material impact on the Company’s consolidated
results of operations and financial condition.




In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations, which
replaces SFAS No. 141, Business
Combinations.  The statement retains the purchase method of
accounting for acquisitions but requires a number of changes, including changes
in the way assets and liabilities are recognized in the purchase
accounting.  It also changes the recognition of assets acquired and
liabilities assumed arising from contingencies, requires the capitalization of
in-process research and development at fair value, and requires the expensing of
acquisition-related costs as incurred. SFAS No. 141(R) is effective for the
Company beginning July 1, 2009, and will apply prospectively to business
combinations completed on or after that date.  The Company does not
expect the adoption of this standard to have a material impact on the Company’s
consolidated results of operations and financial condition.





In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities.  SFAS 159 provides companies
with an option to report selected financial assets and liabilities at fair
value.  The standard’s objective is to reduce both the complexity in
accounting for financial instruments and the volatility in earnings caused by
measuring related assets and liabilities differently.  SFAS
No. 159 also establishes presentation and disclosure requirements designed
to facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities.  The Company
adopted SFAS No. 159 effective July 1, 2008, but has not elected to measure
any permissible items at fair value.  As a result, the adoption of
this statement did not have a material impact on its consolidated financial
statements.





In
September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements.  This Statement defines fair value, establishes a
framework for measuring fair value in accordance with GAAP, and expands
disclosures about fair value measurements.  The definition of fair value
retains the exchange price notion in earlier definitions of fair value.
 This Statement clarifies that the exchange price is the price in an
orderly transaction between market participants to sell the asset or transfer
the liability in the market in which the reporting entity would transact for the
asset or liability, that is, the principal or most advantageous market for the
asset or liability.  Emphasis is placed on fair value being a market-based
measurement, not an entity-specific measurement; and therefore, a fair value
measurement should be determined based on the assumptions that market
participants would use in pricing the asset or liability.  As a basis for
considering these market participant assumptions, a fair value hierarchy has
been established to distinguish between (1) market participant assumptions
developed based on market data obtained from sources independent of the
reporting entity (observable inputs) and (2) the reporting entity’s own
assumptions about market participant assumptions developed based on the best
information available in the circumstances (unobservable inputs).  In
February 2008, the FASB issued a Staff Position which delays the effective date
of SFAS No. 157 for non-financial assets and non-financial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis, to fiscal years beginning after
November 15, 2008.  The Company adopted this statement, except
for items covered by the Staff Position, as of July 1, 2008; and the
adoption did not have a material impact on its consolidated results of
operations and financial condition.





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of Accounting Research Bulletin
(ARB) No. 51.  This Statement amends ARB No. 51 to establish
accounting and reporting standards for the noncontrolling interest in a
subsidiary and for the deconsolidation of a subsidiary.  It clarifies
that a noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements.  This Statement is effective for fiscal years
beginning on or after December 15, 2008 and the Company is in the process of
evaluating the impacts of adopting SFAS No. 160 which will become effective for
the Company on July 1, 2009 and will impact the recording of the Technest, Inc.
minority interest.




Subsequent
Events





-17-





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
August 21, 2009, Technest was awarded $23,778,403 by an American Arbitration
Association panel for the breach by EOIR Holdings LLC of the Stock Purchase
Agreement dated September 10, 2007 for the sale of EOIR Technologies,
Inc.   EOIR Holdings LLC has petitioned to vacate the
award.  If the award is vacated or not paid, Technest’s financial
condition will be significantly harmed.





In
connection with the sale of EOIR Technologies, Inc. (“EOIR”) and the dispute
over the related contingent consideration, 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.    Technest had filed a
demand for arbitration on September 24, 2008 against EOIR Holdings LLC (“LLC), a
portfolio company of The White Oak Guggenheim Aerospace and Defense Fund, L.P.,
for breach of the Stock Purchase Agreement (“SPA”) which the parties entered
into on September 10, 2007 to effectuate the sale of EOIR, in exchange for
approximately $34 million.  Technest alleged in its demand
that  LLC breached the SPA when it failed to pay to Technest
approximately $23 million of the purchase price, which became due upon the
successful award to EOIR of the follow-on of an existing contract with the U.S.
Army’s Night Vision and Electronic Sensors Directorate
(“NVESD”).   LLC alleged that the amount was not due because the
award of the contract to EOIR did not meet the requirements for payment under
the SPA.  However, the arbitration panel unanimously agreed with
Technest and ruled that  LLC breached the SPA and must pay the
remainder of the purchase price, including interest, in the amount of
$23,778,403 plus interest from the date of the award through date of
payment.





On August
24, 2009, Technest filed a motion to confirm the arbitration award and for entry
of judgment in the U.S. District Court for the Eastern District of
Virginia.  On September 4, 2009,  LLC filed an objection to
Technest’s motion to confirm the award and for entry of judgment and entered a
motion to stay the proceeding until the resolution of the motion it filed to
vacate the award in the U.S. District Court for the District of Columbia on
September 8, 2009.  On September 11, 2009, at a hearing
for  LLC’s motion to stay the proceeding, the U.S. District Court for
the Eastern District of Virginia ordered that in the interest of judicial
economy, Technest’s motion to confirm the award and for entry of judgment be
transferred to the U.S. District Court for the District of Columbia to be heard
before the same judge that is to hear  LLC’s motion to vacate the
award.  On September 20, 2009,  LLC filed a superseding
petition to vacate the arbitration award in the U.S. District Court for the
District of Columbia.  On September 21, 2009, Technest filed its
opposition to  LLC's motion to vacate the award. As detailed in
Technest's opposition, the bases for vacating an arbitration award are extremely
limited. On October 5, 2009, Technest filed its opposition to  LLC's
superseding petition to vacate the arbitration award. If, however, the award
were to be vacated or 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 June 30, 2009,
our accumulated deficit was approximately $16 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.




-18-




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.





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





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





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





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





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





·
            retaining
      key employees.





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





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





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





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





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





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





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





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





-19-


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





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





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





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





·
            our
      success in winning competitions for
orders;





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





·
            the
      mix of products we sell;





·
            competitive
      pricing pressures; and





·
            general
      economic climate.





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





Risks
Related to Contracting with the United States Government





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





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





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





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





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





·
            changes
      in Government programs or
requirements;




-20-






·
            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 September 23, 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.





-21-




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.





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;





-22-





(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 September 2009, the trading price
of our common stock ranged from a low price of $0.05 per share to a high price
of $11.35 per share. Many factors may cause the market price of our common stock
to fluctuate, including:





·
            variations
      in our quarterly results of
operations;





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





·
            acquisitions
      or strategic alliances involving us or our
  competitors;





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





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





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





-23-





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.







-24-





Item
8.  Financial Statements




TECHNEST
HOLDINGS, INC.


CONSOLIDATED
FINANCIAL STATEMENTS





INDEX





Page
      NumberTechnest
      Holdings, Inc. and SubsidiariesYears
      ended June 30, 2009 and 2008Report
      of Independent Registered Public Accounting Firm
            F-2Consolidated
      Balance Sheets
            F-3Consolidated
      Statements of Operations
            F-5Consolidated
      Statements of Changes in Stockholders’ Equity
            F-6Consolidated
      Statements of Cash Flows
            F-8Notes
      to Consolidated Financial Statements
            F-10











F-1








REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors


Technest
Holdings, Inc. and Subsidiaries


Bethesda,
Maryland





We have
audited the accompanying consolidated balance sheets of Technest Holdings, Inc.
and subsidiaries as of June 30, 2009 and 2008 and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for the
years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.





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





In our
opinion, the financial statements referred to above present fairly, in all
material respects the financial position of Technest Holdings, Inc. and
subsidiaries as of June 30, 2009 and 2008, and the results of its operations and
its cash flows for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.





As
discussed in Note 1 to the financial statements, subsequent to year end an
arbitration panel awarded the Company approximately $24 million related to a
dispute over contingent consideration previously recorded by the Company in
conjunction with the sale of EOIR Technologies, Inc.  There continues
to be ongoing litigation related to this matter and the successful outcome of
this litigation is critical to the Company’s ultimate receipt of this contingent
consideration.








/s/ Wolf
& Company, P.C.





Boston,
Massachusetts


October
13, 2009







F-2





TECHNEST
      HOLDINGS, INC.CONSOLIDATED
      BALANCE SHEETSJUNE
      30, 2009 AND 20082009
            
            
            2008ASSETSCurrent
      AssetsCash
      and cash equivalents
            
            $
            5,567
            
            
            $
            76,761Accounts
      receivables
            
            
            260,381
            
            
            
            600,908Unbilled
      receivables
            
            
            -
            
            
            
            23,888Inventory
      and work in process
            
            
            26,745
            
            
            
            36,542Restricted
      cash
            
            
            216,697
            
            
            
            237,288Prepaid
      expenses and other current assets
            
            
            750,013
            
            
            
            125,900Assets
      related to discontinued operations
            
            
            22,948,333
            
            
            
            22,948,333Total
      Current Assets
            
            
            24,207,736
            
            
            
            24,049,620Property and Equipment–
      Net of accumulated depreciation $94,703 and $109,467
            
            
            37,363
            
            
            
            78,413Other
      AssetsDeposits
            
            
            28,525
            
            
            
            28,525Definite-lived
      intangible assets – Net of accumulated amortization $1,420,740 and
      $1,095,999
            
            
            322,173
            
            
            
            635,111Goodwill
            
            
            4,876,038
            
            
            
            4,876,038Total
      Other Assets
            
            
            5,226,736
            
            
            
            5,539,674Total
      Assets
            
            $
            29,471,835
            
            
            $
            29,667,707LIABILITIES,
      REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITYCurrent
      LiabilitiesAccounts
      payable
            
            $
            745,159
            
            
            $
            379,710Accrued
      expenses and other current liabilities
            
            
            626,381
            
            
            
            1,075,291Liabilities
      related to discontinued operations
            
            
            5,246,838
            
            
            
            2,721,211Accrued
      income taxes
            
            
            293,091
            
            
            
            127,000Deferred
      tax liability
            
            
            -
            
            
            
            732,000Total
      Current Liabilities
            
            
            6,911,469
            
            
            
            5,035,212Total
      Liabilities
            
            
            6,911,469
            
            
            
            5,035,212








(Continued)


F-3




TECHNEST
      HOLDINGS, INC.CONSOLIDATED
      BALANCE SHEETSJUNE
      30, 2009 AND 2008
              (concluded)  2009
              
              
              2008




Commitments
      and ContingenciesNon
      Controlling Interest
            
            
            -
            
            
            
            -Series
      D Redeemable, Convertible Preferred Stock - $.0001 par
    value;3,000
      shares authorized; 1,640 and 0 shares issued and outstanding at June 30,
      2009 and2008,
      respectively (preference in liquidation of  $1,690,483 at June
      30, 2009)
            
            
            1,690,483
            
            
            
            -Stockholders’
      EquitySeries
      A Convertible Preferred Stock - $.001 par value; 150 shares
      authorized;64.325
      shares issued and outstanding (preference in liquidation
of$64,325
      at June 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 June 30, 2009)
            
            
            402
            
            
            
            402Common
      stock - par value $.001 per share; 495,000,000 shares
      authorized;20,676,211
      and 20,505,335 shares issued and outstanding
            
            
            20,675
            
            
            
            20,504Additional
      paid-in capital
            
            
            37,032,781
            
            
            
            37,792,582Accumulated
      deficit
            
            
            (16,183,975
            )
            
            
            (13,180,993
            )Total
      Stockholders’ Equity
            
            
            20,869,883
            
            
            
            24,632,495Total
      Liabilities, Redeemable Preferred Stock and Stockholders’
      Equity
            
            $
            29,471,835
            
            
            $
            29,667,707








See notes
to consolidated financial statements.






F-4





TECHNEST
      HOLDINGS, INC.CONSOLIDATED
      STATEMENTS OF OPERATIONSFOR
      THE YEARS ENDED JUNE 30, 2009 AND 20082009
            
            
            2008Revenues
            
            $
            2,482,726
            
            
            $
            2,469,085Cost
      of Revenues
            
            
            1,333,896
            
            
            
            1,390,527Gross
      Profit
            
            
            1,148,830
            
            
            
            1,078,558Operating
      ExpensesSelling,
      general and administrative
            
            
            2,142,630
            
            
            
            4,868,657Research
      and development
            
            
            192,349
            
            
            
            46,002Amortization
      of intangible assets
            
            
            324,741
            
            
            
            324,741Total
      Operating Expenses
            
            
            2,659,720
            
            
            
            5,239,400Operating
      Loss from Continuing Operations
            
            
            (1,510,890
            )
            
            
            (4,160,842
            )Other
      Income (Expenses), NetOther
      income (expense)
            
            
            (4,657
            )
            
            
            7,664Interest
      income
            
            
            722,071
            
            
            
            -Interest
      expense
            
            
            -
            
            
            
            (11,329
            )Total
      Other Income (Expenses), Net
            
            
            717,414
            
            
            
            (3,665
            )Loss
      from Continuing Operations Before Non-controlling Interest
            
            
            (793,476
            )
            
            
            (4,164,507
            )Non-controlling
      interest in net loss of subsidiary
            
            
            -
            
            
            
            -Net
      Loss from Continuing Operations Before Income Taxes
            
            
            (793,476
            )
            
            
            (4,164,507
            )Income
      tax (provision) benefit
            
            
            -
            
            
            
            2,011,000Net
      Loss from Continuing Operations
            
            
            (793,476
            )
            
            
            (2,153,507
            )Discontinued
      Operations(Loss)
      gain from discontinued operations (including(loss)
      gain on disposal of ($2,775,415) and $14,801,367 duringthe
      years ended June 30, 2009 and 2008, respectively)
            
            
            (2,775,415
            )
            
            
            11,867,149Income
      tax benefit (provision)
            
            
            565,909
            
            
            
            (2,870,000
            )(Loss)
      gain on discontinued operations
            
            
            (2,209,506
            )
            
            
            8,997,149Net
      (Loss) Income
            
            
            (3,002,982
            )
            
            
            6,843,642Deemed
      Dividend to Preferred Stockholders - Series D
            
            
            1,386,484
            
            
            
            -Net
      (Loss) Income Applicable to Common Shareholders
            
            $
            (4,389,466
            )
            
            $
            6,843,642Basic
      and Diluted Income (Loss) Per Common ShareFrom
      continuing operations
            
            $
            (0.04
            )
            
            $
            (0.11
            )From
      discontinued operations
            
            $
            (0.11
            )
            
            $
            0.46Net
      Income (Loss) Per Share - Basic and Diluted
            
            $
            (0.15
            )
            
            $
            0.35Basic
      and Diluted Income (Loss) Applicable to Common
              Shareholders
      per Common Share - Basic and Diluted
            
            $
            (0.21
            )
            
            $
            0.35Weighted
      Average Number of Common Shares OutstandingBasic
      and diluted
            
            
            20,662,486
            
            
            
            19,752,017





See notes
to consolidated financial statements.


F-5





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY


FOR
THE YEARS ENDED JUNE 30, 2009 AND 2008








Series
      A
            
            
            Series
      CConvertible
            
            
            ConvertibleCommon
      stock
            
            
            Preferred
      stock
            
            
            Preferred
      stockShares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalance
      - July 1, 2007
            
            
            16,878,451
            
            
            $
            16,877
            
            
            
            64
            
            
            $
            -
            
            
            
            632,185
            
            
            $
            632Stock
      issued in connection with termination ofstockholder
      and license agreement
            
            
            3,000,000
            
            
            
            3,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Issuance
      and amortization of stock-basedcompensation
      related to restricted stock grants
            
            
            397,000
            
            
            
            397
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Stock
      issued in connection with conversion ofSeries
      C Convertible Preferred Stock
            
            
            229,884
            
            
            
            230
            
            
            
            -
            
            
            
            -
            
            
            
            (229,884
            )
            
            
            (230
            )Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Balance
      - June 30, 2008
            
            
            20,505,335
            
            
            $
            20,504
            
            
            
            64
            
            
            
            -
            
            
            
            402,301
            
            
            
            402Issuance
      and amortization of stock-basedcompensation
      related to restricted stock grants
            
            
            170,876
            
            
            
            171
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Accretion
      of Series D redeemable convertiblepreferred
      stock to redemption value
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Beneficial
      conversion feature on  Series Dredeemable
      convertible preferred stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Accretion
      of dividend on Series Dredeemable
      convertible preferred stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Balance
      - June 30, 2009
            
            
            20,676,211
            
            
            $
            20,675
            
            
            
            64
            
            
            $
            -
            
            
            
            402,301
            
            
            $
            402





See notes
to consolidated financial statements.





(continued)


F-6





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY


FOR
THE YEARS ENDED JUNE 30, 2009 AND 2008 (concluded)








Additional
            
            
            
            
            
            TotalPaid-In
            
            
            Accumulated
            
            
            Stockholders'Capital
            
            
            Deficit
            
            
            EquityAmount
            
            
            Amount
            
            
            AmountBalance
      - July 1, 2007
            
            $
            36,115,030
            
            
            $
            (20,024,635
            )
            
            $
            16,107,904Stock
      issued in connection with termination ofstockholder
      and license agreement
            
            
            1,377,000
            
            
            
            -
            
            
            
            1,380,000Issuance
      and amortization of stock-basedcompensation
      related to restricted stock grants
            
            
            300,552
            
            
            
            -
            
            
            
            300,949Stock
      issued in connection with conversion ofSeries
      C Convertible Preferred Stock
            
            
            -
            
            
            
            -
            
            
            
            -Net
      income
            
            
            -
            
            
            
            6,843,642
            
            
            
            6,843,642Balance
      - June 30, 2008
            
            
            37,792,582
            
            
            
            (13,180,993
            )
            
            
            24,632,495Issuance
      and amortization of stock-basedcompensation
      related to restricted stockgrants
            
            
            110,683
            
            
            
            -
            
            
            
            110,854Accretion
      of Series D redeemable convertiblepreferred
      stock to redemption value
            
            
            (1,336,000
            )
            
            
            -
            
            
            
            (1,336,000
            )Beneficial
      conversion feature on  Series Dredeemable
      convertible preferred stock
            
            
            516,000
            
            
            
            -
            
            
            
            516,000Accretion
      of dividend on Series Dredeemable
      convertible preferred stock
            
            
            (50,484
            )
            
            
            -
            
            
            
            (50,484
            )Net
      loss
            
            
            -
            
            
            
            (3,002,982
            )
            
            
            (3,002,982
            )Balance
      - June 30, 2009
            
            $
            37,032,781
            
            
            $
            (16,183,975
            )
            
            $
            20,869,883





See notes
to consolidated financial statements.








F-7





TECHNEST
      HOLDINGS, INC.CONSOLIDATED
      STATEMENTS OF CASH FLOWSFOR
      THE YEARS ENDED JUNE 30, 2009 AND
2008





2009
            
            
            2008Cash
      Flows From Operating Activities:Net
      (loss) income
            
            $
            (3,002,982
            )
            
            $
            6,843,642Adjustment
      to reconcile net (loss) income to net cash used inoperating
      activities:Depreciation
      and amortization of property and equipment
            
            
            31,791
            
            
            
            44,740Amortization
      of intangible assets
            
            
            324,741
            
            
            
            324,741Non-cash
      interest expense
            
            
            -
            
            
            
            1,538,276Stock-based
      compensation to employees and directors
            
            
            110,854
            
            
            
            300,949Stock
      issued in connection with termination of stockholderand license
    agreement
            
            
            -
            
            
            
            1,380,000Loss
      on disposal of equipment
            
            
            7,531
            
            
            
            -Loss
      (gain) on disposal of discontinued operations
            
            
            2,775,415
            
            
            
            (14,801,367
            )Deferred
      income tax (benefit) expense
            
            
            (732,000
            )
            
            
            859,000Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            340,527
            
            
            
            8,778,975Unbilled
      receivables
            
            
            23,888
            
            
            
            1,491,671Inventory
            
            
            9,797
            
            
            
            (25,289
            )Restricted
      cash
            
            
            20,591
            
            
            
            (237,288
            )Deposits
      and prepaid expenses and other current assets
            
            
            (624,113
            )
            
            
            118,667Accounts
      payable
            
            
            365,449
            
            
            
            (7,892,053
            )Unearned
      revenue
            
            
            -
            
            
            
            (267,309
            )Accrued
      expenses and other current liabilities
            
            
            (698,698
            )
            
            
            327,044Accrued
      income taxes
            
            
            166,091
            
            
            
            -Due
      to related parties
            
            
            -
            
            
            
            (290,036
            )Net Cash Used In Operating
      Activities
            
            
            (881,118
            )
            
            
            (1,505,637
            )Cash
      Flows From Investing Activities:Proceeds
      from sale of equipment
            
            
            1,727
            
            
            
            (41,838
            )Proceeds
      from disposal of discontinued operations, net of transaction
      costs
            
            
            -
            
            
            
            10,269,615Acquisition
      of new definite-lived intangible assets
            
            
            (11,803
            )
            
            
            -Net Cash (Used In) Provided by
      Investing Activities
            
            
            (10,076
            )
            
            
            10,227,777








(continued)


F-8




TECHNEST
      HOLDINGS, INC.CONSOLIDATED
      STATEMENTS OF CASH FLOWSFOR
      THE YEARS ENDED JUNE 30, 2009 AND 2008
  (concluded)





Cash
      Flows From Financing Activities:Proceeds
      from issuance of Series D Redeemable, Convertible Preferred
      Stock
            
            
            820,000
            
            
            
            -Repayment
      of revolving line of credit, net
            
            
            -
            
            
            
            (4,562,809
            )Repayment
      of term loan
            
            
            -
            
            
            
            (2,166,667
            )Repayment
      of notes payable
            
            
            -
            
            
            
            (3,056,130
            )Net
      Cash Provided by (Used In) Financing Activities
            
            
            820,000
            
            
            
            (9,785,606
            )Net
      Decrease In Cash
            
            
            (71,194
            )
            
            
            (1,063,466
            )Cash and Cash Equivalents -
      Beginning of Period -including $0 and
              $1,028,539,
      respectively, of cash related to discontinued operations
            
            
            76,761
            
            
            
            1,140,227Cash
      and Cash Equivalents - End of Period
            
            $
            5,567
            
            
            $
            76,761Supplemental
      Disclosures Of Cash Flow Information:Cash
      paid during the periods for:Interest
            
            $
            -
            
            
            $
            1,329,411Taxes
            
            $
            -
            
            
            $
            -Non-Cash
      Investing and Financing Activities:Beneficial
      conversion on Series D Redeemable, Convertible Preferred
    Stock
            
            $
            516,000
            
            
            $
            -Accretion
      of Series D Redeemable, Convertible Preferred Stock to redemption
      value
            
            $
            1,336,000
            
            
            $
            -Accrued
      dividend on Series D Redeemable, Convertible Preferred
    Stock
            
            $
            50,484
            
            
            $
            -





See notes
to consolidated financial statements










F-9





TECHNEST
HOLDINGS INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2009 AND 2008





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.





In
connection with the sale of EOIR Technologies, Inc. (“EOIR”) and the dispute
over the related contingent consideration (see Note 3), 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.  Technest had
filed a demand for arbitration on September 24, 2008 against EOIR Holdings LLC
(“LLC”), a portfolio company of The White Oak Guggenheim Aerospace and Defense
Fund, L.P., for breach of the Stock Purchase Agreement (“SPA”) which the parties
entered into on September 10, 2007 to effectuate the sale of EOIR, in exchange
for approximately $34 million.  Technest alleged in its demand that
LLC breached the SPA when it failed to pay to Technest approximately $23 million
of the purchase price, which became due upon the successful award to EOIR of the
follow-on of an existing contract with the U.S. Army’s Night Vision and
Electronic Sensors Directorate.  LLC alleged that the amount was not
due because the award of the contract to EOIR did not meet the requirements for
payment under the SPA.  However, the arbitration panel unanimously
agreed with Technest and ruled that LLC breached the SPA and must pay the
remainder of the purchase price, including interest, in the amount of
$23,778,403 plus interest from the date of the award through date of
payment.





On August
24, 2009, Technest filed a motion to confirm the arbitration award and for entry
of judgment in the U.S. District Court for the Eastern District of
Virginia.  On September 4, 2009, LLC filed an objection to Technest’s
motion to confirm the award and for entry of judgment and entered a motion to
stay the proceeding until the resolution of the motion it filed to vacate the
award in the U.S. District Court for the District of Columbia on September 8,
2009.  On September 11, 2009, at a hearing for LLC’s motion to stay
the proceeding, the U.S. District Court for the Eastern District of Virginia
ordered that in the interest of judicial economy, Technest’s motion to confirm
the award and for entry of judgment be transferred to the U.S. District Court
for the District of Columbia to be heard before the same judge that is to hear
LLC’s motion to vacate the award.  On September 20, 2009, LLC filed a
superseding petition to vacate the arbitration award in the U.S. District Court
for the District of Columbia.  On September 21, 2009, Technest filed
its opposition to LLC's motion to vacate the award. As detailed in Technest's
opposition, the bases for vacating an arbitration award are extremely limited.
On October 5, 2009, Technest filed its opposition to LLC's superseding petition
to vacate the arbitration award.





On
February 17, 2009, LLC filed a complaint against Technest in the U.S. District
Court for the District of Delaware.  The complaint alleges that
Technest breached the SPA when it did not pay a Net Working Capital Adjustment
to the Closing Date Purchase Price under the Agreement.  In its answer
and concurrently filed motion to stay the proceedings, Technest maintains that
the Net Working Capital Adjustment is not due because LLC had previously
breached the SPA by failing to pay to Technest the full purchase price for
EOIR.  On April 21, 2009, the Court granted Technest's motion to stay
the proceedings pending completion of arbitration regarding the Contingent
Purchase Price issue but ordered the parties to complete their initial
disclosures to include limited discovery regarding the calculated amount of the
Net Working Capital Adjustment.  The parties submitted their initial
disclosures with the requested discovery information on July 2,
2009.  On September 30, 2009,  LLC filed another complaint
against Technest in the U.S. District Court for the District of
Delaware.  The second complaint alleges that Technest breached the SPA
by violating various representations, warranties, and covenants that governed
the conditions of the sale of EOIR Technologies, Inc.




F-10


2. 
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Basis
of Presentation





The
consolidated financial statements include the accounts of Technest and its
wholly-owned subsidiary, Genex Technologies, Inc.  Also included in
the consolidation are the results of Technest’s 49% owned subsidiary Technest,
Inc. (see Note 4).  Technest, Inc. conducts research and development
in the field of computer vision technology and the Company has the right of
first refusal to commercialize products resulting from this research and
development.  The Company’s Chief Executive Officer beneficially owns
23% of Technest, Inc. and a former employee of the Company and current
employee of Technest, Inc. owns an additional 23%.  The remaining 5%
interest is held by an unrelated third party.  Technest, Inc. is
considered a variable interest entity (VIE) for which the Company is the primary
beneficiary.   As Technest, Inc.’s formation coincided with its
consolidation with the Company, Technest, Inc. did not have any material assets,
liabilities or non-controlling interests upon initial
measurement.  The Company initially measured any assets transferred by
the Company to Technest, Inc. at the same amounts at which the assets and
liabilities would have been measured if they had not been
transferred.   No gain or loss was recognized as a result of such
transfers.  The equity of the non-controlling shareholders in the
capital and retained earnings of Technest, Inc. are shown separately on the
liability side of the consolidated balance sheet, between liabilities and
stockholders' equity.  This non-controlling interest is adjusted for
the non-controlling shareholders' proportionate share of Technest, Inc.’s net
income and losses.  In the event that the non-controlling interest’s
portion of net losses exceeds the carrying value of the non-controlling
interest, the carrying amount will not be reduced below zero and the Company
will recognize all of the excess losses.  Upon the return to
profitable operations, net income attributable to the Company’s interest would
not be reduced for the non-controlling interest until the Company has fully
recovered the losses that were attributable to, but not recognized for, the
non-controlling interest during the loss period.  All significant
inter-company balances and transactions have been eliminated in
consolidation.





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





Use of
Estimates





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





Reclassification





Certain
amounts in the 2008 financial statements have been reclassified to conform with
the 2009 presentation.





Concentrations and
Risks





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





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





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





Cash and Cash
Equivalents





The
Company considers all highly liquid investments with maturities of ninety days
or less to be cash equivalents. The company had no cash equivalents as of June
30, 2009.





Restricted
cash represents amounts held in an escrow account related to the sale of EOIR
and a certificate of deposit securing a Company credit card.  The
certificate of deposit is recorded at cost plus accumulated interest earned at
1.75%.





Accounts
Receivable





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





F-11


A
significant portion of the Company's receivables are due from government
contracts, either directly or as a subcontractor. The Company has not
experienced any material losses in accounts receivable related to these
contracts and has provided no allowance at June 30, 2009 and 2008. If management
determines amounts to be uncollectible, they will be charged to operations when
that determination is made.





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





Inventory and Work in
Process





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





Property and
Equipment





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





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





Software
            
            
            3
      yearsComputer
      equipment
            
            
            3
      yearsFurniture
      and fixtures
            
            
            5
      years





Property
and equipment consisted of the following at June 30, 2009 and 2008:





2009
              
              
              2008Software
              
              $
              11,242
              
              
              $
              49,940Computer
      equipment
              
              
              26,655
              
              
              
              26,655Furniture
      and fixtures
              
              
              94,169
              
              
              
              111,285132,066
              
              
              
              187,880Less
      accumulated depreciation
              
              
              (94,703
              )
              
              
              (109,467
              )$
              37,363
              
              
              $
              78,413





Depreciation
expense from continuing operations for the years ended June 30, 2009 and 2008
was $31,791 and $44,740, respectively.





Definite-lived Intangible
Assets





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





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





Redeemable Preferred
Stock





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




F-12


Fair Value of Financial
Instruments





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





Unless
otherwise indicated, the fair values of financial instruments approximate their
carrying amounts. By their nature, all financial instruments involve risk,
including credit risk for non-performance by counterparties. The maximum
potential loss may exceed any amounts recognized in the consolidated balance
sheet.





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





Operating
Segments





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





Revenue
Recognition





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





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





Revenues
from firm fixed price contracts are recognized on the percentage-of-completion
method, either measured based on the proportion of costs recorded to date on the
contract to total estimated contract costs or measured based on the proportion
of labor hours expended to date on the contract to total estimated contract
labor hours, as specified in the contract. Revenues from firm fixed price
contracts with payments tied to milestones are recognized when all milestone
requirements have been achieved and all other revenue recognition criteria have
been met.  Currently, payments under all firm fixed price contracts
are due upon delivery of the underlying products.





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





Shipping
Costs





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





Research and
Development





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





Income
Taxes





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





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





F-13


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





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





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





Income (Loss) Per
Share





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





Common
stock equivalents, consisting of Series A and C Preferred Stock, Series D
Redeemable, Convertible Preferred Stock and warrants were not included in the
calculation of the diluted loss per share for the year ended June 30, 2009 and
2008 because their inclusion would have had the effect of decreasing the net
loss from continuing operations per share otherwise computed (see Note
9).





Goodwill and
Impairment





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





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





During
the years ended June 30, 2009 and 2008 and subsequent to year-end, the Company's
stock price and its market capitalization continued to be volatile due to the
limited trading volume in the stock, the current economic environment and
overall volatility in the stock market, especially for micro capitalization
stocks.  At June 30, 2009, the Company's market capitalization was
less than its book value. As described above, the Company utilizes a discounted
cash flow analysis for the reporting unit containing the goodwill as its
principal valuation method, but also considers market transactions and market
capitalization in its evaluation of recoverability of goodwill. The Company
considered and evaluated the fluctuation in market capitalization as well as the
other factors described above, and concluded that its goodwill balance of
approximately $4.9 million at June 30, 2009 continues to be recoverable. The
Company will continue to monitor the need to test our intangibles for impairment
as required, including considering the uncertainty surrounding the current
economic environment, changes in estimates of future cash flows, volatility in
the stock market, as well as in the Company's own stock price in assessing
goodwill recoverability.




F-14


Impairment of Long-Lived
Assets





The
Company continually monitors events and changes in circumstances that could
indicate carrying amounts of long-lived assets may not be recoverable. An
impairment loss is recognized when expected cash flows are less than the asset's
carrying value. Accordingly, when indicators of impairment are present, the
Company evaluates the carrying value of such assets in relation to the operating
performance and future undiscounted cash flows of the underlying assets.
Technest’s policy is to record an impairment loss when it is determined that the
carrying amount of the asset may not be recoverable. The Company tested its
long-lived assets for impairment and no impairment charges were recorded in the
years ended June 30, 2009 and 2008.





Stock-Based
Compensation





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





Recent Accounting
Pronouncements





In
June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles, which establishes the FASB Accounting Standards
Codification as the single source of authoritative GAAP. The Codification will
supersede all existing non-SEC accounting and reporting standards.  As a
result, upon adoption, all references to accounting literature in the Company’s
SEC filings will conform to the appropriate reference within the Codification.
This statement is effective for financial statements issued for interim and
annual periods ending after September 15, 2009.  The Company is
required to adopt SFAS No. 168 on September 30, 2009, and does not expect the
adoption to have an impact on its financial position or results of
operations.





In April
2009, the FASB issued Staff Position No. FAS 107-1 and APB 28-1, Interim Disclosures About Fair Value
of Financial Instruments, (“FSP 107-1 and APB 28-1”), which amends FASB
SFAS No.107, Disclosures about
Fair Value of Financial Instruments, to require disclosures about fair
value of financial instruments for interim reporting periods of publicly traded
companies as well as in annual financial statements.  This FSP also
amends APB Opinion No. 28, Interim Financial Reporting,
to require these disclosures in summarized financial information for interim
reporting periods. This FSP was effective for interim and annual periods ending
after June 15, 2009.  The adoption of FSP FAS 107-1 and APB 28-1 did
not have a material impact on the Company’s consolidated financial
statements.





In June
2008, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 07-5
(“EITF 07-5”), Determining
Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity's Own
Stock.  EITF 07-5 provides that an entity should use a two-step
approach to evaluate whether an equity-linked financial instrument (or embedded
feature) is indexed to its own stock, including evaluating the instrument's
contingent exercise and settlement provisions.   EITF 07-5 is effective for
fiscal years beginning after December 15, 2008.  The consensus must be
applied to outstanding instruments as of the beginning of the fiscal year in
which the consensus is adopted and should be treated as a cumulative-effect
adjustment to the opening balance of retained earnings.  Early
adoption is not permitted.  The Company does not expect the adoption
of EITF 07-5 to have a material impact on the Company’s consolidated financial
statements.





In
April 2008, the FASB issued FASB Staff Position Financial Accounting
Standard 142-3 (“FSP FAS 142-3”), Determination of the Useful Life of
Intangible Assets.  FSP FAS 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS
No. 142, Goodwill and
Other Intangible Assets.  The intent of this FSP is to improve
the consistency between the useful life of a recognized intangible asset under
SFAS No. 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141 (revised 2007), Business Combinations, and
other GAAP.  This statement is effective for fiscal years beginning on
or after December 15, 2008, and interim periods within those
years.  Early application is not permitted.  The Company
does not expect the adoption of this standard to have a material impact on its
consolidated results of operations and financial condition.





In April
2008, the FASB issued FSP Accounting Principles Board 14-1 (“FSP APB 14-1”),
Accounting for Convertible
Debt Instruments That May be Settled in Cash upon Conversion (Including Partial
Settlement).  FSP APB 14-1 requires the issuer of certain
convertible debt instruments that may be settled in cash (or other assets) on
conversion to separately account for the liability (debt) and equity (conversion
option) components of the instrument in a manner that reflects the issuer’s
nonconvertible debt borrowing rate.  FSP APB 14-1 is effective for
fiscal years beginning after December 15, 2008, and on a retroactive
basis.  The Company is evaluating the potential impact, if any, of the
adoption of FSP APB 14-1 on its consolidated results of operations and financial
condition.





In March
2008, the FASB issued SFAS No. 161,Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB statement No. 133
(SFAS No. 161).  SFAS No. 161 requires enhanced
disclosures regarding an entity’s derivative instruments and related hedging
activities.  These enhanced disclosures include information regarding how
and why an entity uses derivative instruments; how derivative instruments and
related hedge items are accounted for under SFAS No. 133,Accounting for Derivative
Instruments and Hedging Activities, and its related interpretations;
and how derivative instruments and related hedge items affect an entity’s
financial position, financial performance, and cash flows.  SFAS
No. 161 is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008.  The adoption of
SFAS No. 161 did not have a material impact on the Company’s consolidated
results of operations and financial condition.




F-15




In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations, which
replaces SFAS No. 141, Business
Combinations.  The statement retains the purchase method of
accounting for acquisitions but requires a number of changes, including changes
in the way assets and liabilities are recognized in the purchase
accounting.  It also changes the recognition of assets acquired and
liabilities assumed arising from contingencies, requires the capitalization of
in-process research and development at fair value, and requires the expensing of
acquisition-related costs as incurred. SFAS No. 141(R) is effective for the
Company beginning July 1, 2009, and will apply prospectively to business
combinations completed on or after that date.  The Company does not
expect the adoption of this standard to have a material impact on the Company’s
consolidated results of operations and financial condition.





In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities.  SFAS No. 159 provides
companies with an option to report selected financial assets and liabilities at
fair value.  The standard’s objective is to reduce both the complexity
in accounting for financial instruments and the volatility in earnings caused by
measuring related assets and liabilities differently.  SFAS No. 159
also establishes presentation and disclosure requirements designed to facilitate
comparisons between companies that choose different measurement attributes for
similar types of assets and liabilities.  The Company adopted SFAS No.
159 effective July 1, 2008, but has not elected to measure any permissible items
at fair value.  As a result, the adoption of this statement did not
have a material impact on its consolidated financial statements.





In
September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements.  This Statement defines fair value, establishes a
framework for measuring fair value in accordance with GAAP, and expands
disclosures about fair value measurements.  The definition of fair value
retains the exchange price notion in earlier definitions of fair value.
 This Statement clarifies that the exchange price is the price in an
orderly transaction between market participants to sell the asset or transfer
the liability in the market in which the reporting entity would transact for the
asset or liability, that is, the principal or most advantageous market for the
asset or liability.  Emphasis is placed on fair value being a market-based
measurement, not an entity-specific measurement; and therefore, a fair value
measurement should be determined based on the assumptions that market
participants would use in pricing the asset or liability.  As a basis for
considering these market participant assumptions, a fair value hierarchy has
been established to distinguish between (1) market participant assumptions
developed based on market data obtained from sources independent of the
reporting entity (observable inputs) and (2) the reporting entity’s own
assumptions about market participant assumptions developed based on the best
information available in the circumstances (unobservable inputs).  In
February 2008, the FASB issued a Staff Position which delays the effective date
of SFAS No. 157 for non-financial assets and non-financial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis, to fiscal years beginning after
November 15, 2008.  The Company adopted this statement, except
for items covered by the Staff Position, as of July 1, 2008; and the
adoption did not have a material impact on its consolidated results of
operations and financial condition.





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of Accounting Research Bulletin
(ARB) No. 51.  This Statement amends ARB No. 51 to establish
accounting and reporting standards for the noncontrolling interest in a
subsidiary and for the deconsolidation of a subsidiary.  It clarifies
that a noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements.  This Statement is effective for fiscal years
beginning on or after December 15, 2008 and the Company is in the process of
evaluating the impacts of adopting SFAS No. 160 which will become effective for
the Company on July 1, 2009.




In May 2009, the FASB issued SFAS No.
165, “Subsequent
Events”.  SFAS No. 165 establishes general standards of
accounting for and disclosure of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued.
Although there is new terminology, the standard is based on the same principles
as those that currently exist in the auditing standards. The standard, which
includes a new required disclosure of the date through which an entity has
evaluated subsequent events, is effective for interim or annual periods ending
after June 15, 2009.  The adoption of SFAS No. 165 did not have a
material impact on the Company’s results of operations or financial
condition.




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.




F-16




As
discussed in Note 1, there is certain ongoing litigation related to this
matter.





The
Company recorded the $23 million of contingent consideration in the quarter
ended March 31, 2008 as, at that time, the Company determined that the outcome
of the contingency was determinable beyond a reasonable doubt based on having
received notification of award of the NVESD contract pending review by the Small
Business Administration.  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 accrued interest income on the
$23 million receivable is recorded as an asset and income from continuing
operations as the interest represents the consequences of management's
subsequent decisions to hold the related asset.





The gain
on disposal of EOIR recognized in 2008 was determined as follows:





Gross
      sales price (including contingent consideration)
            
            $
            34,069,947Transaction
      costs
            
            
            (800,332
            )Net
      sales price
            
            
            33,269,615Working
      capital adjustment due to LLC
            
            
            (909,137
            )Carrying
      value of Technest’s investment in EOIR
            
            
            (17,559,111
            )Gain
      on disposal of EOIR
            
            $
            14,801,367





The loss
on discontinued operations for the year ended June 30, 2009 was $2,775,415. This
represents primarily legal expenses incurred in connection with the arbitration
process.  The Company expects to incur additional legal expenses
associated with this matter and these expenses will be charged to discontinued
operations as they are incurred.





For the
year ended June 30, 2008, the operations of EOIR have been reported in
discontinued operations in the Statements of Operations.  Revenues and
net loss from discontinued operations were as follows:





June
      30,
              2008Revenues
      from discontinued operations
            
            $
            46,099,851Net
      (loss) from discontinued operations
            
            $
            (2,934,218
            )





In the
years ended June 30, 2009 and 2008, the Company recorded a $566,000 and
($2,870,000) a tax benefit (provision), respectively, which offsets the net gain
(loss) from discontinued operations.





The SPA
calls for an adjustment to the purchase price based on the final working capital
in EOIR on the date of sale and has estimated that it owes approximately
$852,000 related to this adjustment.  The Company also recorded
certain balances payable that were triggered by the earning of the $23,000,000
of contingent consideration on the sale of EOIR of approximately $1,870,000.
These amounts are included in liabilities related to discontinued operations at
June 30, 2008.  In 2009, these liabilities in addition to expenses
incurred in 2009 in connection with the arbitration process approximating
$2,525,000 are included in liabilities related to discontinued
operations.  Assets related to discontinued operations in both years
amounts to $22,948,333 and represent the contingent purchase price excluding
interest income receivable.  Interest income receivable of
approximately $722,000 is included in prepaid expenses and other current assets
as it is a consequence of management's subsequent decision to hold the related
asset.





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 year ended
June 30, 2009, the Company allocated approximately $413,000 of such expenses to
Technest, Inc.




F-17


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.





In the
event that the non-controlling interest’s portion of net losses exceeds the
carrying value of the non-controlling interest, the carrying amount will not be
reduced below zero and the Company will recognize all of the excess losses. The
excess losses recognized by the Company at June 30, 2009 are
$194,069.





5. 
DEFINITE-LIVED INTANGIBLE ASSETS





Definite-lived
intangible assets consist of the following at June 30, 2009:




Useful
                life2009
              
              
              2008
              
              
              (years)Patents
      - commercialized technology
              
              $
              440,000
              
              
              $
              440,000
              
              
              
              5Patents
      – other
              
              
              172,913
              
              
              
              161,110
              
              
              
              15Customer
      relationships and contracts
              
              
              1,130,000
              
              
              
              1,130,000
              
              
              
              5Accumulated
      amortization
              
              
              (1,420,740
              )
              
              
              (1,095,999
              )Net
      definite-lived intangible asset
              
              $
              322,173
              
              
              $
              635,111





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





Amortization expense was $324,741 for
each of the years ended June 30, 2009 and 2008.  Costs incurred on new
patent registrations during the year ended June 30, 2009 was
$11,803.  Future amortization expense related to the definite-lived
intangible asset over the next five years is $206,991 for the year ended June
30, 2010 and $10,741 for each of the years ended June 30, 2011, 2012, 2013 and
2014.





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
October 31, 2008, the Company sold 1,300 shares of its Series D Preferred to
Southridge Partners, LP (“Southridge”), for a purchase price of $650,000 ($500
per share).  On May 20, 2009, the Company sold 140 shares of its Series D
Preferred to Southridge Capital Management LLC (“Southridge LLC”), for a
purchase price of $70,000 ($500 per share).  On June 11, 2009, the
Company sold 200 shares of its Series D Preferred to Southridge LLC for a
purchase price of $100,000 ($500 per share).  $600,000 of these
proceeds was used in connection with the Deer Creek Settlement (see Note
14) and the remainder proceeds were used to meet the expenses for the
arbitration in relation to the sale of EOIR.





F-18




The
Company has determined that as of each of the dates of issuance there was a
beneficial conversion feature which in the aggregate amounted to
$516,000.  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 of $1,640,000 immediately upon issuance.  This
resulted in a deemed dividend in the amount of $1,336,000.  The
carrying value in future periods will be adjusted by additional dividends earned
and expected to be paid upon redemption.  Total dividends accrued on
the Series D Preferred amount to $50,484 at June 30, 2009.





At June
30, 2009, the Company had 1,640 shares of Series D Preferred issued and
outstanding which has a liquidation preference of $1,690,483.





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 Series D Preferred Stock.





At June
30, 2009 and 2008, there were 64.325 shares of Series A Preferred Stock issued
and outstanding.





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.





Technest
entered into a Registration Rights Agreement dated February 14, 2005. Pursuant
to this agreement, Technest agreed to file a registration statement covering the
resale of (a) all of the common stock issuable upon conversion of the Series C
preferred stock, (b) all of the common stock issuable upon exercise of the
common stock purchase warrants, and (c) common stock which may become issuable
to selling stockholders as liquidated damages for breach of covenants contained
in or as a result of adjustments contemplated by the securities purchase
agreement and the registration rights agreement. Technest agreed to use its best
efforts to cause the registration statement to be declared effective as promptly
as possible thereafter. On December 31, 2005, the Company amended the terms of
this Registration Rights Agreement so that liquidated damages could only be paid
for in the Company’s common stock at a rate of 4% of the initial subscription
amount for any month.  On February 7, 2007, the required registration
statement became effective and, as a result, the Company does not expect to
incur any additional liquidated damages.





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





Common Stock
Issuances





During
the year ended June 30, 2009, the Company issued the following amounts of common
stock:





·
            63,125
      shares of its Common Stock with a fair value of $28,911 to two
      non-employee directors of the company as compensation for service on the
      Company’s board of directors for the period January 1, 2008 to June 30,
      2008.




F-19




·
            32,751
      shares of its Common Stock with a fair value of $15,000 to three
      non-employee directors of the company as compensation for service on the
      Company’s board of directors for the period April 1, 2008 to June 30,
      2008.





·
            75,000
      shares of its Common Stock with a fair value of $48,438 to two employees
      of the Company pursuant to achieving milestones set out in employment
      agreements.





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
            
            
            12,678,630Total
      common stock reserves
            
            
            14,036,264





8. 
OPTIONS, WARRANTS AND STOCK-BASED COMPENSATION





Options





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





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





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





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





Warrants





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





The following table summarizes the
Company's warrants outstanding at June 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
            1.5
      years





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





F-20





Stock Award
Plan





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





Technest
has broad discretion in making grants under the 2006 Plan and may make grants
subject to such terms and conditions as determined by the Board of Directors or
the committee appointed by the Board of Directors to administer the Plan. Stock
awards under the 2006 Plan will be subject to the terms and conditions,
including any applicable purchase price and any provisions pursuant to which the
stock may be forfeited, set forth in the document making the award.





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





Shares
            
            
            Weighted-Average
              Grant-Date
              Fair ValueNonvested
      at June 30, 2007
            
            
            261,113
            
            
            $
            4.47Granted
            
            
            275,000
            
            
            
            0.51Vested
            
            
            (291,114
            )
            
            
            3.29Forfeited
            
            
            (80,000
            )
            
            
            5.10Nonvested
      at June 30, 2008
            
            
            164,999
            
            
            $
            4.47Granted
            
            
            170,876
            
            
            
            0.40Vested
            
            
            (335,875
            )
            
            
            2.39Forfeited
            
            
            --Nonvested
      at June 30, 2009
            
            
            --
            
            
            $
            --





Total
stock-based compensation related to shares that vested in the years ended June
30, 2009 and 2008 was $110,854 and $300,949, respectively.  The fair
value of restricted stock granted in the years ended June 30, 2009 and 2008 was
$92,349 and $139,250, respectively.  As of June 30, 2009, there was no
unrecognized compensation cost related to non-vested restricted
stock.





As of
June 30, 2009, the Company has 272,345 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 years ended June 30, 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
            
            
            8,452,417
            
            
            
            -Warrants
            
            
            649,286
            
            
            
            649,286Total
            
            
            9,810,051
            
            
            
            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 years ended June 30, 2009 and 2008 was
$183,010 and $200,143, respectively.





F-21


The
future minimum rental payments required under operating leases that have
non-cancellable or original lease terms in excess of one year as of June 30,
2009 as are follows:





June
      30,2010
            
            $
            188,4232011
            
            
            144,473Total
            
            $
            332,896





Government
Contracts





In the
year ended June 30, 2008, the Defense Contract Audit Agency completed its audit
up to the end of fiscal 2004 and concluded that $65,831 is due to be refunded to
the Government. This amount is included in accrued expenses at June 30, 2008 and
was paid in the year ended June 30, 2009.  In the year ended June 30,
2008 the Department of Health and Human Services contended that funds in excess
of the grant award authorization had been paid to the Company
through February 2008.  An amount of $31,861 is included in
accrued expenses related to this matter in both 2008 and 2009.





In the
year ended June 30, 2008 the Company determined that there were additional
allowable costs incurred under a contract that was completed in
2005.  As a result the Company was permitted to bill approximately
$70,000 in the quarter ended June 30, 2008 which is included in
revenue.





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





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





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





·
            a
      term of five years beginning on January 14,
  2008;





·
            a
      base salary of $350,000 per year to Mr. Pereira and a base salary of
      $220,000 per year to Mr. Kotak.





·
            payment
      of all necessary and reasonable out-of-pocket expenses incurred by the
      executive in the performance of his duties under the
      agreement;





·
            $5,000
      per month for auto expense, home office expense and other personal
      expenses to Mr. Pereira





Mr.
Pereira is entitled to receive a bonus of 5% of the Company’s EBITDA (Earnings
Before Interest, Taxes, Depreciation and Amortization) calculated on an annual
basis at the end of the Company’s fiscal year, up to a maximum allowable cash
bonus of 300% of his annual salary (the EBITDA Bonus). In addition, Mr. Pereira
is eligible to receive equity bonus compensation under the Company’s 2006 Stock
Award Plan in the amounts determined as follows: shares of common stock
calculated by dividing 7% of the increase, if any, of the Market Capitalization
of the Company’s common stock as of the prior fiscal year end compared to the
following fiscal year end, by the closing price of the Company’s common stock on
the trading day immediately prior to the issuance of such shares (the Market Cap
Bonus Shares).  At June 30, 2009, the Company has not accrued any cash
or equity bonus for Mr. Pereira.





Mr. Kotak
is entitled to receive cash bonus and equity bonus compensation from time to
time as determined by the Board of Directors of the Company, or a compensation
committee of the Board of Directors of the Company, or subset of such committee,
composed in accordance with the corporate governance requirements of the listing
exchange.  Mr. Kotak has been granted an initial stock award of 50,000
shares of the Company’s common stock which vested on the first anniversary of
the agreement.  At June 30, 2009, the Company has not accrued any cash
bonus for Mr. Kotak.





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




F-22




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





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





11. 
INCOME TAXES





The
income tax provision (benefit) for the years ended June 30, 2009 and 2008 was as
follows:





2009
            
            
            2008Continuing
      Operations -Current:U.S. federal
            
            $
            --
            
            
            $
            --State and local
            
            
            --
            
            
            
            --Deferred:U.S. federal
            
            
            --
            
            
            
            (1,748,000
            )State and local
            
            
            --
            
            
            
            (263,000
            )Total
      provision (benefit) – continuing operations
            
            $
            --
            
            
            $
            (2,011,000
            )Discontinued
      Operations -Current:U.S. federal
            
            $
            166,091
            
            
            $
            --State and local
            
            
            --
            
            
            
            127,000Deferred:U.S. federal
            
            
            (636,000
            )
            
            
            2,384,000State and local
            
            
            (96,000
            )
            
            
            359,000Total
      provision (benefit) – discontinued operations
            
            
            (565,909
            )
            
            
            2,870,000Total
      provision (benefit)
            
            $
            (565,909
            )
            
            $
            859,000





The
income tax benefit differs from the amount of income tax determined by applying
the U.S. federal income tax rate to pretax income from continuing operations for
the years ended December 31, 2009 and 2008, due to the following:





2009
            
            
            2008Computed
      “expected” tax benefit
            
            
            (35%
            )
            
            
            (35%
            )Increase
      (decrease) in income taxes resulting from:State
      taxes, net of federal benefit
            
            
            (3%
            )
            
            
            (3%
            )Stock-based
      compensation
            
            
            0%
            
            
            
            8%Other
      permanent differences
            
            
            4%
            
            
            
            1%Increase
      (decrease) in the valuation reserve
            
            
            19%
            
            
            
            (19%
            )(15%
            )
            
            
            (48%)




F-23




Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities at June 30, 2009 and 2008 are as
follows:





2009
            
            
            2008Deferred
      tax assets:Net
      operating loss carryforward
            
            $
            3,855,000
            
            
            $
            3,370,000Stock-based
      compensation
            
            
            97,000
            
            
            
            105,000Intangibles
            
            
            385,000
            
            
            
            302,000Miscellaneous
      accruals
            
            
            611,000
            
            
            
            601,000Property
      and equipment
            
            
            5,000
            
            
            
            2,000Valuation
      allowance
            
            
            (3,045,000
            )
            
            
            (2,369,000
            )Deferred
      tax assets
            
            
            1,908,000
            
            
            
            2,011,000Deferred
      tax liabilities:Accrued
      interest
            
            
            (298,000
            )
            
            
            --Deferred
      gain on sale of EOIR
            
            
            (1,610,000
            )
            
            
            (2,743,000
            )Deferred
      tax liabilities
            
            
            (1,908,000
            )
            
            
            (2,743,000
            )Net
      deferred tax asset (liability)
            
            $
            --
            
            
            $
            (732,000
            )





The net
deferred tax liability at June 30, 2008 has been included in current liabilities
in the accompanying balance sheet.





As of
June 30, 2009 and 2008, the Company had a valuation allowance of $3,045,000 and
$2,369,000, respectively.  The Company has recorded a valuation
allowance against deferred tax assets as management has determined certain net
operating loss carryforwards will not be available due to Internal Revenue Code
Section 382 ownership changes and the utilization of other net operating loss
carryforwards is uncertain.  In the years ended June 30, 2009 and
2008, the valuation allowance increased (decreased) by $676,000 and
($2,239,000), respectively.  The increase in the valuation allowance
in the year ended June 30, 2009 related to the Company’s current year net
operating losses exceeding the amount needed to offset the deferred gain on the
sale of EOIR (see Note 3).  As of June 30, 2009, the Company has net
operating loss carryforwards not subject to IRC Section 382 limitations of
approximately $3,887,000 which begin to expire in 2024.





In the
year ended June 30, 2009, the Company recorded a current federal tax payable of
approximately $166,000 related to Alternative Minimum Tax as a result of the
Company’s use of the installment method related to the gain on the sale of
EOIR.





During
the years ended June 30, 2009 and 2008, the Company recognized approximately $0
and $38,000 of interest and penalties, respectively. Tax years subsequent to
2004 are subject to examination by federal and state authorities. Tax returns
subsequent to 2004 are in the process of being filed.





12.
 RELATED PARTY TRANSACTIONS





On
October 1, 2008, the Company formed and acquired a 49% interest in Technest,
Inc. in exchange for the transfer of certain contracts and employees. Technest,
Inc. conducts research and development in the field of computer vision
technology. Technest Holdings has the right of first refusal to commercialize
products resulting from this research and development. The Company’s Chief
Executive Officer beneficially owns 23% of Technest, Inc. (see Note
4).





On
October 30, 2008, Technest Holdings, Inc. sold 1,300 shares of its Series D 5%
Convertible Preferred Stock, with a stated value of $1,000 per share, to
Southridge Partners, LP, the holder of a majority of Technest’s shares of common
stock, for a purchase price of $650,000. On May 20, 2009, the Company sold 140
shares of its Series D Preferred to Southridge Capital Management LLC
(“Southridge LLC”), an affiliate of Southridge Partners, LP, for a purchase
price of $70,000 ($500 per share).  On June 11, 2009, the Company sold
200 shares of its Series D Preferred to Southridge LLC for a purchase price of
$100,000 ($500 per share).




During
the year ended June 30, 2008, Markland Technologies, Inc. (“Markland”) invoiced,
and EOIR paid, $264,306 in conjunction with the supply of products pursuant to a
sub-contract agreement.  Markland is a shareholder of the
Company.





During
the year ended June 30, 2008, Technest paid Southridge Partners LP, $250,000 in
satisfaction of a payable assigned to Southridge from Markland in June
2007.  Southridge is a majority shareholder and Markland is a
shareholder of the Company.  During 2008, the Company also issued
Southridge 3,000,000 shares of its common stock with a fair value of $1,380,000
in connection with the termination of certain sections of a stockholder
agreement and a licensing agreement both dated March 13, 2007 .




F-24


13.  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 these plans in the years ended June 30, 2009 and 2008 were
$99,044 and $105,236, respectively.





14. 
LITIGATION





Litigation Related to the Sale of EOIR
Technologies, Inc.





As
discussed in Note 1, there is certain ongoing litigation related to the sale of
EOIR Technologies, Inc.





Deer Creek





On or
about May 30, 2006, Deer Creek Fund LLC filed a claim for interference with
contract and breach of the implied covenant of good faith and fair dealing
against Technest Holdings, Inc., seeking unspecified monetary damages. 
Deer Creek alleged misconduct on the part of Technest related to a proposed sale
by Deer Creek of 157,163 shares of Technest common stock at $7.00 per share and
the applicability of certain selling restrictions under a registration rights
agreement entered into between the parties.  The trial for this claim
took place on April 8, 2008. On August 12, 2008, a decision was rendered against
Technest.  As of September 22, 2008, the parties agreed to settle the
judgment in lieu of further appeals in the amount of $600,000.  The
settlement amount was paid in October 2008 upon receipt of the proceeds from the
Series D Preferred issuance (see Note 6).





15.  SUBSEQUENT EVENTS





Management
has evaluated subsequent events through October 13, 2009, which is the date the
financial statements were issued.





Common Stock
Issuance





On
September 22, 2009, the Company issued the following amounts of its 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.





Series D Redeemable,
Convertible Preferred Stock Issuance





On July
17, 2009, the Company sold 300 shares of its Series D Redeemable, Convertible
Preferred Stock to Southridge Capital Management LLC, an affiliate of Southridge
Partners, LP,  for a purchase price of $150,000 ($500 per
share).  The entire proceeds were used to meet the legal expenses for
the arbitration in relation to the sale of EOIR.





Stock Award
Plan





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





F-25





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





None.





Item 9A(T). Controls and Procedures





Disclosure
Controls and Procedures





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





Our
management, with the participation of our Chief Executive Officer (“CEO”) and
our Chief Financial Officer (“CFO”), evaluated the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e)
promulgated under the Exchange Act) as of June 30, 2009, the end of our fiscal
year. In designing and evaluating disclosure controls and procedures, we and our
management recognize that any disclosure controls and procedures, no matter how
well designed and operated, can only provide reasonable assurance of achieving
the desired control objective. As of June 30, 2009 management concludes that our
disclosure controls and procedures are effective.





Management’s
Report on Internal Control over Financial Reporting





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





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





Our
management performed an assessment of the effectiveness of our internal control
over financial reporting as of June 30, 2009. Management based its assessment on
the criteria described in the “Internal Control - Integrated Framework” issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The objective of this assessment was to determine whether our internal control
over financial reporting was effective as of June 30, 2009. Management’s
assessment included evaluation of elements such as the design and operating
effectiveness of key financial reporting controls, process documentation,
accounting policies, and our overall control environment. Based on our
evaluation of internal control over financial reporting, our management
concluded that our internal control over financial reporting was effective as of
June 30, 2009.





Attestation
Report of the Registered Public Accounting Firm





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





Changes
in Internal Controls





There
were no changes in our internal controls over financial reporting during the
fourth quarter of fiscal 2009 that materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.





-25-





Limitations
on the Effectiveness of Controls





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





ITEM 9B. Other Information.





None.





PART III




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




Our
current directors and executive officers are:




Name
            Age
            Position
            Year BeganGino
      M. Pereira
            52
            Chief
      Executive Officer, President,Chairman
      of the Board of Directors
            2005Nitin
      V. Kotak
            52
            Chief
      Financial Officer
            2005Robert
      A. Curtis
            55
            Director
            2008Laurence
      J. Ditkoff
            49
            Director
            2008David
      R. Gust
            66
            Director
            2006Stephen
      M. Hicks
            50
            Director
            2008Henry
      Sargent
            42
            Director
            2008


_______________________


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




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





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




-26-




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




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





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





Stephen M.
Hicks has served on our Board of Directors since March 11, 2008. Mr.
Hicks is the Chief Executive Officer and founding principal of Southridge LLC.
Mr. Hicks sets the overall strategic direction for the Southridge group of
companies, and is responsible for business development and execution. Mr. Hicks
founded Southridge Capital Management, an investment firm that provides capital
to growing enterprises internationally, in 1996. Active in the investment
industry for over 20 years, Mr. Hicks has broad experience in financial
structuring, derivatives, risk arbitrage, and investment banking. He received
his BS in Business Administration from King's College in Briarcliff Manor, New
York, and an MBA from Fordham University, in New York City.





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





Code of
Ethics





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




-27-


Section
16(a) Beneficial Ownership Reporting Compliance




Our
executive officers and directors and persons who own beneficially more than ten
percent of our equity securities are required under Section 16(a) of the
Securities Exchange Act of 1934 to file reports of ownership and changes in
their ownership of our securities with the Securities and Exchange
Commission.  They must also furnish copies of these reports to
us.  Based solely on a review of the copies of reports furnished to us
and written representations that no other reports were required, we believe that
for fiscal year 2009 our executive officers, directors and 10% beneficial owners
complied with all applicable Section 16(a) filing requirements, except that Mr.
Hicks filed a late Form 4 on December 22, 2008 which was due December 19, 2008
for the purchase of shares of Common Stock by Trillium Partners LP, of which Mr.
Hicks is the control person.




ITEM
11.  EXECUTIVE COMPENSATION




Executive
Officer Compensation





Summary
Compensation:The following table sets forth certain
compensation information for our chief executive officer and our other most
highly compensated executive officer (other than our chief executive officer)
who served as an executive officer during the year ended June 30, 2009 and whose
annual compensation exceeded $100,000 for that year.





Summary
Compensation Table




Name
      and Principal Position
            
            Year
            
            Salary
                ($)
            
            
            Bonus
                ($)
            
            
            Stock
                Awards
      ($)
            
            
            All
      other compensation
                ($)
            
            
            Total
      ($)Gino
      M. Pereira (1)
            
            2009
            
            $
            350,000
            (1)
            
            $
            -
            
            
            $
            -
            
            
            $
            69,775
            (2)
            
            $
            419,775Chief
      Executive Officer and President
            
            2008
            
            
            350,000
            
            
            
            -
            
            
            
            -
            
            
            
            420,500
            (3)
            
            
            770,500Nitin
      V. Kotak (4)
            
            2009
            
            $
            220,000
            (1)
            
            $
            -
            
            
            $
            -
            
            
            $
            10,980
            (5)
            
            $
            230,980Chief
      Financial Officer
            
            2008
            
            
            185,000
            
            
            
            -
            
            
            
            22,500
            (6)
            
            
            11,100
            (5)
            
            
            218,600


_____________________________


(1)
            Salaries
      include voluntary deferred cash compensation by Mr Pereira and Mr Kotak of
      $114,000 and $37,000, respectively.




(2)
            Consists
      of (i) $60,000 earned by Mr. Pereira as the executive’s fixed amount per
      month for auto expense, business office expense and other personal
      expenses pursuant to Mr. Pereira’s employment agreement, and (ii) $9,775
      as Technest’s matching and safe harbor contributions under its 401(k)
      plan.





(3)
            Consists
      of (i) $350,000 paid to Mr. Pereira in accordance with his March 13, 2006
      employment agreement upon the sale of EOIR Technologies, Inc., (ii)
      $60,000 paid to Mr. Pereira as the executive’s fixed amount per month for
      auto expense, business office expense and other personal expenses pursuant
      to Mr. Pereira’s March 13, 2006 employment agreement, and (ii) $10,500 as
      Technest’s matching and safe harbor contributions under its 401(k)
      plan.





(4)
            On
      January 1, 2008, Mr. Kotak became the Chief Financial Officer upon the
      sale of EOIR Technologies, Inc. to EOIR Holdings, LLC. Prior to becoming
      the Chief Financial Officer, Mr. Kotak was the Vice President, Finance
      & Operations of Technest.





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





(6)
            Pursuant
      to Mr. Kotak’s January 14, 2008 employment agreement, he received an
      initial award of 50,000 shares of Common Stock which vested on January 14,
      2009. The fair value of the stock award was estimated on the grant
      date.




-28-


Outstanding Equity Awards at Fiscal
Year-End





As of
June 30, 2009, none of our named executive officers had any unvested equity
awards.





Employment
Agreement with Gino M. Pereira




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





·
            a
      term of five years beginning on January 14,
  2008;





·
            a
      base salary of $350,000 per year, which is the same base salary as set
      forth in Mr. Pereira’s prior employment agreement (the “Annual
      Salary”);





·
            payment
      of all necessary and reasonable out-of-pocket expenses incurred by Mr.
      Pereira in the performance of his duties under the
    agreement;





·
            $5,000
      per month for auto expense, business office expense and other personal
      expenses, which is the same amount as set forth in Mr. Pereira’s prior
      employment agreement;





·
            eligibility
      to receive a performance based bonus of 5% of  Technest’s EBITDA
      (Earnings Before Interest, Taxes, Depreciation and Amortization)
      calculated on an annual basis at the end of Technest’s fiscal year, up to
      a maximum allowable cash bonus of 300% of the Annual Salary (the “EBITDA
      Bonus”), payable by Technest within 90 days of the end of Technest’s
      fiscal year; and





·
            eligibility
      to receive a performance based stock award under Technest’s 2006 Stock
      Award Plan calculated by dividing (x) 7% of the increase, if any, of the
      Market Capitalization (as defined below) of Technest’s Common Stock as of
      the prior fiscal year end compared to the following fiscal year end, by
      (y) the closing price of Technest’s Common Stock on the trading day
      immediately prior to the issuance of such shares (the “Market Cap Bonus
      Shares”).  Such Market Cap Bonus Shares shall be issued within 7
      days of the end of the Company’s fiscal year.  For purposes of
      the employment agreement, “Market Capitalization” shall mean the average
      closing price of Technest’s Common Stock as traded on the Over-the-Counter
      Bulletin Board (or if the Common Stock is no longer listed on that market,
      the principal securities exchange or trading market on which the Common
      Stock is listed, quoted or traded), for 20 consecutive trading days ending
      immediately prior to the measurement date, multiplied by the average
      number of shares of Technest’s Common Stock outstanding for the same 20
      consecutive trading days.





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





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





Employment
Agreement with Nitin V. Kotak





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





·
            a
      term of five years beginning on January 14,
  2008;





·
            An
      initial base salary of $220,000 per year (the “Annual
      Salary”);




-29-




·
            payment
      of all necessary and reasonable out-of-pocket expenses incurred by Mr.
      Kotak in the performance of his duties under the
  agreement;





·
            eligibility
      to receive cash bonuses as determined by the board of directors;
      and





·
            eligibility
      to receive equity awards under Technest’s 2006 Stock Award Plan as
      determined by the board of directors, with an initial award of 50,000
      shares of Common Stock which vested on January 14,
  2009.





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





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





Director
Compensation




Summary
Compensation:The following table sets forth the compensation
of our directors for the year ended June 30, 2009.





Name
      and Principal Position
            
            Director
              Fees
              ($)
      (1)
            
            
            Stock
      Awards ($)(2)
            
            
            All
      other compensation
              ($)
            
            
            Total
      ($)Robert
      A. Curtis
            
            
            —
            
            
            $
            20,000
      (3)(4)
            
            
            
            —
            
            
            $
            20,000Laurence
      Ditkoff
            
            
            —
            
            
            
            20,000
      (4)(5)
            
            
            
            —
            
            
            
            20,000David
      R. Gust
            
            
            —
            
            
            
            20,000
      (4)(6)
            
            
            
            —
            
            
            
            20,000Stephen
      Hicks
            
            
            —
            
            
            
            20,000
      (4)(5)
            
            
            
            —
            
            
            
            20,000Henry
      Sargent
            
            
            —
            
            
            
            20,000
      (4)(5)
            
            
            
            —
            
            
            
            20,000


_____________________________


(1)
            Director
      fees include all fees earned for director services including an annual
      retainer and committee chairman fees, to the extent
      applicable.


(2)
            The
      fair value of the stock awarded on September 21,
  2009.


(3)
            Dr.
      Curtis joined the Board of Directors on January 14, 2008. Dr. Curtis has
      previously been awarded 44,915 shares of Technest Common Stock for his
      services as a director.


(4)
            Each
      director received 130,246 shares of Technest Common Stock as compensation
      for their services for the fiscal year ended June 30, 2009. These shares
      were issued to the directors on September 21,
  2009.


(5)
            Messrs.
      Ditkoff, Hicks and Sargent joined the Board of Directors on March 11,
      2008. They each received 10,917 shares of Technest Common Stock as
      compensation for their services for the fourth quarter of the 2008 fiscal
      year.


(6)
            General
      Gust joined the Board of Directors on March 15, 2006.  He has
      previously been awarded 78,210 shares of Technest Common Stock for his
      services as a director.





Director Fees and Stock
Awards. During our fiscal year ended June 30, 2009, our non-employee
directors were to be paid $20,000 per year as compensation for their services
paid in Technest Common Stock on a quarterly basis; the number of shares to be
issued was determined by using the average closing price for the last five
trading days of the respective quarter. Directors who are also our employees
receive no additional compensation for serving as directors.





-30-




Equity
Compensation Plan Information





The
following table provides information about the securities authorized for
issuance under the Company's equity compensation plans as of June 30,
2009:




Plan
      category
            
            Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
            
            
            Weighted
      average exercise price of outstanding
              options,
      warrants and
              rights
            
            
            Number
      of securities remaining available for future issuance(a)
            
            
            (b)
            
            
            (c)Equity
      compensation plans approved by security holders (1)
            
            
            0
            
            
            $
            0
            
            
            
            10,000,000Equity
      compensation plans not approved by security holders (2)
            
            
            (2
            )
            
            
            
            
            
            
            272,345
            (2)Total
            
            
            (2
            )
            
            $
            0
            
            
            
            10,272,345
            (2)




(1)
            2001
      Stock Option Plan.





(2)
            On
      March 13, 2006, Technest adopted the Technest Holdings, Inc. 2006 Stock
      Award Plan, pursuant to which Technest may award up to 1,000,000 shares of
      its common stock to employees, officers, directors, consultants and
      advisors to Technest and its subsidiaries.  On September 21,
      2009, the Board of Directors of Technest increased the number of shares
      issuable under the plan from 1,000,000 shares to 2,000,000 shares. The
      purpose of this plan is to secure for Technest and its shareholders the
      benefits arising from capital stock ownership by employees, officers and
      directors of, and consultants or advisors to, Technest and its
      subsidiaries who are expected to contribute to the Company’s future growth
      and success.  Technest has broad discretion in making grants
      under the plan and may make grants subject to such terms and conditions as
      determined by the board of directors or the committee appointed by the
      board of directors to administer the plan.  Stock awards under
      the plan will be subject to the terms and conditions, including any
      applicable purchase price and any provisions pursuant to which the stock
      may be forfeited, set forth in the document making the
      award.  As of June 30, 2009, the Company had 272,345 shares
      available for issuance under the plan. As of September 22, 2009, after the
      increase in the number of shares available for issuance under the plan and
      the recent issuances to the Board of Directors, the Company currently has
      621,115 shares available for issuance under the
  plan.







-31-




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




The
following tables set forth information regarding the beneficial ownership of our
common stock as of September 23, 2009 by:




-
            each
      of our directors and officers;


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


-
            all
      current directors and executive officers as a
  group.




Beneficial
ownership is determined in accordance with the rules of the SEC. In computing
the number of shares beneficially owned by a person and the percentage ownership
of that person, shares of Common Stock subject to options, warrants and any
other type of convertible securities held by that person that are currently
exercisable or exercisable within 60 days of September 23, 2009, are deemed
issued and outstanding. These shares, however, are not deemed outstanding for
purposes of computing percentage ownership of each other stockholder. Percentage
of ownership is based on 21,327,969 shares of common stock outstanding on
September 23, 2009, subject to adjustment for options, warrants and any other
type of convertible securities as previously described.




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




Beneficial Owner of 5% or
    more
            
            Number
      of Shares
              Beneficially
      OwnedShares
            
            
            PercentSouthridge
      Partners LP
              90
      Grove Street
              Ridgefield,
      CT 06877
            
            
            17,863,850
            (1)
            
            
            63.4
            %
      (1)Aberdeen
      Avenue LLC
              Cayside,
      2nd Floor Georgetown,
              Grand
      Cayman, Cayman Islands, British West Indies
            
            
            5,014,782
            (2)
            
            
            20.45
            %
      (2)Southshore
      Capital Fund Ltd.
              90
      Grove Street
              Ridgefield,
      CT 06877
            
            
            1,072,257
            (3)
            
            
            5.01
            %
      (3)Directors and Executive
      OfficersGino
      M. Pereira, Chief Executive Officer, President and
Director
            
            
            447,000
            
            
            
            2.10
            %Nitin
      V. Kotak, Chief Financial Officer
            
            
            50,000
            
            
            
            *Robert
      A. Curtis, Director
            
            
            175,161
            
            
            
            *Laurence
      Ditkoff, Director
            
            
            141,163
            
            
            
            *David
      R. Gust, Director
            
            
            208,456
            
            
            
            *Stephen
      Hicks, Director
            
            
            24,862,849
            (4)
            
            
            78.35
            %Henry
      Sargent, Director
            
            
            331,766
            (5)
            
            
            1.56
            %All
      Current Directors and Executive Officers as a Group (6
      Persons)
            
            
            26,166,395
            (4)(5)
            
            
            82.45
            %
      (4)(5)




-32-




*Less
than 1%




(1)
Southridge Partners is the beneficial owner of an aggregate of 17,863,850 shares
of Technest Common Stock, which includes 11,019,023 shares of Common Stock,
344,827 shares of Technest Series C Convertible Preferred Stock, which is
convertible, subject to certain restrictions, into 344,827 shares of Technest
Common Stock, and 1,300 shares of Technest Series D 5% Convertible Preferred
Stock, which is convertible, subject to certain restrictions, into 6,500,000
shares of Technest Common Stock.




The
Technest Series C Preferred Stock can be converted only to the extent that the
Series C stockholder will not, as a result of the conversion, hold in excess of
4.999% of the total outstanding shares of our common stock.  The
Series C stockholder may elect to waive this restriction, but such a waiver
shall not be effective until the 65th day after which it is given to
us.  In no event can the Series C Preferred Stock be converted if such
conversion will result in the holder will hold in excess of 9.999% of our common
stock.




The
Series D 5% Convertible Preferred Stock is convertible into Technest common
stock at the option of the stockholder at any time. The number of shares of
Technest common stock into which each share of Series D 5% Convertible Preferred
Stock is convertible is determined by dividing $1,000 (the stated value) plus
any accrued but unpaid dividends (to the extent to be paid in shares of Common
Stock) by $.20 per share. The holders of Series D 5% Convertible Preferred Stock
are entitled to receive cumulative dividends on the preferred stock at the rate
per share (as a percentage of the stated value per share) equal to five percent
(5%) per annum payable in cash or shares of Common Stock, at the option of the
holders. The Series D 5% Convertible Preferred Stock may be redeemed by Technest
under certain circumstances, upon the receipt of the contingent purchase price
from the sale of its subsidiary, EOIR Technologies, Inc.




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




(2)
Aberdeen Avenue LLC is the beneficial owner of an aggregate of 5,014,782 shares
of Technest Common Stock, which includes (i) 1,416,101 shares of Technest Common
Stock; (ii) 640 shares of Technest Series D 5% Convertible Preferred Stock,
which is convertible, subject to certain restrictions, into 3,200,000 shares of
Technest Common Stock: (iii) as reported in Schedule 13D/A filed in October
2009, 1,203.18 shares of Series G Preferred Stock issued by Markland
Technologies Inc., convertible subject to certain restrictions into an
additional 398,681 shares of Technest Common Stock. The shares of Technest
Series D 5% Convertible Preferred Stock were assigned to Aberdeen Avenue LLC
from Southridge Capital Management LLC.  See footnote (1) for the
conversion features of Technest Series D 5% Convertible Preferred
Stock.




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




(3) Southshore Capital Fund
Ltd. is the beneficial owner of an aggregate of 1,059,063 shares of Technest
Common Stock, which includes (i) 977,741 shares of Technest Common Stock; (ii)
57,467 shares of the Technest Series C Convertible Preferred Stock, convertible
into 57,467 shares of Technest Common Stock; (iii) as reported in Schedule 13D/A
filed in October 2009, 111.81 shares of Series G Preferred Stock issued by
Markland Technologies Inc., convertible subject to certain restrictions into an
additional 37,049 shares of Technest Common Stock. See footnote (1) for the
conversion features of Technest Series C Convertible Preferred
Stock.




Each of
David Sims and Stephen Hicks has voting and investment control over the
securities held by Southshore Capital Fund Ltd. and each
disclaims beneficial ownership of such shares.




(4)
Includes (i) the shares beneficially owned by Southridge Partners, LP, Aberdeen
Avenue LLC and Southshore Capital Fund Ltd. set forth in footnotes (1)(2) and
(3), (ii) 141,163 shares of Technest Common Stock owned directly by Mr. Hicks;
(iii) 304,578 shares of Technest Common Stock issuable to Garth LLC upon
conversion of 64.631 shares of Technest Series A Preferred Stock (Mr. Hicks has
voting and investment control over the securities held by Garth LLC, but
disclaims beneficial ownership of such shares);  and  (iv)
466,219 shares of Common Stock owned by Trillium Partners, LP for which Mr.
Hicks is the President of the general partner.




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




-33-




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





Southridge
Partners LP





On August
31, 2007, Technest entered into a Release Agreement with Southridge Partners,
LP, a Delaware limited partnership, a current stockholder of the Company,
pursuant to which the parties agreed, among other things, to the
following:




Termination
of Certain Sections of Stockholder Agreement and of License Agreement. Technest
and Markland Technologies, Inc. (“Markland”) were parties to a Stockholder
Agreement, dated March 13, 2006 (the “Stockholder Agreement”), and a License
Agreement dated March 13, 2006 (the “License Agreement”).  Pursuant to
that an Assignment and Assumption Agreement dated as of August 30, 2007 between
Markland and Southridge, Markland assigned all of its rights in the Stockholder
Agreement and the License Agreement to Southridge. As part of the Release
Agreement, Southridge and Technest agreed to (a) terminate the obligations set
forth in Section 1 of the Stockholder Agreement that restrict the ability of
Technest to issue equity securities, convertible debt or derivative securities,
(b) terminate the obligations set forth in Section 5 of the Stockholder
Agreement relating to a right of co-sale and (c) terminate the License Agreement
in its entirety.  All rights, title and interest in the intellectual
property that was subject to the License Agreement revert back to Technest and
its subsidiaries.




Voting Agreement. Southridge
agreed that it will vote all shares of Technest common stock owned by it and to
cause its affiliates that own shares of Technest common stock or Technest
Preferred Stock to vote all of their shares, in favor of certain transactions
entered into by September 10, 2007 that are approved and recommended by a
majority of the directors of Technest under certain conditions.




Board Representation.The
Board of Directors of Technest agreed to increase the size of the board from
five to six and fix the number of directors of Technest at six and to elect two
reasonably qualified individuals representing Southridge to fill the newly
created directorships in accordance with Technest’s Bylaws.





The above
description summarizes the material terms of the Release Agreement, which was
filed as exhibit 10.1 to a current report on Form 8-K filed with the SEC on
September 7, 2007 and is incorporated by reference herein. For further
information on the Release Agreement, please refer to exhibit 10.1.





As
consideration for the Release Agreement, Technest agreed to issue Southridge
3,000,000 shares of Technest common stock, $0.001 par value per share. The
issuance of these securities was not registered under the Securities Act of
1933, as amended, but was made in reliance upon the exemptions from the
registration requirements of the Securities Act set forth in Section 4(2)
thereof.




In
addition, during the year ended June 30, 2008, Technest paid Southridge Partners
LP $250,000 in satisfaction of a payable assigned from Markland Technologies,
Inc. in June 2007.





On
October 30, 2008, Technest Holdings, Inc. sold 1,300 shares of its Series D 5%
Convertible Preferred Stock, with a stated value of $1,000 per share, to
Southridge Partners, LP, the holder of a majority of Technest’s shares of common
stock, for a purchase price of $650,000. The certificate of designation of the
Series D 5% Convertible Preferred Stock was filed as exhibit 4.18 to Technest’s
annual report on Form 10-KSB for the year ended June 30, 2008 filed with the
Securities and Exchange Commission on October 2, 2008 and is incorporated by
reference herein. The
issuance and sale of the securities were not registered under the Securities Act
of 1933, but were made in reliance upon the exemptions from the registration
requirements of the Securities Act set forth in Section 4(2)
thereof.





The
Series D 5% Convertible Preferred Stock is convertible into Technest common
stock at the option of the stockholder at any time. The number of shares of
Technest common stock into which each share of Series D 5% is convertible is
determined by dividing $1,000 (the stated value) plus any accrued but unpaid
dividends (to the extent to be paid in shares of Common Stock) by $.20 per
share. Currently, the 1,300 shares of Series D 5% Preferred Stock issued to
Southridge Partners LP are convertible into 6,500,000 shares of Technest common
stock. The holders of Series D 5% Convertible Preferred Stock are entitled to
receive cumulative dividends on the preferred stock at the rate per share (as a
percentage of the stated value per share) equal to five percent (5%) per annum
payable in cash or shares of Common Stock, at the option of the holders. The
Series D 5% Convertible Preferred Stock may be redeemed by Technest under
certain circumstances upon the receipt of the contingent purchase price from the
sale of its subsidiary, EOIR Technologies, Inc.





The above
description summarizes the material terms of the Securities Purchase Agreement,
which was filed as exhibit 10.1 to a current report on Form 8-K filed with the
SEC on November 5, 2008 and is incorporated by reference herein. For further
information on the Securities Purchase Agreement, please refer to exhibit
10.1.




On May
20, 2009, Technest sold 140 shares of its Series D Preferred to Southridge
Capital Management LLC (“Southridge LLC”), an affiliate of Southridge Partners,
LP, for a purchase price of $70,000.  On June 11, 2009, Technest sold
an additional 200 shares of its Series D Preferred to Southridge LLC for a
purchase price of $100,000.  On July 17, 2009, Technest sold an
additional 300 shares of its Series D Preferred to Southridge LLC for a purchase
price of $150,000.  The 640 shares of Series D Preferred sold to
Southridge LLC are convertible into 3,200,000 shares of Technest Common Stock.
The conversion features of the Series D Preferred are set forth
above.  The issuance and sale of these securities were not registered
under the Securities Act of 1933, but were made in reliance upon the exemptions
from the registration requirements of the Securities Act set forth in Section
4(2) thereof.




The above
description summarizes the material terms of the Securities Purchase Agreements,
which were filed as exhibits 10.1 to current reports on Form 8-K filed with the
SEC on May 27, 2009, June 16, 2009 and July 22, 2009 and are incorporated by
reference herein. For further information on the Securities Purchase Agreements,
please refer to the corresponding exhibit 10.1.





-34-





Technest,
Inc.





On
October 1, 2008, the Company formed and acquired a 49% interest in Technest,
Inc. in exchange for the transfer of certain contracts and employees. Technest,
Inc. conducts research and development in the field of computer vision
technology. Technest Holdings has the right of first refusal to commercialize
products resulting from this research and development. The Company’s Chief
Executive Officer beneficially owns 23% of Technest, Inc.





Director
Independence




For the
fiscal year ended June 30, 2009, our Board of Directors determined that two of
the six directors- Robert A. Curtis and David R. Gust, were independent
directors as defined by the NASDAQ Rule 4200(a)(15) governing the independence
of directors.





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











-35-





ITEM
14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES




Fees
and Services





Audit Fees.The
aggregate audit fees billed for professional services rendered by the
independent registered public accounting firm for the audit of our financial
statements as of and for the years ended June 30, 2009 and 2008, the reviews of
the financial statements in our Form 10-Q/10-QSB filings for the respective
years, our filings with the Securities and Exchange Commission and other audit
fees were $97,250 and $126,000, respectively.




Audit Related Fees.The
aggregate audit related fees billed for professional services by the independent
registered public accounting firm as of and for the years ended June 30, 2009
and June 30, 2008 were $2,400 and $16,050, respectively. In the year ended June
30, 2009, the audit related fees include services rendered for issuing and
assisting with SEC comment letter responses.  In the year ended June
30, 2008, the audit related fees primarily include assistance with the sale of
EOIR Technologies, Inc.




Tax Fees.The aggregate
tax fees billed for professional services by the independent registered public
accounting firm as of and for the years ended June 30, 2009 and 2008 were
$41,125 and $14,025, respectively.  The tax fees for both periods
include fees for the preparation of federal and state income tax returns,
assistance with IRC Section 382 analysis as well as due diligence assistance
with the EOIR transaction.




All Other Fees.No other
fees were billed by or paid to the independent registered public accounting firm
during the years ended June 30, 2009 or 2008.




Other
than the services discussed above, Wolf & Company, P.C. has not rendered any
non-audit related services for the period ended June 30, 2009.




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





For the
year ended June 30, 2009, the full Board of Directors, functioning as the Audit
Committee, approved the audit or non-audit services before the accounting firm
was engaged to perform any such services.  Management must obtain the
specific prior approval of the Audit Committee for each engagement of the
independent registered public accounting firm to perform any audit-related or
other non-audit services.  The Audit Committee does not delegate its
responsibility to approve services performed by the independent registered
public accounting firm to any member of management.





Item 15. 
Exhibits.





Exhibit
      No.
            Description
            Filed
      with this
              10-K
            Incorporated
              by
      reference
              From
            Filing
      Date
            Exhibit
      No.2.1
            2001
      Stock Option Plan
            
            DEF
      14A
            June
      14, 2001
            C2.2
            Stock
      Purchase Agreement dated September 10, 2007 between Technest Holdings,
      Inc., EOIR Holdings, LLC and E-OIR Technologies, Inc.
            
            8-K
            September
      13, 2007
            2.12.3
            Form
      of Voting Agreement with a list of signatories.
            
            8-K
            September
      13, 2007
            2.22.4
            First
      Amendment to Stock Purchase Agreement dated December 31, 2007 among
      Technest Holdings, Inc., EOIR Holdings, LLC and EOIR Technologies,
      Inc.
            
            8-K
            January
      4, 2008
            2.33.1
            Restated
      Articles of Incorporation dated December 22, 1998
            
            SB-2
            February
      26, 1999
            3.13.2
            Restated
      Articles of Incorporation of Registrant, dated as of December 14, 2000, as
      filed with the Secretary of State of the State of Nevada on March 2,
      2001.
            
            10-KSB
            April
      16, 2001
            3.2   -36-
  3.3
              Certificate
      of Amendment to Articles of Incorporation
              
              8-K
              August
      9, 2001
              3.13.4
              Amended
      and Restated By-Laws dated May 21, 2001.
              
              DEF
      14A
              June
      14, 2001
              B3.5
              Bylaw
      Amendments
              
              8-K
              December
      20, 2006
              3.13.6
              By-law
      Amendments
              
              8-K
              October
      4, 2007
              3.14.1
              Form
      of Common Stock Certificate
              
              SB-2
              February
      26, 1999
              4.14.2
              Series
      A Convertible Preferred Stock Certificate of Designations, filed with the
      Secretary of State of Nevada on February 8, 2005.
              
              8-K
              February
      14, 2005
              4.1




4.3
                Form
      of Technest Common Stock Purchase Warrant
                
                8-K
                February
      15, 2005
                4.64.4
                Technest
      Series B Convertible Preferred Stock Certificate of Designations filed
      with the Secretary of State of Nevada on February 14,
2005.
                
                8-K
                February
      15, 2005
                4.74.5
                Technest
      Series C Convertible Preferred Stock Certificate of Designations filed
      with the Secretary of State of Nevada on February 14, 2005
                
                8-K
                February
      15, 2005
                4.84.6
                Technest
      Common Stock Warrant issued to Silicon Valley Bank dated August 4,
      2006.
                
                8-K
                August
      14, 2006
                4.14.7
                Registration
      Rights Agreement between Technest Holdings, Inc. and Silicon Valley Bank
      dated August 4, 2006.
                
                8-K
                August
      14, 2006
                4.24.8
                Technest
      Common Stock Warrant issued to Crystal Research Associates LLC dated July
      17, 2006
                
                10-KSB
                October
      13, 2006
                4.154.9
                Registration
      Rights Agreement between Technest Holdings, Inc. and Crystal Research
      Associates LLC dated July 17, 2006.
                
                10-KSB
                October
      13, 2006
                4.164.10
                Technest
      Series D 5% Convertible Preferred Stock Certificate of Designations filed
      with the Secretary of State of Nevada on October
      1,  2008
                
                10K-SB
                October 2, 2008
                4.1810.1
                Office
      Lease Agreement between Motor City Drive, LLC and Genex Technologies,
      Inc., dated December 20, 2005.
                
                10-QSB
                February
      21, 2006
                10.710.2*
                Form
      of Restricted Stock Agreement between Gino M. Pereira and Technest
      Holdings, Inc.
                
                8-K
                March
      17, 2006
                10.610.3*
                Technest
      Holdings, Inc. 2006 Stock Award Plan.
                
                8-K
                March
      17, 2006
                10.8
  -37-




10.4
              Indemnification
      Agreement between Technest Holdings, Inc. and Markland Technologies, Inc.
      dated September 1, 2006.
              
              10-KSB
              October
      13, 2006
              10.3610.5
              Office
      Lease Agreement Amendment No. 1 by and among Genex Technologies,
      Incorporated, Technest Holdings, Inc. and Motor City Drive, LLC dated as
      of November 1, 2006.
              
              10-QSB
              February
      14, 2007
              10.110.6
              Asset
      Contribution Agreement between Technest Holdings, Inc. and Genex
      Technologies Incorporated dated November 1, 2006.
              
              10-QSB
              February
      14, 2007
              10.210.7
              Release
      Agreement dated August 31, 2007 between Technest Holdings, Inc. and
      Southridge Partners, LP
              
              8-K
              September
      7, 2007
              10.110.8
              Form
      of Non-competition Agreement entered into between EOIR Technologies, Inc.
      and Technest Holdings, Inc. and Genex Technologies, Inc.
              
              Definitive
                Information
                Statement
      on Schedule 14C
              December
      7, 2007
              Annex
      D10.9
              Form
      of Release entered into by Technest Holdings, Inc. and Genex Technologies,
      Inc. and acknowledged by EOIR Holdings LLC
              
              Definitive
                Information
                Statement
      on Schedule 14C
              December
      7, 2007
              Annex
      C10.10*
              Employment
      Agreement between Gino M. Pereira and Technest Holdings, Inc. dated
      January 14, 2008.
              
              8-K
              January
      18, 2008
              10.110.11*
              Employment
      Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated January
      14, 2008.
              
              8-K
              January
      18, 2008
              10.210.12*
              Restricted
      Stock Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated
      January 15, 2008.
              
              8-K
              January
      18, 2008
              10.310.13*
              Restricted
      Stock Agreement between David R. Gust and Technest Holdings, Inc. dated
      January 15, 2008.
              
              8-K
              January
      18, 2008
              10.510.14*
              Restricted
      Stock Agreement between Dr. Robert A. Curtis and Technest Holdings, Inc.
      dated January 15, 2008.
              
              8-K
              January
      18, 2008
              10.610.15*
              Severance
      Agreement between Joseph P. Mackin and Technest Holdings, Inc. dated
      December 31, 2007.
              
              10-QSB
              February
      19, 2008
              10.810.16*
              Agreement
      between Gino M. Pereira and Technest Holdings, Inc. dated December 31,
      2007.
              
              10-QSB
              February
      19, 2008
              10.910.17
              Asset
      Contribution Agreement between Technest Holdings, Inc. and Technest, Inc.
      dated September 17, 2008, effective as of October 1, 2008.
              
              10-KSB
              October
      2, 2008
              10.48
   -38-
  10.18
              Securities
      Purchase Agreement dated October 31, 2008 between Technest Holdings, Inc.
      and Southridge Partners, LP.
              
              8-K
              November
      5, 2008
              10.110.19
              Securities
      Purchase Agreement dated May 20, 2009 between Technest Holdings, Inc. and
      Southridge Capital Management LLC
              
              8-K
              May
      27,2009
              10.110.20
              Securities
      Purchase Agreement dated June 11, 2009 between Technest Holdings, Inc. and
      Southridge Capital Management LLC
              
              8-K
              June
      16, 2009
              10.110.21
              Securities
      Purchase Agreement dated July 17, 2009 between Technest Holdings, Inc. and
      Southridge Capital Management LLC
              
              8-K
              July
      22, 2009
              10.110.22
              Form
      of Non-Employee Director Restricted Stock Grant Agreement entered into by
      each non-employee director and Technest Holdings, Inc. dated September 21,
      2009
              x





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





*
Indicates a management contract or compensatory plan.





-39-





Signatures





In
accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused
this Report to be signed on its behalf by the undersigned, thereunto duly
authorized on October 13, 2009.





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





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





Signature
            
            Title
            
            Date/s/
      Gino Miguel Pereira
            
            Chief
      Executive Officer, President and Chairman of the Board
            
            October  13,
      2009Gino
      Miguel Pereira
            
            of
      Directors/s/
      Nitin V. Kotak
            
            Chief
      Financial Officer and Principal Accounting
      Officer
            
            October
      13, 2009Nitin
      V. Kotak/s/
      Robert Curtis
            
            Director
            
            October
      13, 2009Robert
      Curtis/s/
      Laurence Ditkoff
            
            Director
            
            October
      13, 2009Laurence
      Ditkoff/s/
      David R. Gust
            
            Director
            
            October
      13, 2009David
      R. Gust/s/
      Stephen Hicks
            
            Director
            
            October
      13, 2009Stephen
      Hicks/s/
      Henry Sargent
            
            Director
            
            October 13
      2009Henry
      Sargent







-40-