Accel Brands 10Q 2009 Q2 Quarterly report

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

	(Mark One)

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

For the quarterly period ended: December 31, 2008

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

For the transition period from ______________ to ______________

Commission File Number 000-27023

TECHNEST HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

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

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

(Address of principal executive offices and zip code)

(301) 767-2810

(Registrant’s telephone number, including area code)

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

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

As of February 9, 2009, there were 20,676,211 shares of common stock, $0.001 par value, of the registrant issued and outstanding.

TECHNEST HOLDINGS, INC.

FORM 10-Q

TABLE OF CONTENTS

DECEMBER 31, 2008

	Page

PART I. FINANCIAL INFORMATION	1

Item 1. Financial Statements (Unaudited)


Consolidated Balance Sheets as of December 31, 2008 and June 30, 2008		1

Consolidated Statements of Operations for the Six Months Ended December 31, 2008 and 2007		3

Consolidated Statements of Operations for the Three Months Ended December 31, 2008 and 2007		4

Consolidated Statement of Changes in Stockholders’ Equity for the Six Months Ended December 31, 2008		5

Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2008 and 2007		6

Notes to Condensed Consolidated Financial Statements		8

Item 2. Management’s Discussion and Analysis or Plan of Operation		18

Item 4T. Controls and Procedures		24

PART II. OTHER INFORMATION		24

Item 1. Legal Proceedings		24

Item 1A. Risk Factors		25

Item 6. Exhibits		33

Signatures		34

STATEMENTS CONTAINED IN THIS FORM 10-Q, WHICH ARE NOT HISTORICAL FACTS CONSTITUTE FORWARD-LOOKING STATEMENTS AND ARE MADE UNDER THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. FORWARD-LOOKING STATEMENTS INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. YOU CAN IDENTIFY THESE STATEMENTS BY FORWARD-LOOKING WORDS SUCH AS "MAY", "WILL", "EXPECT", "ANTICIPATE", "BELIEVE", "ESTIMATE", "CONTINUE", AND SIMILAR WORDS. YOU SHOULD READ STATEMENTS THAT CONTAIN THESE WORDS CAREFULLY. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS FORM 10-Q ARE BASED ON INFORMATION AVAILABLE TO US ON THE DATE HEREOF, AND WE ASSUME NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. EACH FORWARD-LOOKING STATEMENT SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND NOTES THERETO IN PART I, ITEM 1, OF THIS QUARTERLY REPORT AND WITH THE INFORMATION CONTAINED IN ITEM 2 TOGETHER WITH MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION CONTAINED IN OUR ANNUAL REPORT ON FORM 10-KSB FOR THE YEAR ENDED JUNE 30, 2008, INCLUDING, BUT NOT LIMITED TO, THE SECTION THEREIN ENTITLED "RISK FACTORS."

PART I. FINANCIAL INFORMATION

TECHNEST HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2008 AND JUNE 30, 2008

	December 31, 2008		June 30, 2008
	(unaudited)
ASSETS

Current Assets
Cash and cash equivalents	$	114,051	$	76,761
Accounts receivable		272,127		600,908
Unbilled receivables		-		23,888
Inventory		66,652		36,542
Restricted cash		218,658		237,288
Prepaid expenses and other current assets		20,993		74,233
Receivable from sale of EOIR		23,000,000		23,000,000
Total Current Assets		23,692,481		24,049,620

Property and Equipment – Net of accumulated depreciation of $118,144 and $109,467		52,620		78,413

Other Assets
Deposits		28,525		28,525
Definite-lived intangible assets – Net of accumulated amortization of $1,258,369 and $1,095,999		481,383		635,111
Goodwill		4,876,038		4,876,038
Total Other Assets		5,385,946		5,539,674

Total Assets	$	29,131,047	$	29,667,707


LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY

Current Liabilities
Accounts payable	$	658,166	$	379,710
Accrued expenses and other current liabilities		3,119,142		3,796,502
Accrued state income taxes		127,000		127,000
Deferred tax liability		494,400		732,000
Total Current Liabilities		4,398,708		5,035,212

Total Liabilities		4,398,708		5,035,212

See notes to condensed consolidated financial statements.

TECHNEST HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS (concluded)

	December 31, 2008			June 30, 2008
	(unaudited)
Non-controlling interest		-			-

Series D Redeemable, Convertible Preferred Stock - $.0001 par value;
3,000 shares authorized; 1,300 and 0 shares issued and outstanding at
December 31, and June 30, 2008, respectively (preference in liquidation of
$1,316,431 at December 31, 2008)		1,316,431			-

Commitments and Contingencies

Stockholders’ Equity
Series A Convertible Preferred Stock - $.001 par value; 150 shares authorized;
64.325 shares issued and outstanding (preference in liquidation of
$64,325 at December 31, 2008)		-			-
Series C Convertible Preferred Stock - $.001 par value; 1,149,425 shares
authorized; 402,301 issued and outstanding (preference in liquidation
of $875,005 at December 31, 2008)		402			402
Common stock - par value $.001 per share; 495,000,000 shares authorized;
20,676,211 and 20,505,335 shares issued and outstanding		20,675			20,504
Additional paid-in capital		37,233,600			37,792,582
Accumulated deficit		(13,838,769	)		(13,180,993	)
Total Stockholders’ Equity		23,415,908			24,632,495

Total Liabilities, Redeemable Preferred Stock and Stockholders’ Equity	$	29,131,047		$	29,667,707

See notes to condensed consolidated financial statements.

TECHNEST HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2008 AND 2007

(Unaudited)

	2008			2007

Revenues	$	1,215,163		$	1,323,573

Cost of Revenues		675,899			729,234

Gross Profit		539,264			594,339

Operating Expenses
Selling, general and administrative		1,157,068			2,547,952
Research and development		111,935			-
Amortization of intangible assets		162,370			162,370
Total Operating Expenses		1,431,373			2,710,322

Operating Loss from continuing operations		(892,109	)		(2,115,983	)

Other Income (Expenses), Net
Other income (expense)		(3,267	)		152
Interest expense		-			(11,329	)
Total Other Expenses, Net		(3,267	)		(11,177	)

Loss from continuing operations before non-controlling interest		(895,376	)		(2,127,160	)
Non-controlling interest in net loss of subsidiary		-			-
Net Loss from continuing operations before income taxes		(895,376	)		(2,127,160	)
Income tax benefit		237,600			-
Net Loss from continuing operations		(657,776	)		(2,127,160	)

Net Loss from discontinued operations
(including loss on disposal in 2007 of $7,949,039)		-			(9,211,778	)

Net Loss		(657,776	)		(11,338,938	)

Deemed Dividend on Series D Redeemable Preferred Stock		1,121,431			-

Net Loss Applicable to Common Shareholders	$	(1,779,207	)	$	(11,338,938	)

Basic and Diluted Loss Per Common Share
From continuing operations	$	(0.09	)	$	(0.11	)
From discontinued operations	$	-		$	(0.49	)
Net Loss per share - basic and diluted	$	(0.09	)	$	(0.60	)

Weighted Average Number of Common Shares Outstanding
Basic and diluted		20,662,486			19,025,636

See notes to condensed consolidated financial statements.

TECHNEST HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED DECEMBER 31, 2008 AND 2007

(Unaudited)

	2008			2007

Revenues	$	767,959		$	761,800

Cost of Revenues		401,359			520,316

Gross Profit		366,600			241,484

Operating Expenses
Selling, general and administrative		633,885			530,481
Research and development		38,691			-
Amortization of intangible assets		81,185			81,185
Total Operating Expenses		753,761			611,666

Operating Loss from continuing operations		(387,161	)		(370,182	)

Other Income (Expenses), Net
Other income (expense)		(4,438	)		20
Interest expense		-			(3,270	)
Total Other Expenses, Net		(4,438	)		(3,250	)

Loss from continuing operations before non-controlling interest		(391,599	)		(373,432	)
Non-controlling interest in net loss of subsidiary		-			-
Net Loss from continuing operations before income taxes		(391,599	)		(373,432	)
Income tax benefit		80,600			-
Net Loss from continuing operations		(310,999	)		(373,432	)

Net Loss from discontinued operations
(including loss on disposal in 2007 of $7,949,039)		-			(10,056,641	)

Net Loss		(310,999	)		(10,430,073	)

Deemed Dividend on Series D Redeemable Preferred Stock		1,121,431			-

Net Loss Applicable to Common Shareholders	$	(1,432,430	)	$	(10,430,073	)

Basic and Diluted Loss Per Common Share
From continuing operations	$	(0.07	)	$	(0.02	)
From discontinued operations	$	-		$	(0.50	)
Net Loss per share - basic and diluted	$	(0.07	)	$	(0.52	)

Weighted Average Number of Common Shares Outstanding
Basic and diluted		20,676,211			20,105,342

See notes to condensed consolidated financial statements.

TECHNEST HOLDINGS, INC.

CONSOLIDATED STATEMENT

OF CHANGES IN STOCKHOLDERS' EQUITY

FOR THE SIX MONTHS ENDED DECEMBER 31, 2008

(Unaudited)

					Series A				Series C
					Convertible				Convertible
	Common stock				Preferred stock				Preferred stock
	Shares		Amount		Shares		Amount		Shares		Amount

Balance - June 30, 2008		20,505,335	$	20,504		64	$	-		402,301	$	402

Issuance and amortization of stock based compensation related to restricted stock grants		170,876		171		-		-		-		-

Beneficial conversion feature on Series D redeemable, convertible preferred stock		-		-		-		-		-		-

Accretion of Series D redeemable, convertible preferred stock to redemption value		-		-		-		-		-		-

Accretion of dividend on Series D redeemable, convertible preferred stock		-		-		-		-		-		-

Net loss		-		-		-		-		-		-

Balance - December 31, 2008		20,676,211	$	20,675		64	$	-		402,301	$	402

	Additional						Total
	Paid-In			Accumulated			Stockholders'
	Capital			Deficit			Equity
	Amount			Amount			Amount

Balance - June 30, 2008	$	37,792,582		$	(13,180,993	)	$	24,632,495

Issuance and amortization of stock based compensation related to restricted stock grants		107,449			-			107,620

Beneficial conversion feature on Series D redeemable, convertible preferred stock		455,000			-			455,000

Accretion of Series D redeemable, convertible preferred stock to redemption value		(1,105,000	)		-			(1,105,000	)

Accretion of dividend on Series D redeemable, convertible preferred stock		(16,431	)		-			(16,431	)

Net loss		-			(657,776	)		(657,776	)

Balance - December 31, 2008	$	37,233,600		$	(13,838,769	)	$	23,415,908

See notes to condensed consolidated financial statements.

TECHNEST HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2008 AND 2007

(Unaudited)

	2008			2007

Cash Flows From Operating Activities:
Net loss	$	(657,776	)	$	(11,338,938	)

Adjustment to reconcile net loss to net cash (used in) provided by
operating activities:
Depreciation and amortization of property and equipment		18,091			21,821
Amortization of intangible assets		162,370			162,370
Non-cash interest expense		-			1,538,276
Deferred income tax benefit		(237,600	)		-
Stock-based compensation to employees and directors		107,620			264,308
Stock issued in connection with termination of stockholder and license agreement		-			1,380,000
Loss on sale of equipment		5,974			-
Loss on disposal of discontinued operations		-			7,949,039
Changes in operating assets and liabilities:
Accounts receivable		328,781			8,851,172
Unbilled receivables		23,888			1,515,558
Inventory and work in process		(30,110	)		(2,525	)
Restricted cash		18,630			(235,000	)
Deposits, prepaid expenses and other current assets		53,240			87,044
Accounts payable		278,456			(7,184,252	)
Unearned revenue		-			(255,816	)
Accrued expenses and other current liabilities		(677,360	)		(2,001,181	)
Due to related parties		-			(290,036	)
Net Cash (Used In) Provided by Operating Activities		(605,796	)		461,840

TECHNEST HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2008 AND 2007 (concluded)

(Unaudited)

	2008			2007

Cash Flows From Investing Activities:
Proceeds from sale of equipment		1,728			-
Purchase of property and equipment		-			(38,581	)
Proceeds from disposal of discontinued operations, net of transaction costs		-			10,567,615
Acquisition of new definite-lived intangible assets		(8,642	)		-
Net Cash (Used In) Provided by Investing Activities		(6,914	)		10,529,034

Cash Flows From Financing Activities:
Proceeds from issuance of Series D Redeemable, Convertible Preferred Stock		650,000			-
Repayment of revolving line of credit, net		-			(4,562,808	)
Repayment of term loan		-			(2,166,667	)
Repayment of notes payable		-			(3,056,131	)
Net Cash Provided by (Used In) Financing Activities		650,000			(9,785,606	)

Net Increase In Cash		37,290			1,205,268

Cash and Cash Equivalents - Beginning of Period		76,761			1,140,227

Cash and Cash Equivalents - End of Period	$	114,051		$	2,345,495

Supplemental Disclosures of Cash Flow Information:
Cash paid during the periods for:
Interest	$	-		$	1,329,411
Taxes	$	-		$	-

Non-cash Investing and Financing Activities:
Beneficial conversion on Series D Redeemable, Convertible Preferred Stock	$	455,000		$	-
Accretion of Series D Redeemable, Convertible Preferred Stock and deemed dividend	$	1,105,000		$	-
Accrued dividend on Series D Redeemable, Convertible Preferred Stock	$	16,431		$	-

See notes to condensed consolidated financial statements.

TECHNEST HOLDINGS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2008 AND 2007

(Unaudited)

1. NATURE OF OPERATIONS

Business

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

Sale of EOIR Technologies, Inc.

In May 2007, the Company’s Board of Directors approved a plan to divest the operations of EOIR. On September 10, 2007, Technest and its wholly owned subsidiary, EOIR Technologies, Inc. (“EOIR”), entered into a Stock Purchase Agreement with EOIR Holdings LLC (“LLC”), a Delaware limited liability company, pursuant to which Technest agreed to sell EOIR to LLC (see Note 3). LLC is an entity formed on August 9, 2007 by The White Oak Group, Inc., an Atlanta, Georgia based private investment firm, for the purposes of facilitating this transaction. The White Oak Group, Inc. is focused on investments in the aerospace and defense industry, with an emphasis on the following sectors: Homeland security (detection and deterrence); avionics and instrumentation; command and control; and communication networks and services.

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 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 Stock Purchase Agreement.

On August 26, 2008, LLC notified Technest that, in their opinion, the conditions set forth in the Stock Purchase Agreement triggering payment of the Contingent Purchase Price had not been satisfied. LLC provided no explanation for its contention. Technest strongly believes that all conditions of the Stock Purchase Agreement were met, and LLC’s position is without merit. Technest is aggressively pursuing payment of the Contingent Purchase Price in accordance with the Stock Purchase Agreement. Accordingly on September 24, 2008, Technest notified LLC that it has filed for final and binding arbitration of the matter in accordance with the terms of the Stock Purchase Agreement. On February 4, 2009, the duly selected arbitration panel from the American Arbitration Association (AAA) notified the parties that the arbitration hearing was scheduled to commence on June 22, 2009. Any reduction in the amount of the Contingent Purchase Price as a result of arbitration or settlement would reduce the amount of the gain on disposal of EOIR, net of tax.

In accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141, “Business Combinations”, the Company recorded the $23 million of contingent consideration in the quarter ended March 31, 2008. 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 Company continues to believe the outcome of the contingency is determinable beyond a reasonable doubt. EOIR is presented as a discontinued operation in the consolidated financial statements in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (see Note 3).

2. BASIS OF PRESENTATION

Basis of Presentation

The consolidated financial statements include the accounts of Technest and its wholly-owned subsidiary, Genex Technologies, Inc. Also included in the consolidation are the results of Technest’s 49% owned subsidiary Technest, Inc. (see Note 4). Technest, Inc. conducts research and development in the field of computer vision technology and 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. In accordance with Financial Accounting Standards Board Interpretation No. 46R, Consolidation of Variable Interest Entities (FIN 46R), 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 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. In accordance with SFAS No. 144, the assets, liabilities and results of operations of this consolidated subsidiary have been classified as a discontinued operation for all periods presented in the accompanying consolidated financial statements (see Note 3).

The accompanying unaudited condensed consolidated financial statements of Technest have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, without being audited, pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the financial statements not misleading have been included. Operating results for the six months ended December 31, 2008 are not necessarily indicative of the result that may be expected for the year ending June 30, 2009. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company's annual report on Form 10-KSB for the year ended June 30, 2008 filed with the Securities and Exchange Commission.

Recent Accounting Pronouncements

The Company adopted Statement of Financial Accounting Standards No. 157 (“SFAS 157”), Fair Value Measurements, which provides a framework for measuring fair value under generally accepted accounting principles. This Statement became effective for the Company on July 1, 2008 and did not have a material impact on the Company’s consolidated financial statements. The Company also adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company did not elect fair value treatment for any financial assets or liabilities upon adoption. SFAS 159 also became effective for the Company on July 1, 2008 and did not have a material impact on the Company’s consolidated financial statements.

In accordance with SFAS 157, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value:

Level 1 — Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. For example, Level 2 assets and liabilities may include debt securities with quoted prices that are traded less frequently than exchange-traded instruments or mortgage loans held for sale, for which the fair value is based on what the securitization market is currently offering for mortgage loans with similar characteristics.

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The Company has no such assets or liabilities at July 1, 2008 and December 31, 2008.

Also, the Company may be required, from time to time, to measure certain other financial assets on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The Company had no such assets as of December 31, 2008.

In December 2007, the FASB issued Statement 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 is not expected to have a material impact on the consolidated financial statements of the Company.

In June 2008, the FASB ratified EITF Issue No. 07-5, "Determining Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity's Own Stock" (EITF 07-5). 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 is in the process of evaluating the impacts, if any, of adopting this EITF.

3. DISCONTINUED OPERATIONS

For the three and six months ended December 31, 2007, the operations of EOIR have been reported in discontinued operations in the Statements of Operations in accordance with SFAS No. 144, paragraph 42. Revenues and net loss from discontinued operations were as follows:

	3 Months Ended 12/31/2007			6 Months Ended 12/31/2007

Revenues from discontinued operations	$	28,281,311		$	46,099,851

Net loss from discontinued operations	$	(2,107,602	)	$	(1,262,739	)

Certain general and administrative and interest expenses of the Company that are clearly associated with EOIR totaling $4,075,022 in the six months ended December 31, 2007 have been included in the net loss from discontinued operations.

4. 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. The Company allocates certain general and administrative and overhead expenses to Technest, Inc. and in the three and six months ended December 31, 2008, the Company allocated approximately $53,000 of such expenses to Technest, Inc.

5. DEFINITE-LIVED INTANGIBLE ASSETS

Definite-lived intangible assets consist of the following:

	December 2008		Useful life (years)
Patents - commercialized technology	$	440,000	5
Patents - other		169,752	15
Customer relationships and contracts		1,130,000	5
Accumulated amortization		(1,258,369)
Net definite-lived intangible asset	$	481,383

Amortization expense was $162,370 for each of the six months ended December 31, 2008 and 2007.

6. SERIES D REDEEMABLE, CONVERTIBLE PREFERRED STOCK

On October 1, 2008, the Company’s Board of Directors approved the designation 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 by the Company at a price equal to the stated value plus dividends upon receipt of the Contingent Purchase Price (see Note 1). 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 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). $600,000 of these proceeds was used in connection with the Deer Creek Settlement (see Note 13) and the remainder proceeds are for working capital purposes.

The Company has determined that as of the date of issuance there was a beneficial conversion feature in the aggregate amount of $455,000 for the six months ended December 31, 2008. 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 $1,300,000 immediately upon issuance. This resulted in a deemed dividend in the amount of $1,105,000. 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 $16,431 at December 31, 2008.

At December 31, 2008, the Company had 1,300 shares of Series D Preferred issued and outstanding. The Series D Preferred has a liquidation preference of $1,316,431 at December 31, 2008.

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 December 31, 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 December 31, 2008, the Company had 402,301 shares of Series C Preferred Stock issued and outstanding.

Common Stock Issuances

During the six months ended December 31, 2008, 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.

●	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			649,286
Reserve for conversion of Series A Convertible Preferred Stock			306,047
Reserve for conversion of Series C Convertible Preferred Stock			402,301
Reserve for conversion of Series D Redeemable, Convertible Preferred Stock			9,811,245
Total common stock reserves			11,168,879

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 periods ended December 31, 2008 and 2007 and there are currently no options outstanding under the Plan.

Warrants

Summary information with respect to warrants granted is as follows:

	Number of Shares		Weighted Average Exercise Price
Balance, July 1, 2008		649,286	$	5.00
Issued		-		-
Expired		-		-
Balance, December 31, 2008		649,286	$	5.00

The following table summarizes the Company's warrants outstanding at December 31, 2008:

Exercise price		Number		Expiration Date
$	6.50		374,286	02/14/2010
$	5.85		75,000	08/03/2013
$	1.89		200,000	07/17/2011
			649,286
Weighted average remaining life					1.7 years

As of December 31, 2008 all warrants are exercisable.

Stock Award Plan

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

Technest has broad discretion in making grants under the Plan and may make grants subject to such terms and conditions as determined by the board of directors or the committee appointed by the board of directors to administer the Plan. Stock awards under the Plan will be subject to the terms and conditions, including any applicable purchase price and any provisions pursuant to which the stock may be forfeited, set forth in the document making the award. Pursuant to the Stockholder Agreement with Markland (see Note 10), (i) awards relating to no more than 500,000 shares may be granted in calendar year 2006 (the “2006 Awards”), (ii) the 2006 Awards shall vest no earlier than twelve (12) months following the date of grant of such awards, and (iii) awards granted on or after January 1, 2007 shall vest no more frequently than in four equal quarterly installments.

Total stock-based compensation related to shares that vested in the six months ended December 31, 2008 and 2007 was $107,620 and $264,308, respectively.

As of December 31, 2008, 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 three and six months ended December, 2008 consists of the following:

	Shares Potentially Issuable
	2008		2007
Series A Convertible Preferred Stock		306,047		306,047
Series C Convertible Preferred Stock		402,294		632,185
Series D Redeemable, Convertible Preferred Stock		6,582,155		-
Warrants		649,286		649,286
Total		7,939,782		1,587,518

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 $15,131, increasing annually by 3%. Rent expense for continuing operations in the three months ended December 31, 2008 and 2007 was $55,550 and $44,071, respectively.

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

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

11. INCOME TAXES

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

The Company's deferred tax assets consist primarily of the tax effects of its net operating loss carry forwards. As of December 31, 2008, the Company had a valuation allowance of $2,369,000. The Company has recorded a valuation allowance against deferred tax assets as management has determined certain net operating loss carryforwards will not be available due to Internal Revenue Code Section 382 ownership changes. In the six months ended December 31, 2008, there was no change in the valuation allowance. As of December 31, 2008, the Company has net operating loss carryforwards not subject to IRC Section 382 limitations of $3,333,000 which begin to expire in 2024.

There was no provision for federal or state income taxes for the six months ended December 31, 2007 due to the Company's operating losses and a full valuation reserve on deferred tax assets. As of December 31, 2007, the Company had provided a full valuation reserve against the deferred tax assets because of the Company's loss history and significant uncertainty surrounding the Company's ability to utilize its net operating loss and tax credit carryforward.

12. EMPLOYEE BENEFIT PLANS

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

Contributions and other costs of this plan in the three months ended December 31, 2008 and 2007 were $21,746 and $22,231, respectively.

13. LITIGATION

H&H

On or about July 23, 1998, H & H Acquisition Corporation, individually and purportedly on behalf of Technest Holdings, commenced an action in United States District Court, Southern District of New York entitled H & H Acquisition Corp., individually and on behalf of Technest Holdings, Inc. v. Financial Intranet Holdings, Inc., Technest Holdings, Inc., F/K /A Financial Intranet, Inc., Ben Stein, Interwest Transfer Co., Steven A. Sanders, Michael Sheppard, Maura Marx, Henry A. Schwartz, Leonard Gotshalk, Gotshalk Enterprises, Law Office of Steven A. Sanders, P.C. and Beckman, Millman & Sanders, LLP, 98 Civ. 5269. The plaintiffs are purporting to act on behalf of Technest in the context of a shareholder’s derivative suit. The action’s principal basis appears to be a claim that Ben Stein, a former director and Secretary of Technest, wrongfully claims ownership of shares of common stock that Stein agreed to purchase from H&H. According to H&H, these shares belong to them. H&H asserts sixteen causes of action. Only some of the causes of action make allegations against Technest Holdings, Inc., Michael Sheppard and Maura Marx, former officers of Technest.

Technest, Mr. Sheppard and Ms. Marx believe that the claims against Technest, Mr. Sheppard and Ms. Marx are without merit and are vigorously defending the action. Technest, Mr. Sheppard and Ms. Marx have filed responses to the claims against them. The responses deny all material allegations of the complaint and the claim asserted by the transfer agent, and asserts a variety of defenses.

In June 2006, the court directed the parties to address the court’s continuing subject matter jurisdiction over Technest in the H&H matter. Technest responded to the court’s direction and believes that as a result of intervening corporate actions, the injunctive relief sought by the plaintiff which gives rise the court’s subject matter jurisdiction in this case has been rendered moot, thereby depriving the court of continuing subject matter jurisdiction. On July 31, 2008, the court denied the motion to dismiss for lack of subject matter jurisdiction. On September 5, 2008, in accordance with the judge’s order of July 31, 2008, Technest, Mr. Sheppard and Ms. Marx filed a motion for summary judgment to dismiss all claims against them. We intend to defend our position vigorously and cannot make any assurances about the litigation’s outcome.

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 have 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).

The White Oak Group

On August 26, 2008, EOIR Holdings LLC (“LLC”) notified Technest that, in their opinion, the conditions set forth in the Stock Purchase Agreement triggering payment of the Contingent Purchase Price have not been satisfied. LLC provided no explanation for its contention. Technest strongly believes that all conditions of the Stock Purchase Agreement were met, and LLC’s position is without merit. Technest is aggressively pursuing payment of the Contingent Purchase Price in accordance with the Stock Purchase Agreement. Accordingly on September 24, 2008, Technest notified LLC that it has filed for final and binding arbitration of the matter in accordance with the terms of the Stock Purchase Agreement. On February 4, 2009, the duly selected arbitration panel from the American Arbitration Association (AAA) notified the parties that the arbitration hearing was scheduled to commence on June 22, 2009. Technest is seeking payment of approximately $22 million from LLC representing the contingent portion of the purchase price to be paid by LLC upon the successful re-award to EOIR of the contract with the NVESD less an amount due to LLC for a final working capital adjustment, which is included in accrued expenses and other current liabilities on the Consolidated Balance Sheets. LLC is an entity formed for the purpose of facilitating the acquisition of EOIR by The White Oak Group, Inc., an Atlanta based private equity firm.

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

The following discussion and analysis of our financial condition and results of operations for our financial quarter ending December 31, 2008 should be read together with our financial statements and related notes included elsewhere in this report.

FORWARD LOOKING STATEMENTS

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

OVERVIEW

General

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

Our products leverage several core technology platforms, including:

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

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

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

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

Medical Devices Division

3D Digitizer Systems provide turnkey three-dimensional (3D) imaging solutions.

The EARCAD (Ear Impression) system has been customized for applications in the custom hearing aid and ear mold markets. The EARCAD system automates the process of converting a physical ear impression into a 3D model for streamlined production and quality control. Initial applications are for manufacturers looking to streamline their operations and enables audiology practices to improve turnaround times and accuracy. Approximately 2.5 million hearing aids were sold in the United States in 2007 and the retail market world wide was over $6 billion. Market penetration still has considerable potential growth as 17.6% of the US population, or 56 million people, are over the age of 60 with increasing life expectancy. EARCAD will provide audiologists and manufacturers with a total value added solution from its range of impression and non impression scanners and associated software. In particular the non impression scanner is well suited to the new “behind the ear” fit models which are approaching 50% of all hearing aids sold. The first of these systems was sold in April 2008 to a major international hearing aid manufacturer following a successful debut at the annual American Audiology conference.

The AFOCAD is being developed as a Rapid Design and Fabrication Product/ Service Platform for Custom-Fabricated, Patient Specific, Ankle-Foot Orthoses (AFOs) in collaboration with Northeastern University and Spaulding Rehabilitation hospital in Boston, Massachusetts. The current market size for AFO’s is approximately $1 billion. Many stroke and diabetic patients will require an AFO as a result of their condition. The AFOCAD system is projected to be available before the end of the current calendar year.

The Dental Digitizer™ is being developed for applications in the dental industry. The system automates the process of creating 3D models from dental molds and impressions in a rapid and accurate process. This system offers significant benefits in cost, quality, and turnaround times for dental labs, dentists, and orthodontists in the creation of dental crowns, bridges, aligners, braces, and other dental solutions. In addition the Company is developing a hand held intra oral scanner for taking digital impressions.

Defense and Security Division - 3D-ID

Our major products, developed and in development, include our OmniEye™ Wellcam, OmniEye™ Cerberus, Smart Optical Sensor (SOS), Smart Suite™, OmniEye Viewer, Small Tactical Ubiquitous Detection System (STUDS), 3D SketchArtist, and 3D FaceCam.

OmniEye™ Wellcam is an ultra light, portable 360 degree field of view camera which can be used in field applications, such as detection of underground weapon caches and search and rescue beneath building rubble, due to its durability. OmniEye™ Cerberus is a re-configurable multi-sensor system that is designed for long distance infrared and visible light detection. OmniEye™ Cerberus delivers this flexibility while still maintaining seamless panoramic coverage up to 360 degrees. During the three months ended December 31, 2008, the company delivered 21 Wellcams to the DoD pursuant to it’s IDIQ contract.

SOS high speed image processing platform powers our Smart Suite™ algorithms, enhancing both new and existing sensor systems with capabilities including: reliable target detection, motion tracking, and object classification and recognition. Smart Suite™ algorithms 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.

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. The Company has received an order for 25 copies for use by the Los Angeles Police Department.

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. In April 2008, the Company delivered its first outdoor facial recognition system to the US Army for evaluation.

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 opportunities.

RESULTS OF OPERATIONS

Recent Developments

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, Technest, Inc., 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. This transaction occurred on October 1, 2008 and the novation of contracts commenced 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.

Three and Six months ended December 31, 2008 compared with the Three and Six months ended December 31, 2007

Revenues

Technest had $767,959 in revenues from continuing operations during the three months ended December 31, 2008 compared with $761,800 during the three months ended December 31, 2007. During the three months ended December 31, 2008 the Company delivered 21 WellCams pursuant to our IDIQ contract with the Department of Defense. At December 31, 2008, the Company’s backlog of funded contracts was approximately $1.8 million.

Technest had $1,215,163 in revenues from continuing operations during the six months ended December 31, 2008 compared with $1,323,573 during the six months ended December 31, 2007. These revenues were largely generated by Small Business Innovative Research grants (SBIR’s) in the field of 3-dimensional imaging. We use the revenue from these grants to develop future potential products for our business. By their nature these revenues are not consistent from quarter to quarter.

Gross profit

The gross profit for the three months ended December 31, 2008 was $366,600 or 48% of revenues. The gross profit for the three months ended December 31, 2007 was $241,484 or 32% of revenues. The gross profit margin for the three months ended December 2007 was higher due to better profit margins on firm fixed priced contracts.

The gross profit from continuing operations for the six months ended December 31, 2008 was $539,264 or 44% of revenues. The gross profit for the six months ended December 31, 2007 was $594,339 or 45% of revenues. Technest expects to expand its revenue base to include commercial product revenues and, accordingly, gross profit on future revenues may differ.

Selling, general and administrative expenses

Selling, general and administrative expenses for the three months ended December 31, 2008 and 2007 were $633,885 and $530,481, respectively. These expenses consisted primarily of payroll related expenses and professional fees.

Certain general and administrative expenses of the Company in 2007 that are clearly associated with EOIR have been included in the net loss from discontinued operations. Such amounts totaled $1,810,075, including certain severance payments triggered by the sale of EOIR, in the three months ended December 31, 2007.

Selling, general and administrative expenses for the six months ended December 31, 2008 and 2007 were $1,157,068 and $2,547,952. The 2008 amount relates primarily to payroll related expenses and professional fees. The 2007 amount includes payroll related expenses, professional fees, a $207,491 non-cash amortization of stock-based compensation to directors and officers and a $1,380,000 expense related to the fair value of stock issued in connection with the termination of certain sections of a stockholder agreement dated March 13, 2007 and of a licensing agreement dated March 13, 2007.

Certain general and administrative expenses of the Company in 2007 that are clearly associated with EOIR totaling approximately $4,075,022 in the six months ended December 31, 2007 have been included in the net loss from discontinued operations

Research and development

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

Amortization of intangible assets

Amortization of intangible assets for the three months and six months ended December 31 was $81,185 and $162,370, respectively, for both 2008 and 2007. Amortization expense relates to the definite-lived intangible assets acquired in conjunction with Genex Technologies.

Operating loss

The operating loss from continuing operations for the three months ended December 31, 2008 was $387,161 compared with $370,182 for the three months ended December 31, 2007.

The operating loss from continuing operations for the six months ended December 31, 2008 was $892,109 compared with $2,115,983 for the six months ended December 31, 2007.

Discontinued Operations

The net loss from EOIR’s operations was $2,107,602 in the three months ended December 31, 2007 including costs of $1,810,075 incurred by Technest that are clearly associated with the discontinued operation.

The net loss from EOIR’s operations was $1,262,739 in the six months ended December 31, 2007 including costs of $4,075,022 incurred by Technest that are clearly associated with the discontinued operation.

The loss from discontinued operations for the three and six month periods ended December 31, 2007 includes a loss on disposal $7,949,039 on the sale of EOIR.

Net Loss applicable to common shareholders

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

The net loss attributable to common shareholders for the three and six months ended December 31, 2007 was $10,430,073 and $11,338,938, respectively.

Liquidity and Capital Resources

Cash and Working Capital

On December 31, 2008, Technest had a positive working capital balance of $19,293,773. Net cash used in operating activities for the three months ended December 31, 2008 was $605,796, including a non recurring legal settlement of $600,000.

Cash Used in Investing Activities

In the six months ended December 31, 2008, Technest used cash of $8,642 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 $1,728 resulting in a loss on the sale of $5,974.

Cash Used in Financing Activities

In October 2008, the Company received proceeds of $650,000 related to the issuance of their Series D Preferred Stock (See Note 6).

Sources of Liquidity

During the six months ended December 31, 2008, 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 due to the Company from the sale of EOIR. On August 26, 2008, LLC notified Technest that, in their opinion, the conditions set forth in the Stock Purchase Agreement triggering payment of the Contingent Purchase Price had not been satisfied. LLC provided no explanation for its contention. Technest strongly believes that all conditions of the Stock Purchase Agreement were met, and LLC’s position is without merit. Technest is aggressively pursuing payment of the Contingent Purchase Price in accordance with the Stock Purchase Agreement. Accordingly on September 24, 2008, Technest notified LLC that it has filed for final and binding arbitration of the matter in accordance with the terms of the Stock Purchase Agreement. On February 4, 2009, the duly selected arbitration panel from the American Arbitration Association (AAA) notified the parties that the arbitration hearing was scheduled to commence on June 22, 2009.

The Company is also expanding its efforts in commercial sales and believes that these activities will contribute positively in fiscal 2009. In addition, the Company is aggressively cutting costs and the Company’s officers are deferring a portion of their remuneration. As a result of the forgoing, management believes that Technest has sufficient sources of liquidity to satisfy its obligations for at least the next 12 months.

Off Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders. As of December 31, 2008, Technest had warrants outstanding for the purchase of 649,286 shares of common stock. However, due to the net share settlement provisions of these warrants, Technest does not expect any material cash proceeds upon exercise.

Effect of inflation and changes in prices

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

Critical Accounting Policies and Estimates

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

Our critical accounting policies and use of estimates are discussed in and should be read in conjunction with the annual consolidated financial statements and notes included in the latest Form 10KSB, as filed with the SEC, which includes audited consolidated financial statements for our fiscal years ended June 30, 2008 and 2007.

Item 4T. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

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

Changes in Internal Control Over Financial Reporting.

There was no change in our internal control over financial reporting during the quarter ended December 31, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

H&H

Deer Creek

The White Oak Group

On August 26, 2008, EOIR Holdings LLC (“LLC”) notified Technest that, in their opinion, the conditions set forth in the Stock Purchase Agreement triggering payment of the Contingent Purchase Price have not been satisfied. LLC provided no explanation for its contention. Technest strongly believes that all conditions of the Stock Purchase Agreement were met, and LLC’s position is without merit. Technest is aggressively pursuing payment of the Contingent Purchase Price in accordance with the Stock Purchase Agreement. Accordingly on September 24, 2008, Technest notified LLC that it has filed for final and binding arbitration of the matter in accordance with the terms of the Stock Purchase Agreement. On February 4, 2009, the duly selected arbitration panel from the American Arbitration Association (AAA) notified the parties that the arbitration hearing was scheduled to commence on June 22, 2009. Technest is seeking payment of approximately $22 million from LLC representing the contingent portion of the purchase price to be paid by LLC upon the successful re-award to EOIR of the contract with the NVESD less an amount due to LLC for a final working capital adjustment. LLC is an entity formed for the purpose of facilitating the acquisition of EOIR by The White Oak Group, Inc., an Atlanta based private equity firm.

ITEM 1A. Risk Factors

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

Technest has initiated arbitration proceedings for the payment of the $23,000,000 contingent purchase price under the Stock Purchase Agreement for the sale of EOIR. If Technest is unsuccessful in the arbitration and the contingent purchase price is not paid, Technest’s financial condition will be significantly harmed.

On September 24, 2008, we commenced arbitration proceedings against EOIR Holdings LLC (“LLC”) in accordance with the Stock Purchase Agreement dated September 10, 2007. The arbitration hearing is scheduled to begin on June 22, 2009. We are seeking payment of approximately $22 million from Holdings, which acquired our former subsidiary, E-OIR Technologies, Inc. (“EOIR”) on December 31, 2007. The $22 million payment represents the contingent portion of the purchase price to be paid by LLC upon the successful re-award to EOIR of the contract with the U.S. Army's Night Vision and Electronics Sensors Directorate (“NVESD”). On August 4, 2008, EOIR was awarded the contract with the U.S. Army’s NVESD. We believe the payment became due and payable on August 21, 2008. If we are not successful in the arbitration and the contingent purchase price is not paid, our financial condition will be significantly harmed.

We have a limited operating history. As a result, it may be difficult to evaluate our prospects for profitable operations.

Technest has a limited operating history on which a potential investor may base an evaluation of us, our prospects and our ability to operate profitably. If Technest is unable to sustain profitable operations, investors may lose their entire investment in Technest.

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

Technest has had net operating losses each year since its inception. As of December 31, 2008, our accumulated deficit was approximately $13.8 million. If Technest continues to suffer losses as it has in the past, investors may not receive any return on their investment and may lose their entire investment.

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

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

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

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. In addition, Technest cannot assure you that there will not be substantial unanticipated costs associated with the sale process, that the sale activities will not result in a decrease in revenues in Technest’s other businesses and/or a decrease in the value of Technest common stock, or that there will not be other material adverse effects from the sale. If the benefits of the sale do not meet the market expectations, the market price of Technest common stock may decline.

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

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

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

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

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

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

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

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

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.

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. Government such that the loss of any one contract could materially reduce our revenues. As a result, our financial condition and our stock price would be adversely affected.

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

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

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

changes in Government programs or requirements;

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

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

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 January 27, 2009, Southridge Partners LP, together with its affiliates, were the largest stockholders of Technest, owning approximately 63% of Technest’s outstanding common stock as the record holders of 12,903,872 shares. Recently, Southridge appointed three members to Technest’s board of directors (currently, there are a total of six directors on Technest’s board of directors). As a result, Southridge possesses significant influence over our affairs. Southridge’s stock ownership and relationships with members of Technest’s board of directors may have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of Technest, which in turn could materially and adversely affect the market price of Technest’s common stock.

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

A very small number of investors collectively owned more than 63% 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.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

·	variations in our quarterly results of operations;

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

·	acquisitions or strategic alliances involving us or our competitors;

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

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

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

Risks Relating to New Corporate Governance Standards

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

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

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

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

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

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

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

ITEM 6. Exhibits

Exhibit No.	Description	Filed with this Quarterly Report	Incorporated by reference
			Form	Filing Date	Exhibit No.
4.1	Technest Series D 5% Convertible Preferred Stock Certificate of Designations filed with the Secretary of State of Nevada on October 1, 2008.		10-KSB	October 2, 2008	4.18
10.1	Securities Purchase Agreement dated October 30, 2008 between Technest Holdings, Inc. and Southridge Partners, LP.		8-K	November 5, 2008	10.1
31.1	Certification by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).	X
31.2	Certification by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).	X
32.1	Certification by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section 1350.	X

SIGNATURES

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


	TECHNEST HOLDINGS, INC.


Date: February 13, 2009	By:	/s/ Gino M. Pereira
		Gino M. Pereira Chief Executive Officer and President
Date: February 13, 2009	By:	/s/ Nitin V. Kotak
		Nitin V. Kotak Chief Financial Officer

Exhibit Index

Exhibit No.	Description	Filed with this Quarterly Report	Incorporated by reference
			Form	Filing Date	Exhibit No.
4.1	Technest Series D 5% Convertible Preferred Stock Certificate of Designations filed with the Secretary of State of Nevada on October 1, 2008.		10-KSB	October 2, 2008	4.18
10.1	Securities Purchase Agreement dated October 30, 2008 between Technest Holdings, Inc. and Southridge Partners, LP.		8-K	November 5, 2008	10.1
31.1	Certification by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).	X
31.2	Certification by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).	X
32.1	Certification by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section 1350.	X

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Avg

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