U.S.
SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-Q




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




For
      the quarterly period ended: September 30,
2008




OR




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




For
      the transition period from ______________ to
  ______________






Commission
File Number 000-27023






TECHNEST
HOLDINGS, INC.


(Exact
name of registrant as specified in its charter)




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




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


(Address of principal executive
offices and zip code)





(301)
767-2810


(Registrant’s telephone number,
including area code)




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to filed such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes 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
November 6, 2008, 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


SEPTEMBER
30, 2008






PagePART
      I.    FINANCIAL INFORMATION:Item
      1.       Financial Statements
      (Unaudited)Consolidated
      Balance Sheets at September 30, 2008 and June 30, 2008
            1Consolidated
      Statements of Operations for the Three Months Ended September 30, 2008 and
      2007
            3Consolidated
      Statement of Changes in Stockholders’ Equity for the Three Months Ended
      September 30, 2008
            4Consolidated
      Statements of Cash Flows for the Three Months Ended September 30, 2008 and
      2007
            5Notes
      to Condensed Consolidated Financial Statements
            7Item
      2.       Management’s Discussion and
      Analysis or Plan of Operation
            17Item
      4T.    Controls and Procedures
            23PART
      II.   OTHER INFORMATION
            23Item
      1.       Legal Proceedings
            23Item
      1A.    Risk Factors
            24Item
      6.       Exhibits
            32Signatures
            33




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








TECHNEST
      HOLDINGS, INC.CONSOLIDATED
      BALANCE SHEETSSEPTEMBER
      30, 2008 AND JUNE 30, 2008







ASSETS
            
            September 30,
      2008
            
            
            June 30,
      2008(unaudited)
            
            
            (audited)Current
      AssetsCash
      and cash equivalents
            
            $
            47,867
            
            
            $
            76,761Accounts
      receivables
            
            
            167,172
            
            
            
            600,908Unbilled
      receivables
            
            
            35,746
            
            
            
            23,888Inventory
      and work in process
            
            
            66,332
            
            
            
            36,542Restricted
      cash
            
            
            238,210
            
            
            
            237,288Prepaid
      expenses and other current assets
            
            
            74,724
            
            
            
            74,233Receivable
      from sale of EOIR
            
            
            23,000,000
            
            
            
            23,000,000Total
      Current Assets
            
            
            23,630,051
            
            
            
            24,049,620Property and Equipment–
      Net of accumulated depreciation $119,036 and $109,467
            
            
            68,844
            
            
            
            78,413Other
      AssetsDeposits
            
            
            28,525
            
            
            
            28,525Definitive-lived
      intangible assets – Net of accumulated amortization  $1,177,184
      and $1,095,999
            
            
            562,568
            
            
            
            635,111Goodwill
            
            
            4,876,038
            
            
            
            4,876,038Total
      Other Assets
            
            
            5,467,131
            
            
            
            5,539,674Total
      Assets
            
            $
            29,166,026
            
            
            $
            29,667,707LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      LiabilitiesAccounts
      payable
            
            $
            371,038
            
            
            $
            379,710Unearned
      revenue
            
            
            35,000
            
            
            
            -Accrued
      expenses and other current liabilities
            
            
            3,679,921
            
            
            
            3,796,502Accrued
      state income taxes
            
            
            127,000
            
            
            
            127,000Deferred
      tax liability
            
            
            575,000
            
            
            
            732,000Total
      Current Liabilities
            
            
            4,787,959
            
            
            
            5,035,212Total
      Liabilities
            
            
            4,787,959
            
            
            
            5,035,212






See notes
to condensed consolidated financial statements


1




TECHNEST
HOLDINGS, INC.


CONSOLIDATED
BALANCE SHEETS (concluded)









September 30,
      2008
            
            
            June 30,
      2008(unaudited)
            
            
            (audited)Commitments
      and ContingenciesStockholders’
      EquitySeries
      A Convertible Preferred Stock - $.001 par value; 150 shares authorized;
      64.325 shares issued and outstanding (preference in liquidation of $64,325
      at September 30, 2008 and June 30, 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 September
      30, 2008 and June 30, 2008)
            
            
            402
            
            
            
            402Common
      stock - par value $.001 per share; 495,000,000 shares authorized;
      20,676,211 and 20,505,335 shares issued and outstanding
            
            
            20,675
            
            
            
            20,504Additional
      paid-in capital
            
            
            37,884,760
            
            
            
            37,792,582Accumulated
      deficit
            
            
            (13,527,770
            )
            
            
            (13,180,993
            )Total
      Stockholders’ Equity
            
            
            24,378,067
            
            
            
            24,632,495Total
      Liabilities and Stockholders’ Equity
            
            $
            29,166,026
            
            
            $
            29,667,707See
      notes to condensed consolidated financial statements.


2





TECHNEST
      HOLDINGS, INC.CONSOLIDATED
      STATEMENTS OF OPERATIONSFOR
      THE THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
              (Unaudited)





2008
            
            
            2007Revenues
            
            $
            447,204
            
            
            $
            561,773Cost
      of Revenues
            
            
            274,540
            
            
            
            208,918Gross
      Profit
            
            
            172,664
            
            
            
            352,855Operating
      ExpensesSelling,
      general and administrative
            
            
            523,183
            
            
            
            2,017,471Research
      and development
            
            
            73,244
            
            
            
            -Amortization
      of intangible assets
            
            
            81,185
            
            
            
            81,185Total
      Operating Expenses
            
            
            677,612
            
            
            
            2,098,656Operating
      Loss from continuing operations
            
            
            (504,948
            )
            
            
            (1,745,801
            )Other
      Income (Expenses), NetOther
      income
            
            
            1,171
            
            
            
            132Interest
      expense
            
            
            -
            
            
            
            (8,059
            )Total
      Other Income (Expenses), Net
            
            
            1,171
            
            
            
            (7,927
            )Net
      Loss from continuing operations before income taxes
            
            
            (503,777
            )
            
            
            (1,753,728
            )Income
      tax benefit
            
            
            157,000
            
            
            
            --Net
      Loss from continuing operations
            
            
            (346,777
            )
            
            
            (1,753,728
            )Net
      Income from discontinued operations
            
            
            -
            
            
            
            844,863Net
      Loss Applicable to Common Shareholders
            
            $
            (346,777
            )
            
            $
            (908,865
            )Basic
      Income (Loss) Per Common shareFrom
      continuing operations
            
            $
            (0.02
            )
            
            $
            (0.10
            )From
      discontinued operations
            
            $
            -
            
            
            $
            0.05Net
      Loss per share - basic and diluted
            
            $
            (0.02
            )
            
            $
            (0.05
            )Weighted
      Average Number of Common Shares OutstandingBasic
      and diluted
            
            
            20,621,760
            
            
            
            17,945,929See
      notes to condensed consolidated financial statements.




3





TECHNEST
HOLDINGS, INC.


CONSOLIDATED
STATEMENT OF
CHANGES IN STOCKHOLDERS' EQUITY


FOR
THE THREE MONTHS ENDED SEPTEMBER 30, 2008


(Unaudited)








Series
      A
            
            
            Series
      CConvertible
            
            
            ConvertibleCommon
      stock
            
            
            Preferred
      stock
            
            
            Preferred
      stockShares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalance
      - July 1, 2008
            
            
            20,505,335
            
            
            $
            20,504
            
            
            
            64
            
            
            $
            -
            
            
            
            402,301
            
            
            $
            402Issuance
      and amortization ofstock-based
      compensationrelated to
      restricted stock grants
            
            
            170,876
            
            
            
            171
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Balance
      - September 30, 2008
            
            
            20,676,211
            
            
            $
            20,675
            
            
            
            64
            
            
            $
            -
            
            
            
            402,301
            
            
            $
            402






Additional
            
            
            
            
            
            TotalPaid-In
              Capital
            
            
            Accumulated
              Deficit
            
            
            Stockholders'
              EquityAmount
            
            
            Amount
            
            
            AmountBalance
      - July 1, 2008
            
            $
            37,792,582
            
            
            $
            (13,180,993
            )
            
            $
            24,632,495Issuance
      and amortization ofstock-based
      compensationrelated
      to restricted stock grants
            
            
            92,178
            
            
            
            -
            
            
            
            92,349Net
      loss
            
            
            -
            
            
            
            (346,777
            )
            
            
            (346,777
            )Balance
      - September 30, 2008
            
            $
            37,884,760
            
            
            $
            (13,527,770
            )
            
            $
            24,378,067






See notes
to condensed consolidated financial statements.




4




TECHNEST
      HOLDINGS, INC.CONSOLIDATED
      STATEMENTS OF CASH FLOWSFOR
      THE THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
              (Unaudited)








2008
            
            
            2007Cash
      Flows From Operating Activities:Net
      loss
            
            $
            (346,777
            )
            
            $
            (908,865
            )Adjustment
      to reconcile net loss to net cash used inoperating
      activities:Depreciation
      and amortization of property and equipment
            
            
            9,569
            
            
            
            11,061Amortization
      of intangible assets
            
            
            81,185
            
            
            
            81,185Non-cash
      interest expense
            
            
            -
            
            
            
            30,915Deferred
      income tax benefit
            
            
            (157,000
            )
            
            
            -Stock-based
      compensation to employees and directors
            
            
            92,349
            
            
            
            214,841Stock
      issued in connection with termination of stockholderand
      license agreement
            
            
            -
            
            
            
            1,380,000Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            433,736
            
            
            
            (1,308,835
            )Unbilled
      receivables
            
            
            (11,858
            )
            
            
            353,440Inventory
      and work in process
            
            
            (29,790
            )
            
            
            11,253Restricted
      cash
            
            
            (922
            )
            
            
            -Deposits
      and prepaid expenses and other current assets
            
            
            (491
            )
            
            
            (14,185
            )Accounts
      payable
            
            
            (8,672
            )
            
            
            (920,810
            )Unearned
      revenue
            
            
            35,000
            
            
            
            (97,389
            )Accrued
      expenses and other current liabilities
            
            
            (116,581
            )
            
            
            (2,089
            )Due
      to related parties
            
            
            -
            
            
            
            (42,700
            )Net
      Cash Used In Operating Activities
            
            
            (20,252
            )
            
            
            (1,212,178
            )Cash
      Flows From Investing Activities:Purchase
      of property and equipment
            
            
            -
            
            
            
            (7,905
            )Acquisition
      of new definite lived intangible assets
            
            
            (8,642
            )
            
            
            -Net
      Cash Used In Investing Activities
            
            
            (8,642
            )
            
            
            (7,905
            )Cash
      Flows From Financing Activities:Proceeds
      from revolving line of credit, net
            
            
            -
            
            
            
            1,603,985Repayment
      of term loan
            
            
            -
            
            
            
            (250,000
            )Repayment
      of note payable and long-term debt
            
            
            -
            
            
            
            (338,272
            )Net
      Cash Provided by Financing Activities
            
            
            -
            
            
            
            1,015,713




5




TECHNEST
      HOLDINGS, INC.CONSOLIDATED
      STATEMENTS OF CASH FLOWSFOR
      THE THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(concluded)
              (Unaudited)






2008
            
            
            2007Net
      Decrease In Cash
            
            
            (28,894
            )
            
            
            (204,370
            )Cash and Cash Equivalents -
      Beginning of Period -including $0 and$1,028,539,
      respectively, of cash related to discontinued operations
            
            
            76,761
            
            
            
            1,140,227Cash and Cash Equivalents - End
      of Period -including $0 and $832,426, respectively, of cash
      related to discontinued operations
            
            $
            47,867
            
            
            $
            935,857Supplemental
      Disclosures Of Cash Flow Information:Cash
      paid during the periods for:Interest
            
            $
            -
            
            
            $
            343,935Taxes
            
            $
            -
            
            
            $
            -See
      notes to condensed consolidated financial statements


6




TECHNEST
HOLDINGS INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE MONTHS ENDED SEPTEMBER 30, 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.





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.  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.  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).


7


2. 
BASIS OF PRESENTATION





Basis
of Presentation





The
consolidated financial statements include the accounts of Technest and its
wholly-owned subsidiary, Genex Technologies, Inc.  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 three months ended September 30, 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.


8


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 September 30,
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
September 30, 2008.








3. 
DISCONTINUED OPERATIONS





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. entered into a Stock Purchase Agreement with EOIR Holdings
LLC, a Delaware limited liability company, pursuant to which
Technest agreed to sell EOIR to LLC.  LLC is an entity
formed on August 9, 2007 by The White Oak 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 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.  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.





In
accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141, 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.


9


For the
three months ended September 30, 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:





Revenues
      from discontinued operations
            
            $
            17,818,559Net
      income from discontinued operations
            
            $
            844,863





Certain general and administrative and
interest expenses of the Company that are clearly associated with EOIR totaling
$533,304 in the three months ended September 30, 2007 have been included in the
net income from discontinued operations.





4. 
DEFINITE-LIVED INTANGIBLE ASSETS




Definite-lived
intangible assets consist of the following:




September
      2008
            
            Useful
      life (years)Patents
      - commercialized technology
            
            $
            440,000
            
            5Patents
      - other
            
            
            169,752
            
            15Customer
      relationships and contracts
            
            
            1,130,000
            
            5Accumulated
      amortization
            
            
            (1,177,184
            )Net
      definite-lived intangible asset
            
            $
            562,568




Amortization
expense was $81,185 for the three months ended September 30, 2008 and
2007.




5. 
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 B and C Preferred Stock.




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


10


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 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
September 30, 2008, the Company had 402,301 shares of Series C Preferred Stock
issued and outstanding.







Common Stock
Issuances




During
the three months ended September 30, 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
            
            
            649,286Reserve
      for conversion of Series A Convertible Preferred Stock
            
            
            306,047Reserve
      for conversion of Series C Convertible Preferred Stock
            
            
            402,301Total
      common stock reserves
            
            
            1,357,634




11


6. 
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 September 30,
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
      PriceBalance,
      July 1, 2008
            
            
            649,286
            
            
            $
            5.00Issued
            
            
            -
            
            
            
            -Expired
            
            
            -
            
            
            
            -Balance,
      September 30, 2008
            
            
            649,286
            
            
            $
            5.00




The
following table summarizes the Company's warrants outstanding at September 30,
2008:





Exercise
      price
            
            
            Number
            
            Expiration
      Date$
            6.50
            
            
            
            374,286
            
            02/14/2010$
            5.85
            
            
            
            75,000
            
            08/03/2013$
            1.89
            
            
            
            200,000
            
            07/17/2011649,286Weighted
      average remaining life
            2.0
      years





As of
September 30, 2008 all warrants are exercisable.


12


Stock Award
Plan





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





Technest
has broad discretion in making grants under the Plan and may make grants subject
to such terms and conditions as determined by the board of directors or the
committee appointed by the board of directors to administer the Plan. Stock
awards under the Plan will be subject to the terms and conditions, including any
applicable purchase price and any provisions pursuant to which the stock may be
forfeited, set forth in the document making the award. 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 three months ended
September 30, 2008 and 2007 was $92,349 and $214,841,
respectively.





As of
September 30, 2008, the Company has 272,345 shares available for future grant
under the Plan.




7. 
NET (LOSS) INCOME PER SHARE




Securities
that could potentially dilute basic earnings per share ("EPS") and that were not
included in the computation of diluted EPS because to do so would have been
anti-dilutive for the three months ended September, 2008 and 2007, consist of
the following:




SharesPotentiallyIssuable2008
            
            2007Series
      A Convertible Preferred Stock
            
            306,047
            
            306,047Series
      C Convertible Preferred Stock
            
            402,301
            
            632,185Warrants
            
            649,286
            
            649,286Total
            
            1,357,634
            
            1,587,518





13


8.
COMMITMENTS AND CONTINGENCIES




Facility
Rental




Technest
has a three-year lease for executive offices of approximately 2,000 square feet
in Boston, Massachusetts, which expires December 31, 2008. The monthly rental
amount for this facility is approximately $4,500. In May 2007 this facility was
vacated and subleased.




Technest
currently also 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 September 30, 2008
and 2007 was $48,512 and $52,502, respectively.






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





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







9. 
INCOME TAXES




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





The
Company's deferred tax assets consist primarily of the tax effects of its net
operating loss carry forwards.  As of September 30, 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 three months ended
September 30, 2008, there was no change in the valuation
allowance.   As of September 30, 2008, the Company has net
operating loss carryforwards not subject to IRC Section 382 limitations of
$3,027,000 which begin to expire in 2024.





There was
no provision for federal or state income taxes for the three months ended
September 30, 2007 due to the Company's operating losses and a full valuation
reserve on deferred tax assets.  As of September 30, 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.




10.
 EMPLOYEE BENEFIT PLANS




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




Contributions
and other costs of this plan in the three months ended September 30, 2008 and
2007 were $26,260 and $25,856, respectively.


14


11.  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.  At
September 30, 2008, this amount is included in accrued expenses. The settlement
amount was paid on October 1, 2008.





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.  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.


15


12.
SUBSEQUENT EVENTS





Southridge
Financing





On October 31, 2008, the Company sold 1,300 shares of its Series D 5%
Convertible Preferred Stock (“Series D Preferred”), with a stated value of
$1,000 per share, to Southridge Partners, LP (“Southridge”), for a purchase
price of $650,000 ($500 per share).  Of this amount, $600,000 was paid
directly to Deer Creek to settle litigation (see Note 11).  The
arrangement permits the Company to sell to Southridge a total of 3,000 shares of
Series D Preferred for total gross proceeds of $1,500,000.




The
Series D Preferred has a total face value of $3,000,000, is convertible into
common stock at any time at a price of $0.20 per share and shall be redeemed by
the Company upon receipt of the Contingent Purchase Price (see Note 3). 
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, it will be classified in the Balance Sheet in the
mezzanine, between liabilities and equity.  Since the Series D Preferred
will be issued at a discount to its face value, the Company expects there to be
a beneficial conversion feature at least equal to the proceeds received. 
Therefore, the Company expects to show a deemed dividend in arriving at net
income (loss) applicable to common stockholders equal to the proceeds received
in the period in which the Series D Preferred is issued.





Technest,
Inc.





On
October 1, 2008, the Company 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. As a result, Technest Holdings
expects to consolidate the financial statements of Technest, Inc. into its
financial statements.


16


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




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




17


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 DigitizerTMis 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 OmniEyeTM Wellcam, OmniEyeTM
Cerberus, Smart Optical Sensor (SOS), Smart SuiteTM, OmniEye Viewer, Small
Tactical Ubiquitous Detection System (STUDS), 3D SketchArtist, and 3D
FaceCam.





OmniEyeTM
Wellcam is an ultra light, portable 360 degree field of view camera which can be
used in field applications, such as detection of underground weapon caches and
search and rescue beneath building rubble, due to its durability. OmniEyeTM
Cerberus is a re-configurable multi-sensor system that is designed for long
distance infrared and visible light detection. OmniEyeTM Cerberus delivers this
flexibility while still maintaining seamless panoramic coverage up to 360
degrees.





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




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


18


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.




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.




19


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 months ended September
30, 2008 compared with the three months ended September 30,
2007




Revenues




Technest
had $447,204 in revenues from continuing operations during the three months
ended September 30, 2008 compared with $561,773 during the three months ended
September 30, 2007. These revenues were largely generated by Small Business
Innovative Research grants (SBIR’s) in the field of 3-dimensional imaging and
intelligent surveillance. We use the revenue from these grants to develop future
potential products for our business. By their nature these revenues do not
consistently accrue from quarter to quarter. At September 30, 2008, the
Company’s backlog of funded contracts was approximately $2.4 million, an
increase of 20% over the last quarter.





Gross
profit




The gross
profit for the three months ended September 30, 2008 was $172,664 or 39% of
revenues. The gross profit for the three months ended September 30, 2007 was
$352,855 or 63% of revenues. The gross profit margin for the three months ended
September 2007 was unusually high and the gross profit margin for the three
months ended September 2008 is more reflective of historical levels. Technest
expects to expand its revenue base to include commercial product revenues and,
accordingly, gross profit on future revenues may differ.





Selling,
general and administrative expenses




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





Selling,
general and administrative expenses for the three months ended September 30,
2007 were $2,017,471 and consisted primarily of payroll related
expenses, non cash amortization of stock-based compensation to
directors and officers amounting to $207,491 and $1,380,000 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.


20


Certain
general and administrative expenses of the Company that are clearly associated
with EOIR totaling $533,304 in the three months ended September 30, 2007 have
been included in the net income from discontinued operations.





Research
and Development





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




Amortization
of intangible assets




Amortization
of intangible assets for the three months ended September 30, 2008 and
2007 was $81,185. The majority of amortization expense relates to the
definite-lived intangible assets acquired in conjunction with Genex
Technologies.




Operating
loss





The
operating loss before taxes from continuing operations for the three months
ended September 30, 2008 narrowed to $504,948 compared with $1,745,801 for the
three months ended September 30, 2007








Discontinued
Operations





The net
income from EOIR’s operations was $844,863 in the three months ended September
30, 2007. The net income for the three months ended September 30, 2007 included
costs of $533,304 for costs incurred by Technest that are clearly associated
with the discontinued operation.





Net
Loss applicable to common shareholders





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





The net
loss applicable to common stockholders for the three months ended September 30,
2007 was $908,865.





Liquidity
and Capital Resources




Cash
and Working Capital





On
September 30, 2008, Technest had a positive working capital balance of
$18,842,092. Net cash used in operating activities for the three months ended
September 30, 2008 improved to $20,252 compared with $1,212,178 for the three
months ended September 30, 2007.





Cash
Used in Investing Activities





In the
three months ended September 30, 2007, Technest used cash of $8,642 for the
acquisition of new definite lived intangible assets representing costs
associated with filing for new patents.


21


Sources
of Liquidity




During the three months ended September
30, 2008, we satisfied our operating and investing cash requirements primarily
from cash reserves. Subsequent to September 30, 2008, we entered into an
arrangement with Southridge Partners, LP for the sale of a newly authorized
class of preferred stock (“Series D Preferred”) which permits the Company to
sell to Southridge shares of Series D Preferred for gross proceeds totaling
$1,500,000.  Of this amount, approximately $650,000 was raised and $600,000
was paid to Deer Creek. The arrangement has $850,000 of remaining proceeds
available from the issuance of Series D Preferred.





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.





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
September 30, 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.


22


Item 4T. Controls and Procedures




Evaluation
of Disclosure Controls and Procedures.




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




Changes
in Internal Control Over Financial Reporting.




There was
no change in our internal control over financial reporting during the quarter
ended September 30, 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





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.


23


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.  At
September 30, 2008, this amount is included in accrued expenses. The settlement
amount was paid on October 1, 2008.





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.  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.




Risks
Related To Our Business, Results Of Operations And Financial
Condition





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.  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.


24


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 September 30,
2008, our accumulated deficit was approximately $13.7 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.




25


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.


26


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




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




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





·
            our
      success in winning competitions for
orders;





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





·
            the
      mix of products we sell;





·
            competitive
      pricing pressures; and





·
            general
      economic climate.




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





Risks
Related to Contracting with the United States Government





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




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





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




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





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


27




·
            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.


28


Risks
Related To “Controlled Companies”





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





According
to the stock records of Technest, as of  June 30, 2008, Southridge
Partners LP, together with its affiliates, were the largest stockholders of
Technest, owning approximately 65% of Technest’s outstanding common stock as the
record holders of 13,404,387 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 65% 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.


29


Risks
Related To Investing In Low- Priced Stock




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




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




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




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




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





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




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




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




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




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




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





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




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





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





(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.




30


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 November 2008, the trading price
of our common stock ranged from a low price of $0.11 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.


31


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 referenceForm
            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
            4.1810.1
            Securities
      Purchase Agreement dated October 30, 2008 between Technest Holdings, Inc.
      and Southridge Partners, LP.
            
            8-K
            November
      5, 2008
            10.131.1
            Certification
      by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X31.2
            Certification
      by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X32.1
            Certification
      by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
      1350.
            X





32


SIGNATURES





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




TECHNEST
      HOLDINGS, INC.Date: November
      14, 2008
            By:
            /s/ Gino M.
PereiraGino
      M. Pereira
              Chief
      Executive Officer and PresidentDate: November
      14, 2008
            By:
            /s/ Nitin V. KotakNitin
      V. Kotak
              Chief
      Financial Officer





33


Exhibit
Index




Exhibit
      No.
              Description
              Filed
      with this Quarterly Report
              Incorporated
      by referenceForm
              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
              4.1810.1
              Securities
      Purchase Agreement dated October 30, 2008 between Technest Holdings, Inc.
      and Southridge Partners, LP.
              
              8-K
              November
      5, 2008
              10.131.1
              Certification
      by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
              X31.2
              Certification
      by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
              X32.1
              Certification
      by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
      1350.
              X