**U.S.
      SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




**FORM
      10-QSB**




(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,
                2007




**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 shell company (as defined in Rule
      12b-2 of the Exchange Act).  Yes o No x




As
      of  November 6, 2007, there were 20,030,979 shares of common stock,
      $0.001 par value, of the registrant issued and outstanding.




Transitional
      Small Business Disclosure Format (*Check one*): Yes o  
       No x







**TECHNEST
      HOLDINGS, INC.**




**FORM
      10-QSB**


**TABLE
      OF CONTENTS**


**SEPTEMBER
      30, 2007**






PagePART
                I.      FINANCIAL INFORMATION:Item
                1.       Financial Statements
                (Unaudited)Condensed
                Consolidated Balance Sheet at September 30, 2007
            1Condensed
                Consolidated Statements of Operations for the Three Months Ended
                September
                30, 2007 and 2006
            3Condensed
                Consolidated Statement of Changes in Stockholders’ Equity for the Three
                Months Ended September 30, 2007
            4Condensed
                Consolidated Statements of Cash Flows for the Three Months Ended
                September
                30, 2007 and 2006
            5Notes
                to Condensed Consolidated Financial Statements
            7Item
                2.       Management’s Discussion and
                Analysis or Plan of Operation
            23Item
                3.       Controls and
                Procedures
            40PART
                II.      OTHER INFORMATIONItem
                1.       Legal Proceedings
            40Item
                4.       Submission of Matters to a
                Vote of Security Holders
            41Item
                6.       Exhibits
            41Signatures
            42




STATEMENTS
      CONTAINED IN THIS FORM 10-QSB, 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-QSB ARE BASED ON INFORMATION AVAILABLE TO US ON THE DATE HEREOF,
      AND WE ASSUME NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS.
      EACH
      FORWARD-LOOKING STATEMENT SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL
      STATEMENTS AND NOTES THERETO IN PART I, ITEM 1, OF THIS QUARTERLY REPORT AND
      WITH THE INFORMATION CONTAINED IN ITEM 2 TOGETHER WITH MANAGEMENT'S DISCUSSION
      AND ANALYSIS OR PLAN OF OPERATION CONTAINED IN OUR****ANNUAL
      REPORT ON FORM 10-KSB FOR THE YEAR ENDED JUNE 30, 2007, INCLUDING, BUT NOT
      LIMITED TO, THE SECTION THEREIN ENTITLED "RISK FACTORS."




IMPORTANT
        ADDITIONAL INFORMATION WILL BE FILED WITH THE SEC
  Technest
        intends to mail to its stockholders and file with the Securities and Exchange
        Commission (the “SEC”) an Information Statement in connection with the proposed
        sale of EOIR, and to file other relevant materials with the SEC. The Statement
        and other materials filed with the SEC will contain important information
        about
        Technest, LLC, the sale of EOIR and related matters. Investors and security
        holders are urged to read the Information Statement carefully. Investors
        and
        security holders will be able to obtain free copies of the Statement and
        other
        documents filed with the SEC by Technest through the web site maintained
        by the
        SEC at www.sec.gov.








**TECHNEST
                HOLDINGS, INC. AND SUBSIDIARIES****CONDENSED
                CONSOLIDATED BALANCE SHEET****SEPTEMBER
                30, 2007**
              (Unaudited)






**ASSETS****Current
                Assets**Cash
                and cash equivalents
            
            $
            103,431Accounts
                receivables
            
            
            306,205Unbilled
                receivables
            
            
            57,098Due
                from related parties, net
            
            
            2,604Prepaid
                expenses and other current assets
            
            
            81,154Assets
                related to discontinued operations
            
            
            32,180,829**Total
                Current Assets**
            
            
            32,731,321**Property
                and Equipment**– Net of accumulated depreciation
                $75,788
            
            
            98,859**Other
                Assets**Deposits
            
            
            28,525Definitive-lived
                intangible assets – Net of accumulated amortization
                $852,444
            
            
            878,666Goodwill
            
            
            4,876,038**Total
                Other Assets**
            
            
            5,783,229**Total
                Assets**
            
            $
            38,613,409**LIABILITIES
                AND STOCKHOLDERS’ EQUITY****Current
                Liabilities**Accounts
                Payable
            
            $
            277,058Accrued
                expenses and other current liabilities
            
            
            500,096Liabilities
                related to discontinued operations
            
            
            21,042,375**Total
                Current Liabilities**
            
            
            21,819,529**Total
                Liabilities**
            
            
            21,819,529





1





**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEET (concluded)**


(Unaudited)





**Commitments
                and Contingencies****Stockholders’
                Equity**Series
                A Convertible Preferred Stock - $.001 par value; 150 shares
                authorized;64.325
                shares issued and outstanding (preference in liquidation
                of$64,325
                at September 30, 2007)
            
            ****
            **-**Series
                C Convertible Preferred Stock - $.001 par value; 1,149,425
                sharesauthorized;
                632,185 issued and outstanding (preference in liquidationof
                $1,375,002 at September 30, 2007)
            
            
            632Common
                stock - par value $.001 per share; 500,000,000 shares
                authorized;20,030,451
                shares issued and outstanding
            
            
            20,029Additional
                paid-in capital
            
            
            37,706,719Accumulated
                deficit
            
            
            (20,933,500
            )**Total
                Stockholders’ Equity**
            
            
            16,793,880**Total
                Liabilities and Stockholders’ Equity**
            
            $
            38,613,409See
                notes to condensed consolidated financial statements.




2





**TECHNEST
                HOLDINGS, INC. AND SUBSIDIARIES****CONDENSED
                CONSOLIDATED STATEMENTS OF OPERATIONS****FOR
                THE THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006**
              (Unaudited)








**2007**
            
            
            **2006****Revenues**
            
            $
            561,773
            
            
            $
            777,467**Cost
                of Revenues**
            
            
            208,918
            
            
            
            413,231**Gross
                Profit**
            
            
            352,855
            
            
            
            364,236**Operating
                Expenses**Selling,
                general and administrative
            
            
            2,017,471
            
            
            
            1,059,078Research
                and development
            
            ****
            **-**
            
            
            
            1,060Amortization
                of intangible assets
            
            
            81,185
            
            
            
            80,924**Total
                Operating Expenses**
            
            
            2,098,656
            
            
            
            1,141,062**Operating
                Loss from continuing operations**
            
            
            (1,745,801
            )
            
            
            (776,826
            )**Other
                (Expenses) Income, Net**Other
                income
            
            
            132
            
            
            
            2,498Interest
                expense
            
            
            (8,059
            )
            
            
            (593,362
            )**Total
                Other Expenses, Net**
            
            
            (7,927
            )
            
            
            (590,864
            )**Net Loss
                from continuing operations**
            
            
            (1,753,728
            )
            
            
            (1,367,690
            )**Net
                Income (Loss) from discontinued operations**
            
            
            844,863
            
            
            
            (504,601
            )**Net
                Loss Applicable to Common Shareholders**
            
            $
            (908,865
            )
            
            $
            (1,872,291
            )**Basic
                Income (Loss) Per Common Share**From
                continuing operations
            
            
            (0.10
            )
            
            
            (0.09
            )From
                discontinued operations
            
            
            0.05
            
            
            
            (0.03
            )**Net
                Loss per share – basic and diluted**
            
            $
            (0.05
            )
            
            $
            (0.12
            )**Weighted
                Average Number of Common Shares Outstanding**Basic
                and diluted
            
            
            17,945,929
            
            
            
            16,037,913See
                notes to condensed consolidated financial statements.





3





**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENT**


**OF
      CHANGES IN STOCKHOLDERS' EQUITY**


**FOR
      THE THREE MONTHS ENDED SEPTEMBER 30, 2007**(Unaudited)








Series
                A
            
            
            Series
                CConvertible
            
            
            ConvertibleCommon
                stock
            
            
            Preferred
                stock
            
            
            Preferred
                stockShares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalance
                - July 1, 2007
            
            
            16,878,451
            
            
            $
            16,877
            
            
            
            64
            
            
            $
            -
            
            
            
            632,185
            
            
            $
            632Stock
                issued in connection withtermination
                of stockholderand
                license agreement
            
            
            3,000,000
            
            
            
            3,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Issuance
                and amortization ofstock-based
                compensationrelated
                to restricted stock grants
            
            
            152,000
            
            
            
            152
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
                loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Balance
                - September 30, 2007
            
            
            20,030,451
            
            
            $
            20,029
            
            
            
            64
            
            
            $
            -
            
            
            
            632,185
            
            
            $
            632




Additional
            
            
            
            
            
            TotalPaid-In
            
            
            Accumulated
            
            
            Stockholders'Capital
            
            
            Deficit
            
            
            EquityAmount
            
            
            Amount
            
            
            AmountBalance
                - July 1, 2007
            
            $
            36,115,030
            
            
            $
            (20,024,635
            )
            
            $
            16,107,904Stock
                issued in connection withtermination
                of stockholderand
                license agreement
            
            
            1,377,000
            
            
            
            -
            
            
            
            1,380,000Issuance
                and amortization ofstock-based
                compensationrelated
                to restricted stock grants
            
            
            214,689
            
            
            
            -
            
            
            
            214,841Net
                loss
            
            
            -
            
            
            
            (908,865
            )
            
            
            (908,865
            )Balance
                - September 30, 2007
            
            $
            37,706,719
            
            
            $
            (20,933,500
            )
            
            $
            16,793,880




See
      notes
      to condensed consolidated financial statements.




4




**TECHNEST
                HOLDINGS, INC. AND SUBSIDIARIES****CONDENSED
                CONSOLIDATED STATEMENTS OF CASH FLOWS****FOR
                THE THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006**
              (Unaudited)






**2007**
            
            
            **2006****Cash
                Flows From Operating Activities:**Net
                loss
            
            $
            (908,865
            )
            
            $
            (1,872,291
            )Adjustment
                to reconcile net loss to net cash used inoperating
                activities:Depreciation
                and amortization of property and equipment
            
            
            11,061
            
            
            
            104,613Amortization
                of intangible assets
            
            
            81,185
            
            
            
            446,511Non-cash
                interest expense
            
            
            30,915
            
            
            
            1,292,583Stock-based
                compensation to employees and directors
            
            
            214,841
            
            
            
            398,630Stock
                issued in connection with termination ofstockholder
                and license agreement
            
            
            1,380,000
            
            
            
            -Fair
                value of warrants issued to a consultant
            
            
            -
            
            
            
            253,038Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (1,308,835
            )
            
            
            1,550,982Unbilled
                receivables
            
            
            353,440
            
            
            
            699,629Inventory
                and work in process
            
            
            11,253
            
            
            
            (54,424
            )Deposits
                and prepaid expenses and other current assets
            
            
            (14,185
            )
            
            
            (5,907
            )Accounts
                payable
            
            
            (920,810
            )
            
            
            (2,568,725
            )Unearned
                revenue
            
            
            (97,389
            )
            
            
            -Accrued
                expenses and other current liabilities
            
            
            (2,089
            )
            
            
            (966,687
            )Due
                to related parties
            
            
            (42,700
            )
            
            
            (201,370
            )**Net
                Cash Used In Operating Activities**
            
            
            (1,212,178
            )
            
            
            (923,418
            )**Cash
                Flows From Investing Activities:**Purchase
                of property and equipment
            
            
            (7,905
            )
            
            
            (32,151
            )**Net
                Cash Used In Investing Activities**
            
            
            (7,905
            )
            
            
            (32,151
            )**Cash
                Flows From Financing Activities:**Proceeds
                from term loan
            
            
            -
            
            
            
            3,000,000Proceeds
                from revolving line of credit, net
            
            
            1,603,985
            
            
            
            2,645,621Payment
                of debt issuance costs
            
            
            -
            
            
            
            (141,667
            )Payment
                of loan guarantee fee to Markland
            
            
            -
            
            
            
            (580,372
            )Repayment
                of term loan
            
            
            (250,000
            )
            
            
            (83,333
            )Payment
                of note payable and long-term debt
            
            
            (338,272
            )
            
            
            (5,003,411
            )**Net
                Cash Provided by (Used In) Financing Activities**
            
            
            1,015,713
            
            
            
            (163,162
            )




5





**TECHNEST
                HOLDINGS, INC. AND SUBSIDIARIES****CONDENSED
                CONSOLIDATED STATEMENTS OF CASH FLOWS****FOR
                THE THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
                (concluded)**
              (Unaudited)







**2007**
            
            
            **2006****Net  Decrease
                In Cash**
            
            
            (204,370
            )
            
            
            (1,118,731
            )**Cash
                and Cash Equivalents - Beginning of Period –
                including****$1,028,539
                and $2,859,055, respectively, of cash related to****discontinued
                operations**
            
            
            1,140,227
            
            
            
            3,362,210**Cash
                and Cash Equivalents - End of Period`- including****$832,426
                and $2,069,981, respectively, of cash related to****discontinued
                operations**
            
            $
            935,857
            
            
            $
            2,243,479**Supplemental
                Disclosures Of Cash Flow Information:**Cash
                paid during the periods for:Interest
            
            $
            343,935
            
            
            $
            154,876Taxes
            
            $
            -
            
            
            $
            -**Non-cash
                Investing and Financing Activities:**Fair
                value of common stock and warrants issued asdeferred
                financing costs
            
            $
            -
            
            
            $
            561,870See
                notes to condensed consolidated financial statements





6




**TECHNEST
      HOLDINGS INC. AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**FOR
      THE THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006**


(Unaudited)







**1. 
      NATURE OF OPERATIONS**





Business





Technest
      Holdings, Inc. and its subsidiaries (“Technest” or “the Company”) are 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.





Proposed
      Sale of EOIR Technologies, Inc.





On
      September 10, 2007, Technest and its wholly owned subsidiary, E-OIR
      Technologies, Inc. (“EOIR”), entered into a Stock Purchase Agreement with EOIR
      Holdings LLC, a Delaware limited liability company ( “LLC”), pursuant to which
      Technest will 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 a private investment firm
      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 will be structured as a stock sale in which LLC will acquire
      all
      of the outstanding stock of EOIR in exchange for approximately $34 million
      in
      cash, $11 million of which will be paid at closing and $23 million of which
      will
      be paid upon the successful re-award to EOIR of the contract with the U.S.
      Army's Night Vision and Electronics Sensors Directorate.





EOIR
      is
      presented as a discontinued operation in the consolidated financial statements
      in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets” (see Note
      3).





**2. 
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





Basis
      of  Presentation





The
      consolidated financial statements include the accounts of Technest and its
      wholly-owned subsidiary, Genex Technologies, Inc.  All significant
      inter-company balances and transactions have been eliminated in
      consolidation.





In
      May
      2007, the Company’s Board of Directors approved a plan to divest 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).





Reclassification





Certain
      amounts in the financial statements for the three months ended September 30,
      2006 have been reclassified to conform with presentations for the three months
      ended September 30, 2007 (see Note 3).




Use
      of
      Estimates





The
      preparation of the accompanying consolidated financial statements in conformity
      with accounting principles generally accepted in the United States of America
      requires management to make certain estimates and assumptions that affect the
      reported amounts of assets and liabilities and disclosures of contingent assets
      and liabilities at the date of the financial statements and the reported amounts
      of revenue and expenses during the reporting period. Actual results could differ
      from those estimates. Significant estimates that are particularly susceptible
      to
      change are the revenue recognized under the percentage completion method on
      firm
      fixed price contracts, allowance for doubtful accounts, the estimated useful
      lives of property and equipment, carrying value of goodwill and long-lived
      assets, useful lives of intangible assets, fair value of assets and liabilities
      presented as discontinued operation, the amount due to contracting government
      agencies as a result of their audits, the realizability of deferred tax assets
      and the fair value of derivative liability and equity instruments
      issued.


7




Concentrations
      and Risks





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





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





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





Cash
      and Cash Equivalents





The
      Company considers all highly liquid investments with maturities of ninety days
      or less to be cash equivalents. Cash equivalents consist of money market funds
      as of September 30, 2007.





Accounts
      Receivable





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




A
      significant portion of the Company's receivables are due from government
      contracts, either directly or as a subcontractor. The Company has not
      experienced any material losses in accounts receivable related to these
      contracts and has provided no allowance at September 30, 2007. If management
      determines amounts to be uncollectible, they will be charged to operations
      when
      that determination is made.





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





Property
      and Equipment




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




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




Software
            3
                yearsComputer
                equipment
            3
                yearsFurniture
                and fixtures
            5-7
                years




8


Property
      and equipment consisted of the following at September 30, 2007:




Software
            
            $
            38,697Computer
                equipment
            
            
            24,665Furniture
                and fixtures
            
            
            111,285174,647Less
                accumulated depreciation
            
            
            (75,788
            )$
            98,859




Depreciation
      expense from continuing operations for the three months ended September 30,
      2007
      and 2006 was $11,061 and $9,256, respectively.





Definite-lived
      Intangible Assets




Included
      in definite-lived intangible assets are the amounts assigned to customer
      relationships and contracts and patents acquired in connection with business
      combinations. Also included are certain costs of outside legal counsel related
      to obtaining new patents.




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





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




Fair
      Value of Financial Instruments




The
      financial statements include various estimated fair value information, as
      required by Statement of Financial Accounting Standards No. 107, "Disclosures
      about Fair Value of Financial Instruments." Financial instruments are initially
      recorded at historical cost. If subsequent circumstances indicate that a decline
      in the fair value of a financial asset is other than temporary, the financial
      asset is written down to its fair value.




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




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




Operating
      Segments




The
      Company operates in one Operating Segment as defined in paragraph 10 of SFAS
      No.
      131, “Disclosures about Segments of an Enterprise and Related Information”. This
      is the business of research and development, design and fabrication of 3D
      imaging and of intelligent surveillance products.




Revenue
      Recognition




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




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




9





Revenues
      from firm fixed price contracts are recognized on the percentage-of-completion
      method, either measured based on the proportion of costs recorded to date on
      the
      contract to total estimated contract costs or measured based on the proportion
      of labor hours expended to date on the contract to total estimated contract
      labor hours, as specified in the contract.




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




Shipping
      Costs





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





Research
      and Development




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




Income
      Taxes




In
      accordance with SFAS No. 109, “Accounting for Income Taxes,” the Company
      allocates current and deferred taxes to its subsidiaries as if each were a
      separate tax payer.




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





Effective
      July 1, 2007, the Company adopted the provisions of Financial Accounting
      Standards Board (“FASB”) Interpretation No. 48 (“FIN 48”), Accounting for
      Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.
      The implementation of FIN 48 had no impact on the Company’s financial statements
      as the Company has no unrecognized tax benefits.





The
      Company is primarily subject to U.S. federal, Massachusetts, Virginia and
      Maryland state income tax. Tax years subsequent to 2004 remain open to
      examination by U.S. federal and state tax authorities.





The
      Company’s policy is to recognize interest and penalties related to income tax
      matters in income tax expense. As of July 1 and September 30, 2007, the
      Company had no accruals for interest or penalties related to income tax
      matters.





Loss
      Per Share




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




Common
      stock equivalents, consisting of Series A and C Convertible Preferred Stock
      and
      warrants were not included in the calculation of the diluted loss per share
      in
      the three months ended September 30, 2007 because their inclusion would have
      had
      the effect of decreasing the loss per share otherwise computed.




10


Impairment
      of Intangible Assets




The
      Company records as goodwill the excess of purchase price over the fair value
      of
      the identifiable net assets acquired. Goodwill is identified and recorded at
      the
      reporting unit level as required by paragraphs 30-31 of SFAS No. 142, "Goodwill
      and Other Intangible Assets". SFAS No. 142 prescribes a two-step process for
      impairment testing, at the reporting unit level, of goodwill, which is performed
      annually, as well as when an event triggering impairment may have occurred.
      The
      first step tests for impairment, while the second step, if necessary, measures
      the impairment. The Company has determined that its reporting unit is its
      operating segment since this is the lowest level at which discrete financial
      information is available and regularly reviewed by management. The Company
      has
      elected to perform its annual analysis during the fourth quarter of each fiscal
      year. No impairment charges were recorded in the three months ended September
      30, 2007 and 2006.





Impairment
      of Long-Lived Assets




Pursuant
      to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived
      Assets", Technest continually monitors events and changes in circumstances
      that
      could indicate carrying amounts of long-lived assets may not be recoverable.
      An
      impairment loss is recognized when expected cash flows are less than the asset's
      carrying value. Accordingly, when indicators of impairment are present, Technest
      evaluates the carrying value of such assets in relation to the operating
      performance and future undiscounted cash flows of the underlying assets.
      Technest’s policy is to record an impairment loss when it is determined that the
      carrying amount of the asset may not be recoverable. No impairment charges
      were
      recorded in the three months ended September 30, 2007 and 2006.




Derivative
      Instruments





Technest
      generally does not use derivative instruments to hedge exposures to cash-flow
      or
      market risks. However, certain warrants to purchase common stock that are
      indexed to the Company's common stock are classified as liabilities when the
      Company is not permitted to settle the instruments in unregistered shares.
      In
      such instances, in accordance with Emerging Issues Task Force (“EITF”) Issue No.
      00-19, net-cash settlement is assumed for financial reporting purposes, even
      when the terms of the underlying contracts do not provide for net-cash
      settlement. Such financial instruments are initially recorded at relative fair
      value with subsequent changes in fair value charged (credited) to operations
      in
      each reporting period. If the Company subsequently achieves the ability to
      settle the instruments in unregistered shares, the instruments are reclassified
      to equity at their fair value.





Stock-Based
      Compensation




On
      July 1, 2006, the Company adopted the provisions of SFAS No. 123(R),
“Share-Based Payment”, which is a revision of SFAS No. 123, “Accounting for
      Stock Based Compensation”. There was no cumulative effect to the Company as a
      result of adopting this new accounting principle. Under SFAS No. 123(R),
      the Company now recognizes compensation costs resulting from the issuance of
      stock-based awards to employees and directors as an expense in the statement
      of
      operations over the service period based on a measurement of fair value for
      each
      stock award.





Recent
      Accounting Pronouncements




In
      September 2006, the FASB issued SFAS No. 157, “Fair Value
      Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework
      for measuring fair value in generally accepted accounting principles, and
      expands disclosures about fair value measurements. This statement is effective
      for financial statements issued for fiscal years beginning after November 15,
      2007. The Company is currently evaluating the impact of SFAS 157 on the
      consolidated financial statements.





On
      December 15, 2006 the Securities and Exchange Commission announced that it
      is has modified reporting requirements for smaller public companies under
      Section 404 of the Sarbanes-Oxley Act (SOX 404) of 2002. The Commission
      granted relief to smaller public companies by extending the date by which
      non-accelerated filers must start providing a report by management assessing
      the
      effectiveness of the company's internal control over financial reporting. The
      compliance date for these companies was moved from fiscal years ending on or
      after July 15, 2007, to fiscal years ending on or after December 15,
      2007. The Commission also extended the date by which non-accelerated filers
      must
      begin to comply with the Section 404(b) requirement to provide an auditor's
      attestation report on internal control over financial reporting in their annual
      reports. This deadline was moved to the first annual report for a fiscal year
      ending on or after December 15, 2008. The extension requires all
      non-accelerated filers to complete only management's portion of the internal
      control requirements in their first year of compliance with SOX 404. This
      modification is intended to provide cost savings and efficiency opportunities
      to
      smaller public companies and to assist them as they prepare to comply fully
      with
      SOX 404 reporting requirements. The extension will provide these issuers and
      their auditors an additional year to consider, and adapt to, the changes in
      Auditing Standard No. 5 that the Public Company Accounting Oversight Board
      has issued, as well as the guidance for management the Commission has issued,
      to
      improve the efficiency of the Section 404(b) auditor attestation report
      process.


11




In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities”, including an amendment of FASB
      Statement No. 115 (“SFAS 159”). This pronouncement permits entities to choose to
      measure many financial instruments and certain other items at fair value that
      are not currently required to be measured at fair value and to recognize the
      resulting gains and losses in the results of operations. SFAS 159 is effective
      as of the beginning of an entity’s first fiscal year that begins after November
      15, 2007. The Company is currently evaluating the impact of SFAS 159 on the
      Company’s consolidated financial statements, if any.





**3. 
      DISCONTINUED OPERATIONS**





In
      May
      2007, in order to realize the value of E-OIR Technologies, Inc. for the benefit
      of shareholders, the Company’s Board of Directors approved a plan to divest the
      operations of EOIR.  On September 10, 2007, Technest Holdings, Inc.
      and its wholly owned subsidiary, E-OIR Technologies, Inc. entered into a Stock
      Purchase Agreement with EOIR Holdings LLC, a Delaware limited liability company
      (“LLC”), pursuant to which Technest will 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 Company expects the sale of EOIR to close by
      December 31, 2007.





The
      sale
      of EOIR to LLC will be structured as a stock sale in which LLC will acquire
      all
      of the outstanding stock of EOIR in exchange for approximately $34 million
      in
      cash, $11 million of which will be paid at closing and $23 million of which
      will
      be paid upon the successful re-award to EOIR of the contract with the U.S.
      Army's Night Vision and Electronics Sensors Directorate.  The Company
      expects a decision on this re-award within fiscal 2008.





In
      accordance with SFAS No. 144, paragraph 30, the Company determined that in
      May
      2007, EOIR represented a disposal group that should be presented in the
      financial statements as held for sale.  As a result, the assets and
      liabilities of EOIR have been presented separately as a discontinued operation
      in the consolidated Balance Sheet at September 30, 2007.  The net
      assets of EOIR have been measured at the lower of their carrying amount or
      fair
      value less costs to sell.  As of September 30, 2007, there was no
      write-down of EOIR’s carrying value.  EOIR’s goodwill has been
      accounted for under SFAS No. 142 (see Note 2).




12


The
      major
      classes of assets and liabilities associated with discontinued operations
      were:





**September
                30,****2007**Assets
                related to discontinued operations:Cash
            
            $
            832,426Accounts
                receivable
            
            
            10,382,514Unbilled
                receivable
            
            
            1,105,020Restricted
                cash
            
            
            -Prepaid
                expenses and other current assets
            
            
            125,931Total
                current assets
            
            
            12,445,891Property
                and equipment, net
            
            
            282,205Deposits
            
            
            47,603Deferred
                financing costs
            
            
            1,238,985Definitive
                lived intangible assets, net
            
            
            9,006,632Goodwill
            
            
            9,159,513Total
                non-current assets
            
            
            19,734,938Total
                assets related to discontinued operations
            
            $
            32,180,829Liabilities
                related to discontinued operations:Accounts
                payable
            
            $
            7,073,893Unearned
                revenue
            
            
            169,920Due
                to related party
            
            
            249,940Accrued
                expenses and other current liabilities
            
            
            3,015,679Current
                portion of long term debt
            
            
            10,532,943Total
                current liabilities
            
            
            21,042,375Total
                liabilities related to discontinued operations
            
            $
            21,042,375





All
      of
      the assets and liabilities of EOIR have been classified in the Balance Sheet
      as
      current since the proposed sale is expected to close and proceeds received
      within one year.





For
      the
      three months ended September 30, 2007 and 2006, 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:





**Three
                Months Ended****September
                30,**
            
            
            **September
                30,****2007**
            
            
            **2006**Revenues
                from discontinued operations
            
            $
            17,818,559
            
            
            $
            19,192,171Net
                income (loss) from discontinued operations
            
            $
            844,863
            
            
            $
            (504,601
            )





After
      the
      closing of the EOIR sale, the Company does not expect any additional cash flows
      related to EOIR.  Certain general and administrative and interest
      expenses of the Company that are clearly associated with EOIR totaling
      approximately $533,304 and $243,976 in the three months ended September 30,
      2007
      and 2006, respectively, have been included in the net income (loss) from
      discontinued operations.


13





The
      following information relates to specific assets and liabilities included in
      the
      disposal group.





**Definite-lived
      Intangible Assets**





Definite-lived
      intangible assets consist of the following at September 30, 2007:




Amount
            
            
            Useful
                life (years)C
                Customer relationships and contracts - EOIR- Sensor
                Technologies
            
            
            11,755,000
            
            
            
            9Customer
                relationships and contracts - EOIR- Chemical Detection
            
            
            1,551,944
            
            
            
            1013,306,944Accumulated
                amortization
            
            
            (4,300,312
            )Net
                definite-lived intangible asset
            
            $
            9,006,632





Patents
      are amortized over their estimated useful life but not to exceed the legal
      life
      of the patent. Customer relationships and contracts are amortized over the
      contractual term of the existing contracts plus anticipated contract renewals
      in
      accordance with EITF 02-17. In determining the estimate useful life of the
      customer relationships and contracts, the Company considered a number of factors
      including, its history with these customers which dates back to 1993, the
      remaining term of existing contracts, the status of outstanding bids submitted
      for additional contracts or contract extensions, the stage of development of
      the
      major tasks covered by existing contracts, the likelihood of receiving
      additional contracts or contract extensions and the term over which the Company
      could reasonably predict future revenues from existing customers.




Amortization
      expense, included in net loss from discontinued operations, was $0 and $365,326
      for the three months ended September 30, 2007 and 2006,
      respectively.





In
      May
      2007, the Company ceased amortizing the definite-lived intangible assets and
      other long-lived assets.





**Long-Term
      Debt and Revolving Line of Credit**





It
      is a
      condition of the covenants of the EOIR Stock Purchase Agreement that the
      following loans be paid in full upon the sale of EOIR.  The following
      loans have therefore been included as current liabilities related to
      discontinued operations.   The related interest expense has been
      included in the net loss from discontinued operations.





Note
      payable – Shelter Island





On
      June
      1, 2007, Technest Holdings, Inc. closed on a financing pursuant to a Securities
      Purchase Agreement dated May 31, 2007 with Shelter Island Opportunity Fund,
      LLP
      (“Shelter Island”). Pursuant to the Securities Purchase Agreement, the Company
      issued to Shelter Island a Secured Original Issue Discount Debenture bearing
      interest at the rate of 11.25% (or Prime plus 3%) with an aggregate principal
      amount of $1,650,000 (the “Debenture”) for a subscription amount of $1,500,000.
      The Debenture is due on May 31, 2010, unless otherwise accelerated by its
      terms.  The outstanding principal amount and all accrued interest
      thereon will be payable in 33 equal monthly installments commencing on August
      31, 2007. On the maturity date of the Debenture, the Company also agreed to
      pay,
      as a termination fee (and not as a penalty), an amount equal to the product
      of
      (i) $45,000 and (ii) the number of months that have elapsed between May 31,
      2007
      and the date such payment is made by the Company to Shelter Island.





The
      Debenture is secured by (i) the assets of the Company, including its securities
      in its wholly-owned subsidiaries, (ii) all rights of Markland Technologies,
      Inc.
      (“Markland”) in and to the License Agreement dated March 31, 2006 between the
      Company and Markland, and (iii) the assets of the Company’s wholly-owned
      subsidiary, Genex Technologies Inc. (“Genex”).  Other than the
      security interest from Markland, Shelter Island’s security interests are
      subordinated to the interests of Silicon Valley Bank pursuant to a Subordination
      Agreement entered into between Shelter Island and Silicon Valley Bank. The
      Company’s wholly-owned subsidiaries, Genex and EOIR, guaranteed the
      Debenture.





At
      September 30, 2007, the face value of the notes and unamortized discount was
      $1,550,000 and $133,333, respectively. During the three months ended September
      30, 2007, the Company amortized $12,500 to non-cash interest expense. Interest
      expense on these notes for the three months ended September 30, 2007 was
      $62,438.


14




Bank
      loan





On
      August
      10, 2006, Technest, EOIR and Genex closed on a financing (the “Financing”) under
      two Loan and Security Agreements with Silicon Valley Bank (the “Bank”). One
      Credit Agreement provides for a term loan facility under which the Company
      may
      borrow term loans with an initial minimum loan of $3,000,000 (the “Term Loan”).
      The other Credit Agreement provides for a one year revolving line of credit
      for
      up to $8,750,000 (the “Revolver”), provided that the Company’s borrowing under
      the Revolver is limited to 80% of Eligible Accounts Receivable, as defined.
      In
      addition, the maximum amount outstanding under both Credit Agreements at any
      time may not exceed $10,000,000. Both the Term Loan Facility and the Revolver
      are secured by all of the Company’s assets and the assets of its subsidiaries,
      including all intellectual property.  The Company also entered into a
      Registration Rights Agreement with the Bank pursuant to which we granted
“piggy-back” and S-3 registration rights for the shares of Technest common stock
      underlying the warrant. The Registration Rights Agreement does not include
      any
      liquidated damage provisions.





As
      consideration for the subordination of the security interest to the Bank and
      in
      connection with the closing of the Financing on August 10, 2006, the Company
      issued to the seven remaining EOIR subordinated note holders a total of 99,779
      shares of the Company’s common stock having a fair value of $344,238, of which
      our current Chief Executive Officer and one of the Company’s directors, Joseph
      P. Mackin, received 23,913 shares. The shares vest 18 months from the date
      of
      grant and will accelerate upon the sale of EOIR.  The value of these
      shares was recorded as deferred financing costs and is classified as assets
      related to discontinued operations due to the repayment of the financing upon
      the sale of EOIR.




Upon
      the
      date of closing under the Credit Agreements, the Company borrowed the entire
      $3,000,000 available under the Term Loan facility and borrowed approximately
      $4,445,000 under the Revolver. At September 30, 2007, the outstanding balance
      was $1,916,667 on the Term Loan and $6,166,793 on the Revolver.




Interest
      on all outstanding amounts under the Term Loan is payable monthly at a rate
      equal to the Bank’s prime rate plus 2.75%. Each loan under the Term Loan is
      repayable in 36 equal monthly principal installments (currently $83,333) plus
      accrued interest.




The
      Bank’s prime rate as of September 30, 2007 was 7.75%.  Interest
      expense on these loans for the three months ended September 30, 2007 and 2006,
      was $28,923 and $154,783, respectively.





The
      Revolver bears interest at a rate equal to the Bank’s prime rate plus 0.50% per
      annum, but the Company must pay a minimum quarterly amount equal to the interest
      on an outstanding balance of $1,400,000. In addition, the Company pays a monthly
      collateral handling fee of 0.10% per month on financed receivables. Interest
      and
      handling fees are paid as invoices are collected.





As
      of
      September 30, 2007, the Company had the following covenants with the
      Bank.





1.
            Term
                Loan - Priced at Prime plus 3.50%; Beginning with month ending May
                31,
                2007 and thereafter pricing to be as
                follows:




Fixed
                Charge Coverage Ratio
            Pricing1.00x
                - 1.24x
            Prime
                plus 3.25%1.25x
                - 1.49x
            Prime
                plus 3.00%>=
                1.50x
            Prime
                plus 2.75%





2.
            Revolver
                priced at Prime plus 1.00% and a collateral handling fee of 0.25%
                per
                month; reduces to the existing Interest Rate structure, per the first
                loan
                modification dated February 14, 2007, upon compliance with all financial
                covenants beginning May 31, 2007 and
                thereafter.


Fixed
        Charge Coverage Ratio
 July
        31,
        2007 - 1.25x
 August
        31, 2007 and thereafter of - 1.50x
  In
        the
        event of prepayment, the Company will pay to Bank a Prepayment Fee equal
        to: (i)
        three percent (3.0%) of the amount of any Term Advance prepaid during the
        first
        year of the Term Loan and (ii) two percent (2.0%) of the amount of any Term
        Advance prepaid for each year thereafter, prior to the Commitment Termination
        Date.


15




In
      September 2007, the Company extended the term of the Revolver to February 28,
      2008.





Markland
      has entered into an Unconditional Guaranty pursuant to which Markland agreed
      to
      guaranty up to $6,000,000 of the principal obligations plus interest thereon
      and
      related expenses under certain Credit Agreements and a Stock Pledge Agreement
      pursuant to which Markland pledged to the Bank 1,739,130 shares of Technest
      common stock currently owned by Markland, which had a market value of $6,000,000
      as of August 4, 2006. The Unconditional Guaranty and the Stock Pledge Agreement
      terminate August 3, 2008 if no event of default has occurred. In consideration
      for this Unconditional Guarantee and Stock Pledge Agreement, Technest paid
      Markland $580,372. This amount has been recorded as a debt issuance cost and
      was
      being amortized over the life of the Term Loan of 36 months prior to adoption
      of
      SFAS 144, which halted amortization.





A
      summary
      of the deferred financing costs as of September 30, 2007 is as
      follows:





Payment
                to Markland for Unconditional Guaranty
            
            $
            580,372Fair
                value of warrants granted to Silicon Valley Bank
            
            
            217,732Fair
                value of common stock issued to EOIR note holders in connection with
                subordination
            
            
            344,238Other
                deferred financing costs paid
            
            
            492,953Gross
                deferred financing costs
            
            
            1,635,295Accumulated
                amortization
            
            
            (396,310
            )Net
                deferred financing costs
            
            $
            1,238,985





The
      Company ceased amortizing the deferred financing costs and other long lived
      assets beginning in May 2007 as a result of adopting SFAS 144.





EOIR
      Seller Notes Payable





On
      June
      29, 2004, EOIR issued notes guaranteed by Markland in the face amount of
      $11,000,000 in connection with Markland’s acquisition of EOIR’s common stock.
      These notes accrue interest at 6% compounded monthly and are payable in
      quarterly installments over 60 months. The fair market value of these notes
      was
      $9,532,044 as determined by management based on a number of factors including
      an
      independent valuation. The discount of $1,467,956 is amortized to interest
      expense over the life of the note.





The
      Company used a portion of the proceeds of the Financing to pre-pay the
      outstanding principal of $4,952,526 of certain EOIR promissory notes issued
      in
      June 2004. After these payments, the remaining outstanding notes had a total
      principal balance of $1,655,885. The security interest securing these remaining
      notes was subordinated to the Bank’s first priority security
      interest.





During
      the three months ended September 30, 2007 the security interest of the remaining
      notes was further subordinated to the interest of Shelter Island for the
      Debentures issued to them.  As a consideration for this subordination,
      the Company incurred a cost of $82,795 related to a subordination fee payable
      to
      the Note holders.





At
      September 30, 2007, the face value of the EOIR Seller Notes and unamortized
      discount was $1,167,859 and $135,043, respectively. During the three months
      ended September 30, 2007, the Company amortized $18,415 to non-cash interest
      expense. Interest expense related to the EOIR Seller Notes for the three months
      ended September 30, 2007 and 2006, was $18,297 and $58,716,
      respectively.




**4. 
      DEFINITE-LIVED INTANGIBLE ASSETS**




Definite-lived
      intangible assets consist of the following at September 30, 2007:




Amount
            
            
            Useful
                life (years)Patents
                - commercialized technology
            
            $
            440,000
            
            
            
            5Patents
                - other
            
            
            161,110
            
            
            
            15Customer
                relationships and contracts
            
            
            1,130,000
            
            
            
            5Accumulated
                amortization
            
            
            (852,444
            )Net
                definite-lived intangible asset
            
            $
            878,666




16





Patents
      are amortized over their estimated useful life but not to exceed the legal
      life
      of the patent. Customer relationships and contracts are amortized over the
      contractual term of the existing contracts plus anticipated contract renewals
      in
      accordance with EITF 02-17. In determining the estimate useful life of the
      customer relationships and contracts, the Company considered a number of factors
      including, its history with these customers which dates back to 1993, the
      remaining term of existing contracts, the status of outstanding bids submitted
      for additional contracts or contract extensions, the stage of development of
      the
      major tasks covered by existing contracts, the likelihood of receiving
      additional contracts or contract extensions and the term over which the Company
      could reasonably predict future revenues from existing customers.




Amortization
      expense was $81,185 for the three months ended September 30, 2007 and
      2006




**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.




During
      the year ended June 30, 2006, 59.694 shares of Series A Preferred Stock were
      converted into 282,669 shares of the Company’s common stock.





At
      September 30, 2007 there were 64.325 shares of Series A Preferred Stock issued
      and outstanding.





Series
      B and C Convertible Preferred Stock




The
      Series B Preferred Stock is convertible into Markland common stock upon the
      earlier to occur of February 14, 2006 or the trading day immediately following
      the first period of five trading days during which Markland common stock has
      a
      closing bid price of $2.50 or higher on each day, if any. The number of shares
      to be issuable upon conversion of each share of Series B preferred stock will
      be
      equal to approximately 4.35 divided by the lower of $0.60 and the average
      closing bid price for the 20 trading days preceding such conversion. Shares
      of
      the Series B Preferred Stock have a liquidation preference of $2.175 per share,
      may only vote on changes to the rights, privileges and priority of the Series
      B
      Preferred Stock, do not accrue dividends and are not redeemable. The Series
      B
      Preferred Stock ranks pari passu with the Company's Series A and C
      Preferred Stock.




The
      Series C Preferred Stock is convertible into Technest common stock at any time
      at the option of the stockholder. The number of shares of Technest common stock
      into which each share of Series C Preferred Stock is convertible is determined
      by dividing $2.175 by the Series C Conversion Price. The Series C Conversion
      Price is currently $2.175. Shares of the Series C Preferred Stock have a
      liquidation preference of approximately $2.175 per share, may only vote on
      changes to the rights, privileges and priority of the Series C Preferred Stock,
      receive dividends on an as converted basis whenever dividends are made to the
      Technest common stock holders, and are not redeemable. The Series C Preferred
      Stock ranks pari passu with the Company's Series A and B 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 September 30, 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 (see Note 6).


17




In
      the
      year ended June 30, 2006, Markland entered into a definitive exchange agreement
      with the Deer Creek Fund LLC, pursuant to which Markland exchanged 2,250 shares
      of Markland Series D Preferred Stock for 517,243 shares of Technest Series
      B
      Convertible Preferred Stock. Subsequently, the Technest Series B Convertible
      Preferred Stock held by Markland was cancelled.





In
      the
      year ended June 30, 2006, 517,240 shares of Technest Series C Preferred
      Stock were converted to 517,240 shares of common stock.





At
      September 30, 2007, the Company had -0- shares of Series B Preferred Stock
      and 632,185 shares of Series C Preferred Stock issued and
      outstanding.





In
      conjunction with its Series B and C Convertible Preferred Stock financing,
      the
      Company has obligations under registration rights agreements. In the year ended
      June 30, 2006, the Company incurred liquidated damages of $2,329,466 which
      was
      charged to non-cash interest expense related to the Company's failure to have
      an
      effective registration statement. The Company settled $2,104,461 of this
      obligation through the issuance of 410,888 shares of Technest common stock
      and
      there is $195,000 included in accrued expenses and other current liabilities
      at
      June 30, 2006.




In
      the
      year ended June 30, 2007, the Company incurred liquidated damages related to
      these registration rights of $1,726,426 which was charged to non-cash interest
      expense and settled by the issuance of 850,761 shares of Technest common stock.
      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.





Common
      Stock Issuances




During
      the three months ended September 30, 2007, the Company issued the following
      amounts of common stock:





Ÿ
            152,000
                shares of Technest common stock to three executives of the Company
                pursuant to employment agreements and performance bonuses.
            .Ÿ
            3,000,000
                shares of Technest common stock to Southridge Partners, LP with a
                value of
                $1,380,000 in connection with the Termination of Certain Sections
                of
                Stockholder Agreement and of License Agreement which has been included
                in
                selling, general and administrative expenses from continuing
                operations.





**Termination
      of Certain Sections of Stockholder Agreement and of License
      Agreement**.





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





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





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





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





Ÿ
            *Other
                Terms.*Until March 31, 2008 or upon the satisfaction of
                certain conditions, whichever is earlier, Technest agreed that it
                would
                refrain from (a) issuing any shares of its Common Stock or securities
                convertible into its Common Stock, other than (i) shares to be issued
                in
                certain permissible offerings; (ii) certain shares already awarded
                under
                Technest’s 2006 Stock Award Plan, and (iii) 250,000 shares to be issued
                under the 2006 Stock Award Plan; (b) entering into any transaction
                with
                its officers, directors, stockholders or any of their Affiliates,
                except
                for transactions that are in the ordinary course of Technest’s business,
                upon fair and reasonable terms that are no less favorable to Technest
                than
                would be obtained in an arm’s length transaction with a non-Affiliated
                person or entity.




18




On
      January 19, 2006, the Board of Directors of Technest adopted a resolution
      preventing the Company from designating, authorizing or issuing any series
      of
      preferred stock, or any other security, instrument or contract, convertible
      or
      exercisable, either directly or indirectly into shares of common stock, unless
      the maximum number of shares of common stock potentially issuable upon such
      conversion can be determined at the time of designation, authorization, or
      issuance.




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
            
            
            632,185Total
                common stock reserves
            
            
            1,587,518




**6. 
      OPTIONS, WARRANTS AND STOCK-BASED COMPENSATION**




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,
      2007 and 2006 and there are currently no options outstanding under the
      Plan.





Summary
      information with respect to warrants granted is as follows:




Number
                of
              Shares
            
            
            Weighted
                Average
              Exercise
                PriceBalance,
                July 1, 2007
            
            
            649,286
            
            
            $
            5.00Issued
            
            
            -
            
            
            
            -Expired
            
            
            -
            
            
            
            -Balance,
                September 30, 2007
            
            
            649,286
            
            
            $
            5.00




The
      following table summarizes the Company's warrants outstanding at September
      30,
      2007:





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
            3.2
                years





As
      of
      September 30, 2007 all warrants are exercisable.




19





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, 2007 was $214,841.





As
      of
      September 30, 2007, the Company has 551,421 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, 2007, consist of the
      following:




Shares
              PotentiallyIssuableSeries
                A Convertible Preferred Stock
            
            
            306,047Series
                C Convertible Preferred Stock
            
            
            632,185Warrants
            
            
            649,286Total
                as of September 30, 2007
            
            
            1,587,518




**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, 2009. 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 $14,263, increasing annually
      by 3%.





Rent
      expense for continuing operations in the three months ended September 30, 2007
      and 2006 was $52,502 and $57,086, respectively.




Lien
      on Assets





Silicon
      Valley Bank (see Note 3) has a primary lien on all the assets of Technest and
      its subsidiaries. The balance outstanding to Silicon Valley Bank as of September
      30, 2007 was $8,083,460.




Employment
      Agreements with Joseph P. Mackin and Gino M. Pereira





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


20





Audit
      Committee





On
      August
      9, 2007, Darlene Deptula-Hicks resigned as a director of Technest Holdings,
      Inc.
      for personal reasons.  Ms. Deptula-Hicks served as the chairman of the
      Company’s audit committee.  Until such time as another independent
      director, who also qualifies as a financial expert, is elected to Board of
      Directors, the audit committee has been disbanded.




**9. 
      INCOME TAXES**




There
      was
      no provision for federal or state income taxes for the three months ended
      September 30, 2007 and 2006 due to the Company's operating losses and a full
      valuation reserve on deferred tax assets.





The
      Company's deferred tax assets consist primarily of the tax effects of its net
      operating loss carry forwards. The use of the federal net operating loss carry
      forwards may be limited in future years as a result of ownership changes in
      the
      Company's common stock, as defined by Section 382 of the Internal Revenue Code.
      The Company has not completed an analysis of these changes.




The
      Company has provided a full valuation reserve against the deferred tax asset
      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. 
      RELATED PARTY TRANSACTIONS**




During
      the three months ended September 30, 2007, Markland invoiced, and EOIR paid,
      $42,686 in conjunction with the supply of products pursuant to an arms length
      sub-contract.





At
      September 30, 2007, Technest has an amount due from Markland of
      $2,604.  Included in the liabilities related to discontinued
      operations is $249,940 due to Markland.




**11.
       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, 2007 and
      2006 were $25,856 and $27,819, respectively.





**12. 
      LITIGATION**





*Technest
      Holdings, Inc.*





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 make allegations against
      Technest Holdings, Inc., Michael Sheppard and Maura Marx, former officers of
      Technest.


21




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. We cannot
      make any assurances about the litigation’s outcome.





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 has 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. Technest believes
      that the case as currently styled is fundamentally a dispute between H&H
      Acquisition Corp. and Ben Stein.





As
      of
      November 6, 2007, Technest has not been notified of a trial date for this
      matter.





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, seeking unspecified monetary damages.  Deer Creek alleges
      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. Technest believes that the allegations in this
      lawsuit are entirely without merit. Technest has been aggressively defending
      this action, and has filed an answer denying Deer Creek’s allegations and
      vigorously opposes all relief sought.  A trial date for this claim had
      been set for December 4, 2007.





*Genex
      Technologies, Inc.*





On
      or
      about October 10, 2007, David Tunnell, one of the Company’s employees, commenced
      an action in the United States District Court for the District of Maryland
      against Genex Technologies, Inc. (“Genex”) and Jason Geng, the former sole
      stockholder of Genex.  Mr. Tunnell is seeking damages in the amount of
      $420,000 for breach of contract for an agreement entered into prior to the
      sale
      of Genex to Technest.  Mr. Tunnell also brings suit under a Maryland
      wage payment statute that allows for treble damages.  Genex believes
      that it has substantial defenses against Mr. Tunnell's claims.  Genex
      will be aggressively defending this action, and vigorously opposes all relief
      sought.




**13.
        SUBSEQUENT EVENT**
 
 On
        or
        about November 8, 2007, the Company issued 130,000 shares of its common stock
        with a fair value of $72,800 to employees under the Company’s stock award
        plan.




22





**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, 2007 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**




On
      February 14, 2005, Technest became a majority owned subsidiary of Markland
      Technologies, Inc., a homeland defense, armed services and intelligence
      contractor. Markland is a public company with a class of equity securities
      registered pursuant to Section 12(g) of the Exchange Act. Technest issued to
      Markland 1,954,023 shares of its common stock in exchange for 10,168,764 shares
      of Markland common stock which were used as partial consideration for the
      concurrent acquisition of Genex Technologies, Inc.




Prior
      to
      our acquisition of Genex, we were a public “shell” company with no operations,
      nominal assets, accrued liabilities totaling $184,468 and 139,620 (post-split)
      shares of common stock issued and outstanding. From May 2002 through our
      acquisition of Genex, we had no operations.




On
      August
      17, 2005, pursuant to a Stock Purchase Agreement with Markland Technologies,
      Inc., our majority stockholder, we purchased all of the outstanding stock of
      E-OIR Technologies, Inc., formerly one of Markland’s wholly-owned
      subsidiaries. As consideration for the stock of EOIR, we issued 12 million
      shares of our common stock to Markland.




On
      November 1, 2006, pursuant to the Asset Contribution Agreement between Technest
      and Genex, which was attached to the quarterly report for the period ended
      December 31, 2006 as Exhibit 10.2, Genex transferred certain of its assets
      and
      liabilities to Technest in order to preserve the continued eligibility for
      certain contracts under Small Business Innovation Research programs. The
      transfer primarily involved all of Genex’s government contracts which have since
      been novated to Technest and the associated intellectual property. As our
      financial results are reported on a consolidated basis, this transfer did not
      impact our financial statements.




On
      September 10, 2007, Technest Holdings, Inc. (the “Company” or “Technest”) and
      its wholly owned subsidiary, E-OIR Technologies, Inc. (“EOIR”), entered into a
      Stock Purchase Agreement with EOIR Holdings LLC, a Delaware limited liability
      company ( “LLC”), pursuant to which Technest will 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 a
      private investment firm 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 will be structured as a stock sale in which LLC will acquire
      all
      of the outstanding stock of EOIR in exchange for approximately $34 million
      in
      cash, $11 million of which will be paid at closing and $23 million of which
      will
      be paid upon the successful re-award to EOIR of the contract with the U.S.
      Army's Night Vision and Electronics Sensors Directorate.





In
      accordance with Statement of Financial Accounting Standard No. 144 (“SFAS 144”),
      EOIR is presented as a discontinued operation in the consolidated financial
      statements.


23




**Technest
      Business**




As
      a
      result of the proposed sale of EOIR, the remaining business of Technest
      Holdings, Inc. 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.




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




Our
      major
      products, developed and in development, include our OmniEyeTM Wellcam, OmniEyeTM
Cerberus, Smart Optical Sensor (SOS), Smart SuiteTM, Omnivision, Small Tactical
      Ubiquitous Detection System (STUDS), 3D SketchArtist, 3D FaceCam, 3D Digitizer
      System, EI DigitizerTM and Dental DigitizerTM.





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.





OmniVision
      is a software platform for a wide range of security and surveillance camera
      products. Built as a modular system, OmniVision can operate as a standalone
      application or easily integrate into existing systems. The unique architecture
      of OmniVision puts next-generation capabilities within reach of traditional
      camera and digital video recorder systems. The system includes software
      application modules for many different end user needs.





STUDS
      are
      state-of-the-art, miniature, disposable, low-cost motion-tracking, positioning
      and imaging 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.




24





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 addition, with 3D FaceCam,
      medical professionals can capture and measure physical features in 3D (e.g.,
      volume, surface area, projection, linear distance, and asymmetry), provide
      pre-
      and post-operation analysis to patients, and document surgical or treatment
      plans and results.  Time consuming and inaccurate measurements using
      calipers and reference points are no longer necessary. New techniques, such
      as
      symmetry analysis and implant volume calculations, are also now possible.
      Popular applications may include:




·
            **Biomedical
                Engineering**– Production of custom-fitting
                prostheses.




·
            **Plastic
                and Reconstructive Surgery**– Surgical planning, simulation, and
                pre/post-operation comparison.




·
            **Patient
                Communication**– Simulation, explanation, and modification of
                treatment plans based upon 3D morphing and customer
                feedback.




3D
      Digitizer System is a turnkey three-dimensional (3D) imaging
      solution.





EI
      DigitizerTM****(Ear Impression) system has been customized for
      applications in the custom hearing aid and ear mold markets. The system
      automates the process of converting a physical ear impression into a 3D model
      for streamlined production and quality control.





Dental
      DigitizerTM****has been 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.





**Technest
      Business Strategy**





Moving
      forward it is our goal to establish the Company as the leading supplier of
      3-D
      imaging products and solutions. 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 industry partners to bring technology
                to
                market





·
            Develop
                recurring revenue models;





·
            Consolidate
                our position as a leading innovator in 3-D imaging through continued
                research and development





·
            Continue
                to develop a robust intellectual property portfolio ;
                and





·
            Seek
                strategic acquisitions.





**Discontinued
      Operations - EOIR Business**





EOIR
      currently operates in four principal technical areas: Advanced Sensor Systems,
      Imaging and Intelligence Solutions, Operational Management, and Chemical and
      Explosive Detection.





**Advanced
      Sensor Systems**





Advanced
      Sensor Systems is engaged in design, research and development, systems
      integration, sustainment, support, and upgrade of advanced sensor systems for
      the U.S. military; this includes high performance targeting and surveillance
      sensors, driving enhancements, rifle sights, fusion and automatic target
      recognition, mine and minefield detection, mine neutralization, minefield
      breaching, sensor system performance modeling and analysis, virtual prototyping,
      simulation-based analyses, high-performance multi-color Focal Plane Arrays
      (FPA), multi-function lasers, distributed sensor networks, Long Wavelength
      Infrared (LWIR) and Short Wavelength Infrared (SWIR) arrays, unattended ground
      sensors, and rapid prototyping.





The
      majority of the work performed by Advanced Sensor Systems is carried out through
      an Omnibus Contract with the United States Army Night Vision and Electronic
      Sensors Directorate. EOIR retains non exclusive rights to sell the technologies
      that it develops under this contract.


25




**Imaging
      and Intelligence Solutions**





Imaging
      and Intelligence Solutions is engaged in the design, research and development,
      integration, analysis, modeling, and training of classified solutions in support
      of the United States’ intelligence community and homeland security.





EOIR
      provides support to the National Geospatial-Intelligence Agency (NGA) College,
      including program management support, curriculum development and instruction
      in
      Geospatial and Imaging Analysis, Advanced Geospatial Intelligence, and
      Measurements and Signal Intelligence. EOIR develops core curriculum: platform,
      web- and computer-based training; and maintains the Soft Copy Keys Program.
      EOIR
      develops specialized tools and algorithms for atmospheric computation and
      full-spectrum signal processing, promotes imaging standards, evaluates new
      technology, assists users with Advanced Geospatial Intelligence technologies,
      and maintains spectral libraries used throughout the Intelligence Community.
      For
      the National Ground Intelligence Center, EOIR provides systems modeling,
      intelligence analysis for military operations and disaster relief, and it
      develops and integrates remote triggering devices and monitoring stations used
      in field testing and air-and ground-based sensor analysis. EOIR supports
      maritime advanced geospatial imagery exploitation and counter drug operations,
      as well as all-source analysis for Army operational forces.





**Operational
      Management**





Operational
      Management is engaged in the program management, integration, training,
      logistics, analysis, and field support of numerous projects for the U.S.
      military.





EOIR
      provides program management support for the Marine Corps Systems Command (MCSC),
      which includes providing logistical support of current projects and integration
      with legacy systems. EOIR also is assisting in the development of the
      Electro-Optical Test Facility (EOTF) for the Program Manager Optics and
      Non-Lethal Systems (PM ONLS). This encompasses the full life-cycle of the test
      facility; as EOIR will design the facility, oversee the procurement of
      equipment, develop standard operating procedures, and manage the thermal testing
      portion of the lab. EOIR provides systems integration, board design, training,
      and field support for products, such as DoubleShot, which is currently actively
      deployed in Operation Iraqi Freedom (OIF) in support of the Marine Corps
      Warfighting Lab (MCWL). In addition, EOIR represents the Marine Corps in the
      joint development of Joint Chemical Agent Detector (JCAD), Joint Service Light
      Standoff Chemical Agent Detector (JSLSCAD), Joint Service Light Nuclear,
      Biological, Chemical, Reconnaissance System (JSLNBCRS), as well as other
      engineering technology in support of the MCSC Chemical, Biological,
      Radiological, Nuclear Defense (CBRND) team. This support consists of testing
      emerging technology, providing logistical support and management of legacy
      systems. EOIR also provides systems integration support for the Directed Energy
      Technology Office (DETO) at Naval Surface Warface Center Dahlgren Division
      (NSWCDD) integrating various sensors, such as Driver Viewer Enhancer and Blue
      Force Tracker, into a prototype directed energy system in support of
      OIF.





**Chemical
      and Explosive Detection**





Chemical
      and Explosive Detection is engaged in the design, research and development,
      software and hardware engineering, integration, training, and networking of
      advanced Chemical/Biological and Improvised Explosive Devices (IED) detection
      sensors.





EOIR
      provides technologies that reliably detect the presence of chemical, biological,
      and explosive devices or components from stand-off distances utilizing
      multi-spectral electro-optical sensing methods. EOIR also provides
      Chemical/Biological and IED simulators and real-time training devices with
      product specific specifications. Our major products include our Shipboard
      Automatic Chemical Agent Detection and Alarm (ACADA), Automated, Adaptive
      Chemical Examination System (AACES), and M22 Simulator.





**RESULTS
      OF OPERATIONS**


***Recent
      Developments***




**Sale
      of EOIR Technologies, Inc.**





In
      May
      2007, in order to realize the value of E-OIR Technologies Inc. for the benefit
      of our shareholders, the Board of Directors adopted a plan to sell this wholly
      owned subsidiary of Technest Holdings, Inc. On September 10, 2007, Technest
      and  E-OIR Technologies, Inc., entered into a Stock Purchase Agreement
      with EOIR Holdings LLC, a Delaware limited liability company, pursuant to which
      Technest will 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
      sale
      of EOIR to LLC will be structured as a stock sale in which LLC will acquire
      all
      of the outstanding stock of EOIR in exchange for approximately $34 million
      in
      cash, $11 million of which will be paid at closing and $23 million of which
      will
      be paid upon the successful re-award to EOIR of the contract with the U.S.
      Army's Night Vision and Electronics Sensors Directorate. A majority of the
      contingent payment of $23 million will be distributed to shareholders in the
      form of a cash dividend should it be received.


26




Accordingly,
      in accordance with SFAS 144, we have classified EOIR’s results of operations as
      discontinued operations for all periods presented in the accompanying
      consolidated financial statements.  All debt required to be repaid
      upon the sale of EOIR has been included in the liabilities of discontinued
      operations.  Interest expense on this debt has been included in the
      net loss from discontinued operations.




Three
      months ended September 30, 2007 compared with the three months ended September
      30, 2006




**Revenues**




Technest
      had $561,773 in revenues from continuing operations during the three months
      ended September 30, 2007 compared with $777,467 during the three months ended
      September 30, 2006. These revenues were largely generated by Small Business
      Innovative Research grants (SBIR’s) in the field of 3-dimensional imaging. We
      use the revenue from these grants to develop future potential products for
      our
      business. By their nature these revenues do not consistently accrue from quarter
      to quarter.





**Gross
      profit**




The
      gross
      profit from continuing operations for the three months ended September 30,
      2007
      was $352,855 or 63% of revenues. The gross profit for the three months ended
      September 30, 2006 was $364,236 or 47% of revenues. Technest expects to expand
      its revenue base to include commercial product revenues and, accordingly, gross
      profit on future revenues may differ.





**Selling,
      general and administrative expenses**




Selling,
      general and administrative expenses for the three months ended September 30,
      2007 were $2,017,471 and consisted primarily of payroll related expenses of
      approximately $157,790, 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.





Selling,
      general and administrative expenses for the three months ended September 30,
      2006 were $1,059,078, and consisted primarily of non cash amortization of
      stock-based compensation amounting to $398,630.





Certain
      general and administrative expenses of the Company that are clearly associated
      with EOIR totaling approximately $533,304 and $243,976 in the three months
      ended
      September 30, 2007 and 2006, respectively, have been included in the net
      income (loss) from discontinued operations.




**Amortization
      of intangible assets**




Amortization
      of intangible assets for the three months ended September 30, 2007 and
      2006 was $81,185. Amortization expense relates to the definite-lived
      intangible assets acquired in conjunction with Genex Technologies.




27


**Operating
      loss**





The
      operating loss from continuing operations for the three months ended September
      30, 2007 was $1,745,801. The operating loss from continuing operations for
      the
      three months ended September 30, 2006 was $776,826.





**Other
      (expenses) income**




In
      the
      three months ended September 30, 2007, Technest charged to interest expense
      $8,059. Interest expenses attributable to loans that will be paid off at the
      closing of the sale of EOIR have been included in the cost of discontinued
      operations.





In
      the
      three months ended September 30, 2006, Technest charged to interest expense
      $593,362 which primarily arose from interest paid in common stock related to
      liquidated damages incurred for failure to have an effective registration
      statement.





**Discontinued
      Operations**





Revenues
      from EOIR’s operation in the three months ended September 30, 2007 were
      $17,818,559 compared with $19,192,171 for the three months ended September
      30,
      2006.





The
      net
      income from EOIR’s operations was $844,863 in the three months ended September
      30, 2007 compared with a net loss of $504,601 for the three months ended
      September 30, 2006. The increase is attributable to gains made from overhead
      cost reductions implemented in the fourth quarter of fiscal year 2007. 
The
      net income and net loss for the three months ended September 30, 2007 and 2006
      included costs of $533,304 and $242,976 respectively 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, 2007 was $908,865.





The
      net
      loss applicable to common stockholders for the three months ended September
      30,
      2006 was $1,872,291.





**Liquidity
      and Capital Resources**




**Cash
      and Working Capital**





On
      September 30, 2007, Technest had a negative working capital balance from
      continuing operations of $226,662 and a negative working capital balance from
      discontinued operations of $8,596,484. Net cash used in operating activities
      for
      the three months ended September 30, 2007 was $1,212,178.





**Cash
      Used in Investing Activities**





In
      the
      three months ended September 30, 2007, Technest used cash of $7,905 for the
      acquisition of property and equipment.





**Cash
      Used in Financing Activities**





In
      the
      three months ended September 30, 2007, $588,272 was used for loan repayments,
      primarily related to the EOIR seller notes and the Silicon Valley Bank Term
      note. Our revolver from Silicon Valley Bank provided additional funds of
      $1,603,985.




**Sources
      of Liquidity**





During
      the three months ended September 30, 2007, we satisfied our operating and
      investing cash requirements primarily from financing activities and cash
      reserves. As discussed elsewhere, EOIR is expected to be sold, subject to
      certain conditions, with $11 million being payable in cash to the Company on
      closing plus a working capital adjustment that would have provided an
      additional  $2.5 million had the transaction closed on September 30,
      2007, and a further $23 million payable contingent on the re-award of the NVESD
      contract. There are expected to be no further cash obligations relating to
      discontinued operations after the sale. Our current expectation is for the
      sale
      to close prior to December 31, 2007.  The initial proceeds will be used to
      extinguish debt from Silicon Valley Bank, Shelter Island and the EOIR note
      holders. As of September 30, 2007, the face value of these loans was
      $10,532,943. The balance of the initial proceeds will be used for other
      contractual obligations and working capital.  The decision on the
      contingent payment is also expected during fiscal 2008. EOIR has won this
      contract three times in a row and management believes that EOIR is well
      positioned to do so again although there can be no assurances that it will
      do
      so. The Company is also expanding its efforts in commercial sales and believes
      that these activities will contribute positively in fiscal 2008. 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.


28




**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, 2007,
      Technest had warrants outstanding for the purchase of 649,286 shares of common
      stock. However, due to the net share settlement provisions of these warrants,
      Technest does not expect any material cash proceeds upon exercise.





**Effect
      of inflation and changes in prices**




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




**Critical
      Accounting Policies**




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




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




**Principles
      of Consolidation**




Our
      consolidated financial statements as of September 30, 2007 include the accounts
      of Technest, and our wholly-owned subsidiary- Genex Technologies, Inc. We have
      eliminated all significant inter-company balances and transactions.





In
      May
      2007, the Company’s Board of Directors approved a plan to divest the
      operations of our subsidiary, EOIR Technologies, Inc.  In accordance
      with SFAS No. 144, the assets, liabilities and results of operations of this
      subsidiary have been classified as a discontinued operation for all periods
      presented in the accompanying consolidated financial statements.




**Concentrations**




Statement
      of Financial Accounting Standards ("SFAS") No. 105, "Disclosure of Information
      about Financial Instruments with Off-Balance-Sheet Risk and Financial
      Instruments with Concentrations of Credit Risk," requires that we disclose
      any
      significant off-balance-sheet and credit risk concentrations. We are subject
      to
      concentrations of credit risk because the majority of our revenues and accounts
      receivable are derived from the U.S. government, including the Department of
      Defense, who is not required to provide collateral for amounts owed to us.
      We do
      not believe that we are subject to any unusual credit risks, other than the
      normal level of risk attendant to operating our business.




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




**Research
      and Development**




We
      charge
      research and development costs to expense as incurred. Funded research and
      development is part of our revenue base and the associated costs are included
      in
      cost of revenues. We capitalize costs related to acquired technologies that
      have
      achieved technological feasibility and have alternative uses. We expense as
      research and development costs the technologies we acquire if they are in
      process at the date of acquisition or have no alternative uses.




No
      new
      technologies were acquired during the three months ended September 30, 2007
      and
      as such there are no capitalized or expensed in-process research and development
      costs during this period relating thereto.


29





**Impairment
      of Goodwill and Amortizable Intangibles**




In
      accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," we review
      goodwill and amortizable intangibles for impairment annually, or more frequently
      if an event occurs or circumstances change that would more likely than not
      reduce the fair value of our business enterprise below its carrying value.
      The
      impairment test requires us to estimate the fair value of our overall business
      enterprise down to the reporting unit level. We identify and record our
      intangible assets at the reporting unit level and also conduct our impairment
      tests at the reporting unit level as required by paragraphs 30-31 of SFAS No.
      142, “Goodwill and Other Intangible Assets”.




We
      estimate fair value using either a discounted cash flows model, or an approach
      using market comparables, to determine fair value. Under the discounted cash
      flows method, we utilize estimated long-term revenue and cash flows forecasts
      developed as part of our planning process, together with an applicable discount
      rate, to determine fair value. Under the market approach, fair value is
      determined by comparing us to similar businesses (or guideline companies).
      Selection of guideline companies and market ratios require management's
      judgment. The use of different assumptions within our discounted cash flows
      model or within our market approach model when determining fair value could
      result in different valuations for goodwill.




**Estimated
      Useful Lives of Amortizable Intangible Assets**




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




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




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




Contracts
      and Customer relationships acquired as a result of business
      combinations have been valued by management considering various factors
      including independent appraisals done by valuation and financial advisory firms
      in accordance with SFAS No. 141, “Business Combinations”, SFAS No. 142,
“Goodwill and Other Intangible Assets”, FASB Concepts Statement Number 7 and
      EITF Issue No. 02-17, “Recognition of Customer Relationship Assets Acquired in a
      Business Combination”. These assets are being amortized over the contractual
      terms of the existing contracts plus anticipated contract renewals in accordance
      with EITF Issue No. 02-17.




**Impairment
      of Long-Lived Assets**




Pursuant
      to SFAS No. 144, we continually monitor events and changes in circumstances
      that
      could indicate carrying amounts of long-lived assets may not be recoverable.
      We
      recognize an impairment loss when the carrying value of an asset exceeds
      expected cash flows. Accordingly, when indicators or impairment of assets are
      present, we evaluate the carrying value of such assets in relation to the
      operating performance and future undiscounted cash flows of the underlying
      business. Our policy is to record an impairment loss when we determine that
      the
      carrying amount of the asset may not be recoverable. No impairment charges
      were
      recorded in the three months ended September 30, 2007 and 2006.




**Revenue
      Recognition**




We
      recognize revenue when the following criteria are met: (1) we have persuasive
      evidence of an arrangement, such as agreements, purchase orders or written
      requests, (2) we have completed delivery and no significant obligations remain,
      (3) our price to our customer is fixed or determinable, and (4) collection
      is
      probable.





Revenues
      from time and materials contracts are recognized as costs are incurred. Revenues
      from firm fixed price contracts are recognized on the percentage-of-completion
      method, either measured based on the proportion of costs recorded to date on
      the
      contract to total estimated contract costs or measured based on the proportion
      of labor hours expended to date on the contract to total estimated contract
      labor hours, as specified in the contract. However, during the nine months
      ended September 30, 2007 less than 5% of Technest’s revenue has come from firm
      fixed price contracts.


30




Provisions
      for estimated losses on all contracts are made in the period in which such
      losses become known. Changes in job performance, job conditions, and estimated
      profitability, including those arising from contract penalty provisions, and
      final contract settlements may result in revision to cost and income and are
      recognized in the period in which the revisions are determined. Technest
      participates in teaming agreements where they are the primary contractor and
      they participate with other organizations to provide complex integrated remote
      sensor product and technology development services to the Federal government.
      Technest has managerial and oversight responsibility for all team members as
      well as the responsibility for the ultimate acceptability of all integrated
      technical performance criteria under the contracts for deliverable services
      and
      products. Technest, as the prime contractor who accepts risks for these customer
      funded tasks, includes as revenues the amounts that they bill under the teaming
      arrangements and include as direct costs amounts that are reimbursable or paid
      to team members.





**Impact
      of Recently Issued Accounting Standards**




In
      September 2006, the FASB issued SFAS No. 157, “Fair Value
      Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework
      for measuring fair value in generally accepted accounting principles, and
      expands disclosures about fair value measurements. This statement is effective
      for financial statements issued for fiscal years beginning after Nov. 15, 2007.
      The Company is currently evaluating the impact of SFAS 157 on the consolidated
      financial statements.




On
        December 15, 2006 the Securities and Exchange Commission announced that it
        is
        has modified reporting requirements for smaller public companies under Section
        404 of the Sarbanes-Oxley Act (SOX 404) of 2002. The Commission granted relief
        to smaller public companies by extending the date by which non-accelerated
        filers must start providing a report by management assessing the effectiveness
        of the company's internal control over financial reporting. The compliance
        date
        for these companies was moved from fiscal years ending on or after July 15,
        2007, to fiscal years ending on or after December 15, 2007. The Commission
        also
        extended the date by which non-accelerated filers must begin to comply with
        the
        Section 404(b) requirement to provide an auditor's attestation report on
        internal control over financial reporting in their annual reports. This deadline
        was moved to the first annual report for a fiscal year ending on or after
        December 15, 2008. The extension requires all non-accelerated filers to complete
        only management's portion of the internal control requirements in their first
        year of compliance with SOX 404. This modification is intended to provide
        cost
        savings and efficiency opportunities to smaller public companies and to assist
        them as they prepare to comply fully with SOX 404 reporting requirements.
        The
        extension will provide these issuers and their auditors an additional year
        to
        consider, and adapt to, the changes in Auditing Standard No. 5 that the Public
        Company Accounting Oversight Board has issued, as well as the guidance for
        management the Commission has issued, to improve the efficiency of the Section
        404(b) auditor attestation report process.




In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities”, including an amendment of FASB
      Statement No. 115 (“SFAS 159”). This pronouncement permits entities to choose to
      measure many financial instruments and certain other items at fair value that
      are not currently required to be measured at fair value and to recognize the
      resulting gains and losses in the results of operations. SFAS 159 is effective
      as of the beginning of an entity’s first fiscal year that begins after November
      15, 2007. The impact of adopting SFAS 159 on the Company’s consolidated
      financial statements, if any, has not yet been determined.




**RISK
      FACTORS**




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




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





**We
      have a 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,
      2007, our accumulated deficit was $20,933,500. 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.


31




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.





**Our
      ability to service our debt and meet our cash requirements depends on many
      factors, some of which are beyond our control.**




Although
      there can be no assurances, we believe that the level of borrowings available
      to
      us, combined with cash provided by our operations, will be sufficient to provide
      for our cash requirements for the foreseeable future. However, our ability
      to
      satisfy our obligations will depend on our future operating performance and
      financial results, which will be subject, in part, to factors beyond our
      control, including interest rates and general economic, financial and business
      conditions. If we are unable to generate sufficient cash flow to service our
      debt, we may be required to:





·
            refinance
                all or a portion of our debt;




·
            obtain
                additional financing;




·
            sell
                some of our assets or operations;




·
            reduce
                or delay capital expenditures and/or acquisitions;
                or




·
            revise
                or delay our strategic plans.




If
      we are
      required to take any of these actions, it could have a material adverse effect
      on our business, financial condition, results of operations and liquidity.
      In
      addition, we cannot assure you that we would be able to take any of these
      actions, that these actions would enable us to continue to satisfy our capital
      requirements or that these actions would be permitted under the terms of our
      credit facilities.




**The
      covenants in our term loan facility with Silicon Valley Bank and those in our
      debenture with Shelter Island Opportunity Fund, LLC impose restrictions that
      may
      limit our ability and the ability of our subsidiaries to take certain actions
      and our failure to comply with these covenants could result in an acceleration
      of our indebtedness.**




The
      covenants in our term loan facility with Silicon Valley Bank restrict our
      ability and the ability of our subsidiaries to, among other things:




·
            sell,
                transfer or lease certain parts of our business and property or that
                of
                our subsidiaries;




·
            incur
                additional debt;




·
            pay
                dividends and make other restricted payments and restricts our
                subsidiaries from doing the same;




·
            make
                certain investments, loans and
                advances;




·
            create
                or permit certain liens;




·
            enter
                into transactions with affiliates;




·
            engage
                in certain business activities; and




·
            consolidate
                or merge or sell all or substantially all of our assets or those
                of our
                subsidiaries.




Our
      debenture with Shelter Island Opportunity Fund, LLC contains similar
      covenants.


32





Our
      term
      loan facility contains other covenants customary for credit facilities of this
      nature, including requiring us to meet specified financial ratios and financial
      tests. Our ability to borrow under our term loan facility will depend upon
      satisfaction of these covenants. Events beyond our control can affect our
      ability to meet those covenants.





If
      we are
      unable to meet the terms of our financial covenants, or if we violate any of
      these covenants, a default could occur under these agreements. A default, if
      not
      waived by our lenders, could result in the acceleration of our outstanding
      indebtedness and cause our debt to become immediately due and payable. If
      acceleration occurs, we would not be able to repay our debt, and it is unlikely
      that we would be able to borrow sufficient funds to refinance our debt. Even
      if
      new financing is made available to us, it may not be on terms acceptable to
      us.




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




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




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





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




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




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





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




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





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




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




·
            timing
                of orders from our largest customers - the DOD, Homeland Security
                and various INTEL;




·
            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.




33





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 The Stock Purchase Agreement For The Sale Of
      EOIR**




**We
      will incur significant costs in connection with the sale of EOIR, whether or
      not
      we complete it.**




We
      expect
      to incur significant costs related to the sale of EOIR.  These
      expenses include financial advisory, legal and accounting fees and expenses,
      severance and employee benefit related expenses, filing fees, printing expenses
      and other related charges. We may also incur additional unanticipated expenses
      in connection with the transaction.  A portion of the costs related to
      the sale, such as legal and accounting fees, will be incurred regardless of
      whether the transaction is completed.  These expenses will reduce the
      assets of Technest will have to operate its business after the
      sale.




**Because
      our revenues depend heavily on EOIR, the sale of this subsidiary will have
      a
      negative impact on our operating results.**




Virtually
      all of the Company’s revenues have been derived from EOIR’s contract with the
      United States Army Night Vision and Electronic Sensors
      Directorate.  EOIR contributed approximately $68,349,121 and
      $77,533,227 in revenues in fiscal 2007 and 2006, respectively.  Thus,
      the sale of EOIR will have an adverse effect on our revenues and cash flow
      from
      operations.




**EOIR’s
      contract with the United States Army Night Vision And Electronic Sensors
      Directorate expires in January 2008. EOIR is in the “re-compete” process. If
      EOIR is not awarded a new contract, Technest will not receive the $23,000,000
      contingent purchase price under the Stock Purchase
      Agreement.**




The
      payment of $23,000,000 of the purchase price being paid for EOIR is payable
      only
      upon the award to EOIR of the follow-on NVESD contract.  Although the
      Stock Purchase Agreement requires the acquiror to operate EOIR in a commercially
      reasonable manner post-closing which includes applying adequate and appropriate
      resources commensurate with previous efforts by EOIR to win award of the NVESD,
      there is no guarantee that EOIR will be awarded the follow-on
      contract.  It is also unclear what impact, if any, the sale of EOIR to
      the acquiror will have on EOIR’s ability to win the follow-on
      contract.





Although
      the U.S. Army has not announced the evaluation criteria for the replacement
      contract, there are several factors that are likely to be considered during
      the
      re-compete process, such as EOIR’s ability to do the work or find subcontractors
      that can do the work; EOIR’s competitive pricing; EOIR’s reputation, the
      Government’s prior experience with EOIR’s work; EOIR’s competition; changes in
      Government programs or requirements; budgetary priorities; changes in fiscal
      policies; curtailment of the Government’s use of technology solutions firms; new
      contract requirements; and the government’s need for a diverse contracting
      base.  If EOIR is not able to satisfy the Government’s requirements,
      it may not be awarded a new contract and Technest may not receive the contingent
      portion of the purchase price to be paid in the transaction.




**Certain
      directors and executive officers of Technest have interests in the sale that
      may
      be different from, or in addition to, the interests of Technest
      stockholders.**




Some
      directors and executive officers of Technest have interests in the sale that
      may
      be different from, or in addition to, the interests of Technest stockholders.
      These interests include, among other things, payments in connection with
      employment agreements and the right to continued indemnification and insurance
      coverage by the Company for acts or omissions occurring prior to the sale.
      As a
      result of these interests, these directors and officers could be more likely
      to
      recommend a vote in favor of approval of the sale than if they did not hold
      these interests, and may have reasons for doing so that are not the same as
      the
      interests of other Technest stockholders.




**Failure
      to complete the sale could negatively impact Technest's stock price and future
      business and operations.**




If
      the
      sale is not completed for any reason, Technest may be subject to a number of
      material risks, including the following:




·
            Technest
                may be
                required to pay the acquiror a termination fee of up to
                $1,450,000;·
            the
                price of Technest
                common stock may decline to the extent that the current market price
                of
                Technest common stock reflects an assumption that the
                salewill be
                completed; and·
            Technest
                must
                pay its accrued costs related to the sale, such as legal and accounting
                fees, even if the sale is not
                completed.




34





**Risks
      Related To The Company Following The Sale Of EOIR**




**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 has been the majority of Technest’s business operations.  After
      the sale of EOIR, Technest will operate 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:




·
            maintaining
                the dedication of management resources to sale activities without
                diverting attention from the day-to-day businesses that will remain
                with
                the Company after the sale;




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




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




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




·
            retaining
                key employees.




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




**The
      Common Stock of the Company after the Sale of EOIR may be affected by factors
      different from those affecting the price of Technest Common Stock prior to
      the
      Sale.**




As
      the
      Technest businesses remaining after the sale of EOIR are different from the
      current business of EOIR, the results of operations as well as the price of
      Technest common stock on completion of the sale may be affected by factors
      different from those factors affecting Technest as an entity
      today.  Technest after the sale of EOIR will face additional risks and
      uncertainties not otherwise facing the larger more developed business of
      EOIR.




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





According
      to the stock records of Technest, as of October 22, 2007, the date upon which
      stockholders of record were entitled to give written consent to the sale of
      EOIR, Southridge, together with its affiliates, were the largest stockholders
      of
      Technest, being the record holders of 8,544,397 shares of Technest’s outstanding
      common stock.  Southridge and certain of its affiliates acquired
      shares of our outstanding common stock from Markland, as well as Markland
      preferred stock convertible into outstanding Technest common stock currently
      owned by Markland, in a series of transactions described in a Form 8-K filed
      with the SEC by Markland on June 29, 2007.  Upon conversion of the
      Markland preferred stock recently issued to Southridge and its affiliates that
      is convertible into Technest common stock currently owned by Markland, subject
      to state law, Southridge and its affiliates could acquire greater than a
      majority interest in Technest common stock.  In addition, on August
      31, 2007, we entered into a Release Agreement with Southridge pursuant to which
      we agreed to increase the size of the board of directors of Technest from five
      to six and to elect two reasonably qualified individuals representing Southridge
      to fill the newly created directorships in accordance with Technest’s
      bylaws.  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.




35





**Risks
      Related to EOIR Contracting with the United States
      Government**





**EOIR’s
      contract with the United States Army Night Vision and Electronic Sensors
      Directorate expires in January 2008. EOIR is in the “re-compete” process. If
      EOIR is not awarded a new contract, its revenues would decrease significantly
      and its financial condition, as well as ours, would be adversely
      affected.**





EOIR
      has
      a contract with the United States Army Night Vision and Electronic Sensors
      Directorate that may provide for revenues of up to approximately $406 million
      (including revenue already recognized) depending upon the U.S. Army's needs
      of
      which our subsidiary, EOIR, recognized in excess of approximately $68 million
      in
      revenues for the year ended June 30, 2007 .This contract expires in January
      2008
      (with deliveries under the contract allowed until January 2009); it was recently
      extended for six months - the original contract was to expire in July 2007.
      We
      anticipate that the U.S. Army will competitively award a replacement contract.
      We will expend substantial cost and managerial time and effort to prepare for
      the bid and proposal for this new contract. Although we believe that it is
      likely that EOIR will be awarded a new contract, if EOIR is not awarded a new
      contract, its revenues would significantly decrease and its financial condition
      as well as ours could be adversely affected.





Although
      the U.S. Army has not announced the evaluation criteria for the replacement
      contract, there are several factors that are likely to be considered during
      the
      re-compete process, such as EOIR’s ability to do the work or find subcontractors
      that can do the work; EOIR’s competitive pricing; EOIR’s reputation, the
      Government’s prior experience with EOIR’s work; EOIR’s competition; changes in
      Government programs or requirements; budgetary priorities; changes in fiscal
      policies; curtailment of the Government’s use of technology solutions firms; new
      contract requirements; and the government’s need for a diverse contracting base.
      If EOIR is not able to satisfy the Government’s requirements, EOIR may not be
      awarded a new contract.





**EOIR’s
      largest customers are the DOD, Homeland Security, and various other INTEL whose
      operations are subject to unique political and budgetary constraints, involve
      competitive bidding, and EOIR’s contacts with these customers may be subject to
      cancellation with or without penalty, which may produce volatility in earnings
      and revenue.**




EOIR’s
      largest customers are the DOD, Homeland Security, and various other INTEL.
      Due
      to political and budgetary processes and other scheduling delays that may
      frequently occur relating to the contract or bidding process, some government
      agency orders may be canceled or delayed, and the receipt of revenues or
      payments may be substantially delayed. This irregular and unpredictable revenue
      stream makes it difficult for our business to operate smoothly. Obtaining
      contracts from government agencies is challenging, and government contracts
      often include provisions that are not standard in private commercial
      transactions. For example, government contracts may:





·
            include
                provisions that allow the government agency to terminate the contract
                without penalty under some
                circumstances;




·
            be
                subject to purchasing decisions of agencies that are subject to political
                influence;




·
            contain
                onerous procurement procedures; and




·
            be
                subject to cancellation if government funding becomes
                unavailable.





In
      addition, federal government agencies routinely audit government contracts.
      These agencies review a contractor's performance on its contract, pricing
      practices, cost structure and compliance with applicable laws, regulations
      and
      standards. These audits may occur several years after completion of the audited
      work. An audit could result in a substantial adjustment to revenues because
      EOIR
      would not be reimbursed for any costs improperly allocated to a specific
      contract, and EOIR would be forced to refund any improper costs already
      reimbursed. If a government audit uncovers improper or illegal activities,
      EOIR
      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 federal
      government agencies. In addition, EOIR’s reputation could be harmed if
      allegations of impropriety were made against EOIR.




36





**Risks
      Related To “Controlled Companies”**





**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 50% 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.





**Gino
      Pereira serves as a director and Chief Financial Officer of Technest and
      Markland. Conflicts of interest could arise as a result of these overlapping
      positions.**




While
      Mr.
      Pereira’s is currently spending 90% of his time working for Technest, there can
      be no assurance competing demands on Mr. Pereira at a given time will not result
      in an allocation of time and resources unfavorable to us. Neither our
      organizational documents nor our policies specify a minimum standard of time
      and
      attention that our officers and directors are required to devote to us, and
      there can be no assurance that conflicts of interest will not
      arise.





**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.**




Pursuant
      to the terms of the Merger Agreement and the Registration Rights Agreements
      executed on February 14, 2005 in connection with our acquisition of Genex,
      Technest was obligated to file a registration statement with the Securities
      and Exchange Commission; such registration statement went effective on
      February 7, 2007. In addition, we are obligated to register shares held by
      Markland or any of its transferees. Our common stock is thinly traded. The
      registration of these shares for public resale may result in a greater number
      of
      shares being available for trading than the market can absorb. This may cause
      the market price of our common stock to decrease.





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




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





**Risks
      Related To Investing In Low- Priced Stock**




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




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




37





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




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




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





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




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




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




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




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




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





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




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





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





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





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




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




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




38




**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 2003 to November 2007, the trading price
      of our common stock ranged from a low price of $0.02 per share to a high price
      of $63.29 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, although we recently elected
      directors that satisfy the “independence” standards of NASDAQ, it may be more
      difficult for us to attract and retain other qualified individuals to serve
      as
      members of our board of directors.




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




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





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




39





**Standards
      for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 are uncertain,
      and if we fail to comply in a timely manner, our business could be harmed and
      our stock price could decline.**




Rules
      adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002
      require annual assessment of our internal control over financial reporting,
      and
      attestation of this assessment by our independent registered public accountant.
      We expect that these requirements will first apply to our annual report for
      the
      fiscal year ending June 30, 2008 and June 30, 2009, respectively. The standards
      that must be met for management to assess the effectiveness of the internal
      control over financial reporting are new and complex, and require significant
      documentation, testing and possible remediation to meet the detailed standards.
      We may encounter problems or delays in completing activities necessary to make
      an assessment of its internal control over financial reporting. In addition, we
      may encounter problems or delays in completing the implementation of any
      requested improvements and receiving an attestation of its assessment by our
      independent registered public accountants. If management cannot assess our
      internal control over financial reporting as effective, or our independent
      registered public accounting firm is unable to issue an unqualified attestation
      report on such assessment, investor confidence and share value may be negatively
      impacted.




**Item
      3. 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, 2007 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.**




*Technest
      Holdings, Inc.*





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 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. We cannot
      make any assurances about the litigation’s outcome.


40




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 has 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. Technest believes
      that the case as currently styled is fundamentally a dispute between H&H
      Acquisition Corp. and Ben Stein.





As
      of
      November 6, 2007, Technest has not been notified of a trial date for this
      matter.





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, seeking unspecified monetary damages.  Deer Creek alleges
      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. Technest believes that the allegations in this
      lawsuit are entirely without merit. Technest has been aggressively defending
      this action, and has filed an answer denying Deer Creek’s allegations and
      vigorously opposes all relief sought.  A trial date for this claim had
      been set for December 4, 2007.





*Genex
      Technologies, Inc.*





On
      or
      about October 10, 2007, David Tunnell, one of the Company’s employees, commenced
      an action in the United States District Court for the District of Maryland
      against Genex Technologies, Inc. (“Genex”) and Jason Geng, the former sole
      stockholder of Genex.  Mr. Tunnell is seeking damages in the amount of
      $420,000 for breach of contract for an agreement entered into prior to the
      sale
      of Genex to Technest.  Mr. Tunnell also brings suit under a Maryland
      wage payment statute that allows for treble damages.  Genex believes
      that it has substantial defenses against Mr. Tunnell's claims.  Genex
      will be aggressively defending this action, and vigorously opposes all relief
      sought.


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




On
      October 23, 2007, stockholders of the Company representing approximately 55.5%
      of the total number of issued and outstanding shares of our capital stock
      entitled to vote executed and delivered to the Company their consent approving
      the Stock Purchase Agreement dated September 10, 2007 between Technest Holdings,
      Inc., EOIR Holdings, LLC and E-OIR Technologies, Inc. for the sale of EOIR
      (the
“Sale”) and the transactions contemplated thereby. The stockholder consent is
      sufficient under Nevada law to approve the Stock Purchase Agreement without
      the
      requirement of any other stockholder vote. No further action of the stockholders
      is required to approve the Sale.  Pursuant to Regulation 14C under the
      Securities Exchange Act of 1934, as amended, an information statement must
      be
      transmitted to Technest’s stockholders prior to such action by written consent
      becoming effective; such action is effective on the twentieth (20th) day
      following the date a definitive information statement is first sent to the
      stockholders of Technest.  On October 26, 2007, Technest filed a
      preliminary information statement with the SEC.





**ITEM
      6.  Exhibits**




Exhibit
                No.
            Description
            Filed
                with this Quarterly Report
            Incorporated
                by referenceForm
            Filing
                Date
            Exhibit
                No.2.1
            Stock
                Purchase Agreement dated September 10, 2007 between Technest Holdings,
                Inc., EOIR Holdings, LLC and E-OIR Technologies, Inc.
            
            8-K
            September
                13, 2007
            2.12.2
            Form
                of Voting Agreement with a list of signatories.
            
            8-K
            September
                13, 2007
            2.23.1
            By-law
                amendments.
            
            8-K
            October
                4, 2007
            3.110.1
            Release
                Agreement dated August 31, 2007 between Technest Holdings, Inc. and
                Southridge Partners, LP
            
            8-K
            September
                7, 2007
            10.110.2
            Consulting
                Agreement between E-OIR Technologies, Inc. and Robert Doto effective
                as of
                October 1, 2007.
            
            10-KSB/A
            October
                29, 2007
            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




41


**SIGNATURES**





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




**TECHNEST
                HOLDINGS, INC.**Date: November
                16, 2007
            By:
            /s/ Joseph
                P.
                Mackin
              Joseph
                P. Mackin
              Chief
                Executive Officer and PresidentDate: November
                16, 2007
            By:
            /s/ Gino
                M.
                PereiraGino
                M. Pereira
              Chief
                Financial Officer




42