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: March 31,
2008




OR




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




For
      the transition period from ______________ to
  ______________






Commission
File Number 000-27023






TECHNEST
HOLDINGS, INC.


(Exact
name of registrant as specified in its charter)




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




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


(Address of principal executive
offices and zip code)





(301)
767-2810


(Registrant’s telephone number,
including area code)




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




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




As
of May 12, 2008, there were 20,505,335 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


MARCH
31, 2008






PagePART
      I.      FINANCIAL INFORMATION:
            3Item
      1.       Financial Statements
      (Unaudited)
            3Condensed
      Consolidated Balance Sheet at March 31, 2008
            3Condensed
      Consolidated Statements of Operations for the Three Months Ended March 31,
      2008 and 2007
            5Condensed
      Consolidated Statements of Operations for the Nine Months Ended March 31,
      2008 and 2007
            6Condensed
      Consolidated Statement of Changes in Stockholders’ Equity for the Nine
      Months Ended March 31, 2008
            7Condensed
      Consolidated Statements of Cash Flows for the Nine Months Ended March 31,
      2008 and 2007
            9Notes
      to Condensed Consolidated Financial Statements
            11Item
      2.       Management’s Discussion and
      Analysis or Plan of Operation
            26Item
      3.       Controls and
    Procedures
            43PART
      II.      OTHER INFORMATION
            44Item
      1.       Legal Proceedings
            44Item
      6.       Exhibits
            45Signatures




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 OURANNUAL REPORT ON FORM
10-KSB FOR THE YEAR ENDED JUNE 30, 2007, INCLUDING, BUT NOT LIMITED TO, THE
SECTION THEREIN ENTITLED "RISK FACTORS."











PART
I. FINANCIAL INFORMATION


Item
1. Financial Statements








TECHNEST
HOLDINGS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEET


MARCH
31, 2008


(Unaudited)





ASSETSCurrent
      AssetsCash
      and cash equivalents
            
            $
            486,250Accounts
      receivable
            
            
            563,482Inventory
            
            
            39,918Restricted
      cash
            
            
            236,226Prepaid
      expenses and other current assets
            
            
            128,937Receivable
      from sale of EOIR
            
            
            23,000,000Total
      Current Assets
            
            
            24,454,813Property and Equipment–
      Net of accumulated depreciation $97,924
            
            
            87,966Other
      AssetsDeposits
            
            
            28,525Definitive-lived
      intangible assets – Net of accumulated amortization
    $1,014,814
            
            
            716,296Goodwill
            
            
            4,876,038Total
      Other Assets
            
            
            5,620,859Total
      Assets
            
            $
            30,163,638LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      LiabilitiesAccounts
      payable
            
            $
            225,973Unearned
      revenue
            
            
            11,493Accrued
      expenses and other current liabilities
            
            
            3,176,007Deferred
      tax liability
            
            
            300,000Total
      Current Liabilities
            
            
            3,713,473Total
      Liabilities
            
            
            3,713,473








3














TECHNEST
HOLDINGS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEET


MARCH
31, 2008 (concluded)


(Unaudited)
















Commitments
      and ContingenciesStockholders’
      EquitySeries
      A Convertible Preferred Stock - $.001 par value; 150 shares
      authorized;64.325
      shares issued and outstanding (preference in liquidation
of$64,325
      at March 31, 2008)
            
            
            -Series
      C Convertible Preferred Stock - $.001 par value; 1,149,425
      sharesauthorized;
      402,301 issued and outstanding (preference in liquidationof
      $875,005 at March 31, 2008)
            
            
            402Common
      stock - par value $.001 per share; 500,000,000 shares
      authorized;20,505,335
      shares issued and outstanding
            
            
            20,504Additional
      paid-in capital
            
            
            37,772,644Accumulated
      deficit
            
            
            (11,343,385
            )Total
      Stockholders’ Equity
            
            
            26,450,165Total
      Liabilities and Stockholders’ Equity
            
            $
            30,163,638See
      notes to condensed consolidated financial statements.
















4

















TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIESCONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONSFOR
      THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007(Unaudited)




2008
            
            
            2007Revenues
            
            $
            569,332
            
            
            $
            974,041Cost
      of Revenues
            
            
            377,807
            
            
            
            578,107Gross
      Profit
            
            
            191,525
            
            
            
            395,934Operating
      ExpensesSelling, general and
      administrative
            
            
            828,800
            
            
            
            1,048,208Research and
      development
            
            
            46,002
            
            
            
            -Amortization of intangible
      assets
            
            
            81,185
            
            
            
            81,186Total Operating
      Expenses
            
            
            955,987
            
            
            
            1,129,394Operating
      Loss
            
            
            (764,462
            )
            
            
            (733,460
            )Other
      Income (Expenses), NetOther income
            
            
            5,723
            
            
            
            10Interest
    expense
            
            
            -
            
            
            
            (284,603
            )Total Other Income (Expenses),
      Net
            
            
            5,723
            
            
            
            (284,593
            )Net
      Loss from continuing operations
            
            
            (758,739
            )
            
            
            (1,018,053
            )Discontinued
      Operations (Note 3)Gain
      (loss) from operations of discontinued operations (including gain on
      disposal of $22,750,406 in the three months ended March 31,
      2008)
            
            
            21,078,927
            
            
            
            97,959Provision
      for income taxes
            
            
            (300,000
            )
            
            
            --Gain on discontinued
      operations
            
            
            20,778,927
            
            
            
            97,959Net
      Income (Loss) Applicable to Common Shareholders
            
            $
            20,020,188
            
            
            $
            (920,094
            )Net
      Income (Loss) Per Common Share – basic and dilutedFrom
      continuing operations
            
            $
            (0.04
            )
            
            $
            (0.06
            )From
      discontinued operations
            
            $
            1.02
            
            
            $
            0.01Net
      Income (Loss) per share – basic and diluted
            
            $
            0.98
            
            
            $
            (0.05
            )Weighted
      Average Number of Common Shares OutstandingBasic
            
            
            20,467,427
            
            
            
            16,815,136Diluted
            
            
            20,467,427
            
            
            
            16,815,136See
      notes to consolidated financial statements.


5




TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIESCONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONSFOR
      THE NINE MONTHS ENDED MARCH 31, 2008 AND 2007(Unaudited)2008
            
            
            2007Revenues
            
            $
            1,892,905
            
            
            $
            2,322,030Cost
      of Revenues
            
            
            1,107,041
            
            
            
            1,499,559Gross
      Profit
            
            
            785,864
            
            
            
            822,471Operating
      ExpensesSelling, general and
      administrative
            
            
            3,376,752
            
            
            
            3,230,851Research and
      development
            
            
            46,002
            
            
            
            -Amortization of intangible
      assets
            
            
            243,555
            
            
            
            243,296Total Operating
      Expenses
            
            
            3,666,309
            
            
            
            3,474,147Operating
      Loss
            
            
            (2,880,445
            )
            
            
            (2,651,676
            )Other
      (Expenses) Income, NetOther income
            
            
            5,875
            
            
            
            3,109Interest
expense
            
            
            (11,329
            )
            
            
            (1,531,430
            )Total Other Expenses,
      Net
            
            
            (5,454
            )
            
            
            (1,528,321
            )Net
      Loss from continuing operations
            
            
            (2,885,899
            )
            
            
            (4,179,997
            )Discontinued
      Operations (Note 3)Gain
      (loss) from operations of discontinued operations (including gain on
      disposal of $14,801,367 in the nine months ended March 31,
      2008)
            
            
            11,867,149
            
            
            
            (485,500
            )Provision
      for income taxes
            
            
            (300,000
            )
            
            
            --Gain (loss) on discontinued
      operations
            
            
            11,567,149
            
            
            
            (485,500
            )Net
      Income (Loss) Applicable to Common Shareholders
            
            $
            8,681,250
            
            
            $
            (4,665,497
            )Net
      Income (Loss) Per Common Share – basic and dilutedFrom
      continuing operations
            
            $
            (0.15
            )
            
            $
            (0.25
            )From
      discontinued operations
            
            $
            0.60
            
            
            $
            (0.03
            )Net
      Income (Loss) per share - basic and diluted
            
            $
            0.45
            
            
            $
            (0.28
            )Weighted
      Average Number of Common Shares OutstandingBasic
            
            
            19,502,738
            
            
            
            16,423,488Diluted
            
            
            19,502,738
            
            
            
            16,423,488See
      notes to consolidated financial statements.




6













TECHNEST
HOLDINGS, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENT CHANGES IN OF STOCKHOLDERS' EQUITY


FOR
THE NINE MONTHS ENDED MARCH 31, 2008


(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
            
            
            397,000
            
            
            
            397
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Stock
      issued in connection withconversion
      of Series CConvertible
      Preferred Stock
            
            
            229,884
            
            
            
            230
            
            
            
            -
            
            
            
            -
            
            
            
            (229,884
            )
            
            
            (230
            )Net
      Income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Balance
      - March 31, 2008
            
            
            20,505,335
            
            
            $
            20,504
            
            
            
            64
            
            
            $
            -
            
            
            
            402,301
            
            
            $
            402







7














TECHNEST
HOLDINGS, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENT CHANGES IN OF STOCKHOLDERS' EQUITY


FOR
THE NINE MONTHS ENDED MARCH 31, 2008 (concluded)


(Unaudited)











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
            
            
            280,614
            
            
            
            -
            
            
            
            281,011Stock
      issued in connection withconversion
      of Series CConvertible
      Preferred Stock
            
            
            -
            
            
            
            -
            
            
            
            -Net
      Income
            
            
            -
            
            
            
            8,681,250
            
            
            
            8,681,250Balance
      - March 31, 2008
            
            $
            37,772,644
            
            
            $
            (11,343,385
            )
            
            $
            26,450,165











See notes
to condensed consolidated financial statements.




8







TECHNEST
HOLDINGS, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS


FOR
THE NINE MONTHS ENDED MARCH 31, 2008 AND 2007


(Unaudited)







2008
            
            
            2007Cash
      Flows From Operating Activities:Net
      income (loss)
            
            $
            8,681,250
            
            
            $
            (4,665,497
            )Adjustment
      to reconcile net income (loss) to net cash used inoperating
      activities:Depreciation
      and amortization of property and equipment
            
            
            33,197
            
            
            
            319,868Amortization
      of intangible assets
            
            
            243,555
            
            
            
            1,339,534Non-cash
      interest expense
            
            
            1,538,276
            
            
            
            987,757Stock-based
      compensation to employees and directors
            
            
            281,011
            
            
            
            962,503Stock
      issued in connection with termination of stockholderand license
    agreement
            
            
            1,380,000
            
            
            
            -Stock
      issued in connection with settlement of liquidated damages
            
            
            -
            
            
            
            1,726,426Fair
      value of warrants issued to a consultant
            
            
            -
            
            
            
            253,038Gain
      on disposal of discontinued operations
            
            
            (14,801,367
            )
            
            
            -Deferred
      income tax expense
            
            
            300,000
            
            
            
            -Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            8,816,402
            
            
            
            (170,338
            )Unbilled
      receivables
            
            
            1,515,558
            
            
            
            907,770Inventory
      and work in process
            
            
            (28,665
            )
            
            
            12,785Restricted
      cash
            
            
            (236,226
            )
            
            
            -Deposits
      and prepaid expenses and other current assets
            
            
            63,963
            
            
            
            10,836Accounts
      payable
            
            
            (8,045,789
            )
            
            
            (3,197,902
            )Unearned
      revenue
            
            
            (255,816
            )
            
            
            -Accrued
      expenses and other current liabilities
            
            
            (293,451
            )
            
            
            (1,034,378
            )Due
      to related parties
            
            
            (290,036
            )
            
            
            (232,485
            )Net
      Cash Used In Operating Activities
            
            
            (1,098,138
            )
            
            
            (2,780,083
            )Cash
      Flows From Investing Activities:Purchase
      of property and equipment
            
            
            (39,848
            )
            
            
            (39,609
            )Proceeds
      from sale of discontinued operations, net of transaction
    costs
            
            
            10,269,615
            
            
            
            -Net
      Cash Provided by (Used In) Investing Activities
            
            
            10,229,767
            
            
            
            (39,609
            )





9





TECHNEST
HOLDINGS, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


FOR
THE NINE MONTHS ENDED MARCH 31, 2008 AND 2007 (concluded)


(Unaudited)













Cash
      Flows From Financing Activities:Proceeds
      from term loan
            
            
            -
            
            
            
            3,000,000(Repayment
      of) proceeds from revolving line of credit, net
            
            
            (4,562,808
            )
            
            
            4,415,184Payment
      of debt issuance costs
            
            
            -
            
            
            
            (141,667
            )Payment
      of loan guarantee fee to Markland
            
            
            -
            
            
            
            (580,372
            )Repayment
      of term loan
            
            
            (2,166,667
            )
            
            
            (583,333
            )Repayment
      of notes payable
            
            
            (3,056,131
            )
            
            
            (5,003,411
            )Net
      Cash (Used In) Provided by Financing Activities
            
            
            (9,785,606
            )
            
            
            1,106,401Net
      Decrease In Cash
            
            
            (653,977
            )
            
            
            (1,713,291
            )Cash
      and Cash Equivalents - Beginning of Period
            
            
            1,140,227
            
            
            
            3,362,210Cash
      and Cash Equivalents - End of Period
            
            $
            486,250
            
            
            $
            1,648,919Supplemental
      Disclosures Of Cash Flow Information:Cash
      paid during the periods for:Interest
            
            $
            1,329,411
            
            
            $
            490,135Taxes
            
            $
            -
            
            
            $
            -Fair
      value of common stock and warrants issued asdeferred
      financing costs
            
            $
            -
            
            
            $
            561,970See
      notes to condensed consolidated financial statements











10





TECHNEST
HOLDINGS INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED MARCH 31, 2008 AND 2007


(Unaudited)







1. 
NATURE OF OPERATIONS





Business





Technest
Holdings, Inc. and its subsidiary (“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 Institutes of
Health.





Sale of EOIR Technologies,
Inc.





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





The sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of
the outstanding stock of EOIR in exchange for approximately $34 million in cash,
$11 million of which was paid at closing and $23 million of which 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 sale was completed on December
31, 2007.





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.





On
December 31, 2007, the Company divested the operations of its subsidiary, EOIR
Technologies, Inc.  In accordance with SFAS No. 144, the assets,
liabilities and results of operations of this consolidated subsidiary have been
classified as a discontinued operation for all periods presented in the
accompanying consolidated financial statements (see Note 3).





The
accompanying unaudited condensed consolidated financial statements of Technest
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information, without being
audited, pursuant to the rules and regulations of the Securities and Exchange
Commission. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary to make the financial statements not misleading have been included.
Operating results for the nine months ended March 31, 2008 are not necessarily
indicative of the result that may be expected for the year ending June 30, 2008.
The unaudited condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and footnotes included in
the Company's annual report on Form 10-KSB for the year ended June 30, 2007
filed with the Securities and Exchange Commission.




11


Reclassification





Certain
amounts in the financial statements for the three months and nine months ended
March 31, 2007 have been reclassified to conform with presentations for the
three months and nine months ended March 31, 2008 (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, the amount due to contracting
government agencies as a result of their audits, the realizability of deferred
tax assets including any limitations on the ability to utilize net operating
losses and the fair value of derivative liability and equity instruments
issued.





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 Institutes of 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 March 31, 2008.





Restricted
cash represents amounts held in an escrow account related to the sale of EOIR
and a certificate of deposit securing Company credit cards.




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.




12


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 March 31, 2008. If management
determines amounts to be uncollectible, they will be charged to operations when
that determination is made.





Unbilled
receivables represent amounts earned related to allowable costs incurred under
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




Property
and equipment consisted of the following at March 31, 2008:




Software
            
            $
            49,940Computer
      equipment
            
            
            24,665Furniture
      and fixtures
            
            
            111,285185,890Less
      accumulated depreciation
            
            
            (97,924
            )$
            87,966




Depreciation
expense from continuing operations for the nine months ended March 31, 2008 and
2007 was $33,197 and $31,339 respectively.





Definite-lived Intangible
Assets




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





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




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.




13


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 and accounts payable 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.




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.





14


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, 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 March 31, 2008, the Company had no accruals
for interest or penalties related to income tax matters.





Income (Loss) Per
Share




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




Common
stock equivalents, consisting of Series A and C Convertible Preferred Stock and
warrants were not included in the calculation of the diluted loss per share in
the three months and nine months ended March 31, 2008 because their inclusion
would have had the effect of decreasing the net loss from continuing operations
per share otherwise computed.





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 nine months ended March 31,
2008 and 2007.





Impairment of Long-Lived
Assets




Pursuant
to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived
Assets", the Company continually monitors events and changes in circumstances
that could indicate carrying amounts of long-lived assets may not be
recoverable. An impairment loss is recognized when expected cash flows are less
than the asset's carrying value. Accordingly, when indicators of impairment are
present, the Company evaluates the carrying value of such assets in relation to
the operating performance and future undiscounted cash flows of the underlying
assets. Technest’s policy is to record an impairment loss when it is determined
that the carrying amount of the asset may not be recoverable. No impairment
charges were recorded in the nine months ended March 31, 2008 and
2007.




15


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




The
Company applies the provisions of SFAS No. 123(R), “Share-Based Payment”,
which is a revision of SFAS No. 123, “Accounting for Stock Based
Compensation”. Under SFAS No. 123(R), the Company recognizes
compensation costs resulting from the issuance of stock-based awards to
employees and directors as an expense in the statement of operations over the
requisite service period based on the fair value for each stock award on the
grant date.





Recent Accounting
Pronouncements




In
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.





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.





16


In
December 2007, the FASB issued FAS No. 141(R) “Applying the
Acquisition Method”, which is effective for fiscal years beginning after
December 15, 2008. This statement retains the fundamental requirements in
FAS 141 that the acquisition method be used for all business combinations
and for an acquirer to be identified for each business combination.
FAS 141(R) broadens the scope of FAS 141 by requiring application of
the purchase method of accounting to transactions in which one entity
establishes control over another entity without necessarily transferring
consideration, even if the acquirer has not acquired 100% of its target. Among
other changes, FAS 141(R) applies the concept of fair value and “more
likely than not” criteria to accounting for contingent consideration, and
preacquisition contingencies. As a result of implementing the new standard,
since transaction costs would not be an element of fair value of the target,
they will not be considered part of the fair value of the acquirer’s interest
and will be expensed as incurred. The Company does not expect that the impact of
this standard will have a significant effect on its financial condition and
results of operations.








3. 
DISCONTINUED OPERATIONS





In May
2007, the Company’s Board of Directors approved a plan to divest the operations
of EOIR. On September 10, 2007, Technest and its wholly owned subsidiary, EOIR
Technologies, Inc. entered into a Stock Purchase Agreement with EOIR Holdings
LLC, a Delaware limited liability company, pursuant to which
Technest agreed to sell EOIR to LLC.  LLC is an entity
formed on August 9, 2007 by The White Oak Group, Inc., an Atlanta, Georgia based
private investment firm, for the purposes of facilitating this
transaction.  The White Oak Group, Inc. is focused on investments in
the aerospace and defense industry, with an emphasis on the following sectors:
Homeland security (detection and deterrence); avionics and instrumentation;
command and control; and communication networks and services. The sale was
completed on December 31, 2007.





The sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which 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.  On April 4, 2008, the U.S
Army issued EOIR a Notice of Intent to Issue an Award with respect to this
contract.  Based on this information, the Company concluded that the
outcome of the contingency was determinable beyond a reasonable
doubt.  As a result, the Company has recorded this $23 million
contingent consideration as part of income from discontinued operations in the
quarter ended March 31, 2008.  The award is subject to all contract
awardees meeting the small business criteria and size standard as determined by
the Small Business Administration (“SBA”). EOIR has responded to its request for
size standard information and anticipates receiving the contract award by the
end of June 2008.  The Company has also recorded a $300,000 deferred
tax liability related to this gain, which offsets the gain from discontinued
operations.





The major
classes of assets and liabilities disposed of were:





Assets
      related to discontinued operations:Cash
            
            $
            865,042Accounts
      receivable
            
            
            15,113,331Unbilled
      receivable
            
            
            4,110,027Prepaid
      expenses and other current assets
            
            
            337,516Total
      current assets
            
            
            20,425,916Property
      and equipment, net
            
            
            302,905Deposits
            
            
            47,603Definitive
      lived intangible assets, net
            
            
            9,006,632Goodwill
            
            
            9,159,513Total
      non-current assets
            
            
            18,516,653Total
      assets related to discontinued operations
            
            $
            38,942,569Liabilities
      related to discontinued operations:Accounts
      payable
            
            $
            16,222,997Unearned
      revenue
            
            
            172,784Accrued
      expenses and other current liabilities
            
            
            4,987,678Current
      portion of long term debt
            
            
            5,969,513Total
      current liabilities
            
            
            27,352,972Total
      liabilities related to discontinued operations
            
            $
            27,352,972





17





Included
in the current portion of long term debt above is all debt required to be repaid
at the closing of the sale of EOIR.





The gain
of disposal of EOIR was determined as follows:





Gross
      proceeds from sale
            
            $
            34,069,947Transaction
      costs
            
            
            (800,332
            )Net
      proceeds received at closing
            
            
            33,269,615Working
      capital adjustment due to White Oaks
            
            
            (909,137
            )Technest
      investment in EOIR
            
            
            (17,559,111
            )Gain
      on disposal of EOIR
            
            $
            14,801,367





The Stock
Purchase Agreement calls for an adjustment to the purchase price based on the
final working capital in EOIR on the date of sale.  At December 31,
2007, the Company paid The White Oak Group $50,000 and has estimated that it
owes an additional $859,137 related to this adjustment.  The Company
also recorded certain severance payments triggered by the $23,000,000 of
contingent consideration on the sale of EOIR of approximately
$1,572,000  These amounts are included in accrued expenses and other
current liabilities at March 31, 2008.




For the
three months and nine months ended March 31, 2008 and 2007, the operations of
EOIR have been reported in discontinued operations in the Statements of
Operations in accordance with SFAS No. 144, paragraph 42. Revenues and net loss
from discontinued operations were as follows:





Three
      Months EndedMarch
      31,
            
            
            March
      31,2008
            
            
            2007Revenues
      from discontinued operations
            
            $
            --
            
            
            $
            16,971,026Net
      (loss) income from discontinued operations
            
            $
            (1,671,479
            )
            
            $
            97,959








Nine
      Months EndedMarch
      31,
            
            
            March
      31,2008
            
            
            2007Revenues
      from discontinued operations
            
            $
            46,099,851
            
            
            $
            51,343,547Net
      loss from discontinued operations
            
            $
            (2,934,218)
            
            
            $
            (485,500
            )





Certain
general and administrative and interest expenses of the Company that are clearly
associated with EOIR totaling approximately $5,746,501 and $243,976 in the nine
months ended March 31, 2008 and 2007, respectively, have been included in the
net gain from discontinued operations.





18





4. 
DEFINITE-LIVED INTANGIBLE ASSETS




Definite-lived
intangible assets consist of the following at March 31, 2008:




Amount
            
            
            Useful
              l
      life
              (years)Patents
      - commercialized technology
            
            $
            440,000
            
            
            
            5Patents
      - other
            
            
            161,110
            
            
            
            15Customer
      relationships and contracts
            
            
            1,130,000
            
            
            
            5Accumulated
      amortization
            
            
            (1,014,814
            )Net
      definite-lived intangible asset
            
            $
            716,296







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 estimated useful life of the
customer relationships and contracts, the Company considered a number of factors
including, its history with these customers which dates back to 1993, the
remaining term of existing contracts, the status of outstanding bids submitted
for additional contracts or contract extensions, the stage of development of the
major tasks covered by existing contracts, the likelihood of receiving
additional contracts or contract extensions and the term over which the Company
could reasonably predict future revenues from existing
customers.  Amortization expense was $243,555 for each of the nine
months ended March 31, 2008 and 2007.




5. 
STOCKHOLDERS' EQUITY




Series A Convertible
Preferred Stock




On
February 8, 2005, the Company's Board of Directors designated 150 shares of
preferred stock as Series A Convertible Preferred Stock (“Series A Preferred
Stock”). The Series A Preferred Stock is non-interest bearing, is not entitled
to receive dividends and is not redeemable. The Series A Preferred Stock has a
liquidation preference of $1,000 per share. The holders of Series A Preferred
Stock have no voting rights except that they will be entitled to vote as a
separate class on any amendment to the terms or authorized number of shares of
Series A Preferred Stock, the issuance of any equity security ranking senior to
the Series A Preferred Stock and the redemption of or the payment of a dividend
in respect of any junior security. At any time, holders of Series A Preferred
Stock may elect to convert their Series A Preferred Stock into common stock.
Each share of Series A Preferred Stock is currently convertible into 4,735.3
shares of common stock provided that, following such conversion, the total
number of shares of common stock then beneficially owned by such holder and its
affiliates and any other persons whose beneficial ownership of Common Stock
would be aggregated with the holder's for purposes of Section 13(d) of the
Exchange Act, does not exceed 4.999% of the total number of issued and
outstanding shares of common stock. The Series A Preferred Stock ranks pari
passu with the Company's Series B and C Preferred Stock.




At March
31, 2008 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 was 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 had a closing bid price of $2.50 or higher on each day, if any. The number
of shares to be issued upon conversion of each share of Series B preferred
stock was 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 had 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, did not accrue dividends and were not redeemable. The
Series B Preferred Stock ranked pari passu with the Company's Series A and
C Preferred Stock.




19


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 December 31, 2005, the Company amended the terms of
this Registration Rights Agreement so that liquidated damages could only be paid
for in the Company’s common stock at a rate of 4% of the initial subscription
amount for any month.  On February 7, 2007, the required registration
statement became effective and, as a result, the Company does not expect to
incur any additional liquidated damages.




At March
31, 2008, the Company had -0- shares of Series B Preferred Stock and
402,301 shares of Series C Preferred Stock issued and
outstanding.





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.





Common Stock
Issuances




During
the nine months ended March 31, 2008, the Company issued the following amounts
of common stock:





·
              202,000
      shares of Technest common stock to four executives of the Company pursuant
      to employment agreements and performance
  bonuses.


·
              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.


·
              155,000
      shares of Technest common stock to three employees of the Company pursuant
      to performance bonuses.


·
              218,390
      shares of Technest common stock to DKR Soundshore Oasis Holding Fund Ltd
      upon conversion of 218,390 Series C Preferred
  Stock


·
              11,494
      shares of Technest common stock to DKR Soundshore Strategic Holding Fund
      Ltd upon conversion of 11,494 Series C Preferred
  Stock


·
              40,000
      shares of Technest common stock between David Gust and Robert
      Curtis, our non-employee directors, as compensation for their
      election and service on the Company’s board of
  directors.


20





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:





·
              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.
 
 ·
              Voting Agreement.
      Southridge agreed that it will vote all shares of Technest Common Stock
      owned by it and to cause its Affiliates that own shares of Technest Common
      Stock or Technest Preferred Stock to vote all of their shares, in favor of
      certain transactions entered into by September 10, 2007 that are approved
      and recommended by a majority of the directors of Technest under certain
      conditions.
 
 ·
              Board Representation.The Board of Directors of Technest agreed to increase the size of
      the board from five to six and fix the number of directors of Technest at
      six and to elect two reasonably qualified individuals representing
      Southridge to fill the newly created directorships in accordance with
      Technest’s Bylaws.
 
 ·
              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.




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
            
            
            402,301Total
      common stock reserves
            
            
            1,357,634




21


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 March 31,
2008 and 2007 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,
      March 31, 2008
            
            
            649,286
            
            
            $
            5.00




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





Exercise
      price
            
            
            Number
            
            Expiration
              Date$
            6.50
            
            
            
            374,286
            
            02/14/2010$
            5.85
            
            
            
            75,000
            
            08/03/2013$
            1.89
            
            
            
            200,000
            
            07/17/2011649,286Weighted
      average remaining life
            2.7
              years





As of
March 31, 2008 all warrants are exercisable.




22


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 nine months ended
March 31, 2008 was $281,011.




As
of March 31, 2008, the Company had 306,421 shares available for future grant
under the Plan.




7. 
NET INCOME (LOSS) 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 and nine months ended March 31, 2008, consist
of the following:




Shares
              PotentiallyIssuableSeries
      A Convertible Preferred Stock
            
            
            306,047Series
      C Convertible Preferred Stock
            
            
            402,301Warrants
            
            
            649,286Total
      as of March 31, 2008
            
            
            1,357,634




8.
COMMITMENTS AND CONTINGENCIES




Facility
Rental




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




Technest
currently also leases offices with approximately 6,848 square feet in Bethesda,
Maryland, pursuant to a five-year lease which expires March 31, 2011. Monthly
lease amounts for this facility total approximately $15,131, increasing annually
by 3%.





Rent
expense for continuing operations in the three months ended March 31, 2008 and
2007 was $44,512 and $43,215, respectively.







Employment
Agreements





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





23


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 the Board of
Directors, the audit committee has been disbanded.




9. 
INCOME TAXES




There was
no provision for federal or state income taxes related to continuing operations
for the three and nine months ended March 31, 2008 and 2007 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 is in the process of completing a full Section 382 analysis of these
changes.




As of
result of the sale of EOIR, the Company estimates that it will recognize a
taxable gain of approximately $13,300,000.  The Company expects that
it will have sufficient net operating losses available to offset this
gain.  As a result, the valuation allowance on deferred tax assets was
reduced by approximately $4,000,000 in the three months ended March 31,
2008.  The Company expects to owe Alternative Minimum Tax as a result
of this transaction of approximately $300,000 which will become due in the tax
year in which the EOIR sale proceeds are received.  At March 31, 2008,
this amount has been recorded as a deferred tax liability and included in the
net gain from discontinued operations.





Other
than as described above, 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 nine months ended March 31, 2008, Markland invoiced, and EOIR paid, $264,306
in conjunction with the supply of products pursuant to a sub-contract
agreement.





During
the nine months ended March 31, 2008, Technest paid Southridge Partners LP,
$250,000 in satisfaction of a payable assigned from Markland Technologies in
June 2007.




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 all eligible
employees.




Contributions
and other costs of this plan in the three months ended March 31, 2008 and 2007
were $28,763 and $28,469, respectively.





24


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.




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 May
12, 2008, 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.    The trial for this
claim took place on April 8, 2008. A decision has not been rendered as of May
12, 2008.




13. SUBSEQUENT
EVENT





On April
4, 2008, the U. S. Army issued EOIR a Notice of Intent to Issue an Award
notifying EOIR that the Government intends to award the contract with the U.S.
Army's Night Vision and Electronics Sensors Directorate to EOIR along with three
other companies. The award is subject to all contract awardees meeting the small
business criteria and size standard as determined by the Small Business
Administration (“SBA”). EOIR has responded to its request for size standard
information and anticipates receiving the contract award by the end of June
2008. Based on this information, the Company concluded that receipt of the
award, and accordingly, payment of the contingent consideration, is determinable
beyond a reasonable doubt. The SBA
final determination on small business eligibility of all four awardees is
expected by the end of June, 2008.


25





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 March 31, 2008 should be read
together with our financial statements and related notes included elsewhere in
this report.




FORWARD
LOOKING STATEMENTS




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




OVERVIEW




General




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., we purchased all of the outstanding stock of EOIR 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, EOIR Technologies, Inc. (“EOIR”), entered into a
Stock Purchase Agreement with EOIR Holdings LLC, a Delaware limited liability
company (“LLC”), pursuant to which Technest agreed to sell EOIR to
LLC.  LLC is an entity formed on August 9, 2007 by The White Oak
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.





26


The sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which 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. This transaction closed on December
31, 2007.





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








Technest
Business




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




Our
products leverage several core technology platforms, including:




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




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




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




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




Medical Devices
Division





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





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




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




27


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





Defense
and Security Division - 3D-ID





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





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





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





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





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





3D
SketchArtist is a three-dimensional composite sketch tool that uses our patented
three-dimensional morphing technology. The tool allows you to transform ordinary
two-dimensional sketches into rapidly evolving mock-ups that can be modified via
facial features, poses, expressions, and lighting in seconds.




3D
FaceCam changes the way we capture photographs. The 3D FaceCam uses three
sensors to create precise, complete 3D face images at light speed. By capturing
the very highly detailed geometric and texture information on a face, the 3D
FaceCam overcomes a photo’s traditional limitations of pose, lighting, and
expression. Capture speed is less than half a second, enabling rapid processing
of large numbers of people. 3D FaceCam is also highly accurate, making 3D
FaceCam ideal for facial recognition. In April 2008, the Company sold its
first outdoor facial recognition system to the US Army for
evaluation.







28




Technest
Business Strategy





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







·
              Focus
      on commercialization of pipeline products;
 ·
              Utilize
      relationships with current and new industry partners to bring technology
      to market;
 ·
              Develop
      recurring revenue models where possible;
 ·
              Continue
      to explore the cutting edge of 3-D and 360° imaging through continued
      research and development;
 ·
              Continue
      to develop a robust intellectual property portfolio;
and
 ·
              Seek
      strategic acquisitions






RESULTS
OF OPERATIONS





Recent
Developments




Sale
of EOIR Technologies, Inc.





In May
2007, the Board of Directors adopted a plan to sell this wholly owned subsidiary
of Technest Holdings, Inc. On September 10, 2007, Technest and EOIR
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 was completed on December 31, 2007 and was structured as a stock
sale in which LLC acquired all of the outstanding stock of EOIR in exchange for
approximately $34 million in cash, $11 million of which was paid at closing
and $23 million of which 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 April, 2008, the US Army informed EOIR that it intends to award
the NVESD contract to EOIR, amongst others, subject to verification of its small
business status. A majority of the contingent payment of $23 million, net of
expenses and accruals, will be distributed to shareholders in the form of a cash
dividend when it is received.




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.




Three and nine months ended
March 31, 2008 compared with the three and nine months ended March 31,
2007




Revenues




Technest
had $569,332 in revenues from continuing operations during the three months
ended March 31, 2008 compared with $974,041 during the three months ended March
31, 2007.





Technest
had $1,892,905 in revenues from continuing operations during the nine months
ended March 31, 2008 compared with $2,322,030 during the nine months ended March
31, 2007. These revenues were largely generated by Small Business Innovative
Research grants (SBIR’s) in the field of 3-dimensional imaging. We use the
revenue from these grants to develop future potential products for our business.
By their nature these revenues are not consistent from quarter to
quarter.





29


Gross
profit




The gross
profit from continuing operations for the three months ended March 31, 2008 was
$191,525 or 34 % of revenues. The gross profit for the three months ended three
months ended March 31, 2007 was $395,934 or 41% of revenues.





The gross
profit from continuing operations for the nine months ended March 31, 2008 was
$785,864 or 42% of revenues. The gross profit for the nine months ended March
31, 2007 was $822,471 or 35% 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 March 31, 2008
were $828,800 including payroll related expenses of approximately $363,340, non
recurring legal expenses of $76,639,  non cash amortization of
stock-based compensation to employees amounting to $16,703 and accrual of
approximately $136,467 for a claim made by the Defense Contract Management
Agency for reimbursement of overpayments made to the Company in fiscal year
2004.





Selling,
general and administrative expenses for the three months ended March 31, 2007
were $1,048,208, and consisted primarily of non cash amortization of stock-based
compensation amounting to $250,923 and a management fee of $250,000 paid to
Markland Technologies, Inc.





Certain
general and administrative expenses of the Company that are clearly associated
with EOIR have been reduced from the net gain from discontinued
operations.  Such amounts totaled $1,671,479, including certain
severance payments triggered by the contingent sale consideration on the sale of
EOIR, in the three months ended March 31, 2008.





Selling,
general and administrative expenses for the nine months ended March 31, 2008
were $3,376,752 including payroll related expenses of approximately $798,836,
non cash amortization of stock-based compensation to directors, officers
and employees amounting to $236,212 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 nine months ended March 31, 2007
were $3,230,851, and consisted primarily of non cash amortization of stock-based
compensation amounting to $962,503.





Certain
general and administrative expenses of the Company that are clearly associated
with EOIR totaling approximately $5,746,501 and $243,976 in the nine months
ended March 31, 2008 and 2007, respectively, have been included in the
net gain(loss) from discontinued operations.





Amortization
of intangible assets




Amortization
of intangible assets for the three months and nine months ended March 31, 2008
was $81,185 and $243,555, respectively. Amortization of intangible assets for
the three months and nine months ended March 31, 2007 was $81,186 and $243,296,
respectively. Amortization expense relates to the definite-lived intangible
assets acquired in conjunction with Genex Technologies.




Operating
loss





The
operating loss for the three months ended March 31, 2008 was $764,462. The
operating loss for the three months ended March 31, 2007 was
$733,460.





30


The
operating loss from continuing operations for the nine months ended March 31,
2008 was $2,880,445. The operating loss from continuing operations for the nine
months ended March 31, 2007 was $2,651,676.





Other
income (expenses)




In the
three months ended March 31, 2008, Technest had no charges for interest
expense





In the
three months ended March 31, 2007, Technest charged to interest expense $284,603
which primarily arose from interest paid in common stock related to liquidated
damages incurred for failure to have an effective registration
statement.  Interest expense attributable to loans that were required
to be paid off at the closing of the sale of EOIR have been included in the loss
on discontinued operations.





In the
nine months ended March 31, 2008, Technest charged to interest expense $11,329.
Interest expense attributable to loans that were paid off at the closing of the
sale of EOIR have been included in the loss on discontinued
operations.





In the
nine months ended March 31, 2007, Technest charged to interest expense
$1,531,430 which primarily arose from interest paid in common stock related to
liquidated damages incurred for failure to have an effective registration
statement. Interest expense attributable to loans that were required to be paid
off at the closing of the sale of EOIR have been included in the loss on
discontinued operations.





Discontinued
Operations





The net
gain from discontinued operations was $11,567,149 in the nine months ended March
31, 2008 compared with a net loss of ($485,500) for the nine months ended March
31, 2007. The net gain (loss) for the nine months ended March 31, 2008 and 2007
included costs of $5,746,501 and $243,976 respectively for costs incurred by
Technest that are clearly associated with the discontinued
operations.





The gain
from discontinued operations the nine months ended March 31, 2008 includes a
gain on disposal of $14,801,367 on the sale of EOIR. On April 4, 2008 the
Department of the Army issued EOIR a Notice of Intent to Issue an Award
notifying EOIR that the Government intended to award the contract with the U.S.
Army's Night Vision and Electronics Sensors Directorate to EOIR amongst other
companies. The award is subject to EOIR meeting the small business criteria and
size standard as determined by the Small Business Administration (“SBA”). EOIR
has responded to the request for size standard information. Based on this
information, the Company concluded that the payment of the contingent
consideration is now assured beyond a reasonable doubt.





The SBA
is currently evaluating the small business eligibility of all four potential
awardees and has notified EOIR that the award will likely take place in June
2008.








Net
Income (Loss) applicable to common shareholders





The net
income attributable to common shareholders for the three months and nine months
ended March 31, 2008 was $20,020,188 and $8,681,250 respectively.





The net
loss applicable to common stockholders for the three months and nine months
ended March 31, 2007 was ($920,094) and ($4,665,497), respectively.





Liquidity
and Capital Resources




Cash
and Working Capital





On March
31, 2008, Technest had a positive working capital balance of $20,471,340. Net
cash used in operating activities for the nine months ended March 31, 2008 was
$1,098,138.


31





Cash
Used in Investing Activities





In the
nine months ended March 31, 2008, Technest used cash of $39,848 for the
acquisition of property and equipment.   In the nine months ended
March 31, 2008, the Company received proceeds from the sale of EOIR, net of
transaction costs, of $10,269,615.





Cash
Used in Financing Activities





In the
nine months ended March 31, 2008, $9,785,606 was used for loan repayments,
primarily related to the EOIR seller notes, the Shelter Island note, the Silicon
Valley Bank Term note and the Silicon Valley Bank revolving line of
credit.  These amounts were required to be repaid at the closing of
the EOIR sale and the facilities are no longer available to the
Company.




Sources
of Liquidity





During
the nine months ended March 31, 2008, we satisfied our operating and investing
cash requirements primarily from financing activities and cash
reserves.  We do not currently have any borrowing facilities available
to us.  As discussed elsewhere, EOIR was sold with about $11 million
being received in cash by the Company on closing.  A further $23
million is payable to the Company contingent on the re-award of the NVESD
contract. The Company expects to receive these proceeds during calendar 2008.
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.







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 March
31, 2008, Technest had warrants outstanding for the purchase of 649,286 shares
of common stock. However, due to the net share settlement provisions of these
warrants, Technest does not expect any material cash proceeds upon
exercise.





Effect
of inflation and changes in prices




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




Critical
Accounting Policies




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.




32


Principles
of Consolidation




Our
consolidated financial statements as of March 31, 2008 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 March 31, 2008 and as
such there are no capitalized or expensed in-process research and development
costs during this period relating thereto.





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.


33





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 nine months ended March 31, 2008 and 2007.




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. During the nine months ended
March 31, 2008, approximately 27% of Technest’s revenue has come from firm fixed
price contracts.




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





34


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.





In
December 2007, the FASB issued FAS No. 141(R) “Applying the
Acquisition Method”, which is effective for fiscal years beginning after
December 15, 2008. This statement retains the fundamental requirements in
FAS 141 that the acquisition method be used for all business combinations
and for an acquirer to be identified for each business combination.
FAS 141(R) broadens the scope of FAS 141 by requiring application of
the purchase method of accounting to transactions in which one entity
establishes control over another entity without necessarily transferring
consideration, even if the acquirer has not acquired 100% of its target. Among
other changes, FAS 141(R) applies the concept of fair value and “more
likely than not” criteria to accounting for contingent consideration, and
preacquisition contingencies. As a result of implementing the new standard,
since transaction costs would not be an element of fair value of the target,
they will not be considered part of the fair value of the acquirer’s interest
and will be expensed as incurred. The Company does not expect that the impact of
this standard will have a significant effect on its financial condition and
results of operations.





35





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 March 31,
2008, our accumulated deficit was approximately $11 million. If Technest
continues to suffer losses as it has in the past, investors may not receive any
return on their investment and may lose their entire investment.




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




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





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





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




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




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




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




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




·
            retaining
      key employees.





36





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.




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.





On April
4, 2008, the U. S. Army issued EOIR a Notice of Intent to Issue an Award
notifying EOIR that the Government intends to award the contract with the U.S.
Army's Night Vision and Electronics Sensors Directorate to EOIR along with three
other companies. The award is subject to all contract awardees meeting the small
business criteria and size standard as determined by the Small Business
Administration (“SBA”). EOIR has responded to its request for size standard
information and anticipates receiving the contract award by the end of June
2008. Based on this information, the Company concluded that receipt of the
award, and accordingly, payment of the contingent consideration, is determinable
beyond a reasonable doubt. However, if for any reason EOIR is not awarded the
contract, Technest may not receive the contingent portion of the purchase price
to be paid in the transaction.





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.




37


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





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




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





·
              our ability to perform under
      contracts and manufacture, test and deliver products in a timely and
      cost-effective manner;
 ·
              our success in winning
      competitions for orders;
 ·
              the timing of new product
      introductions by us or our competitors;
 ·
              the mix of products we
      sell;
 ·
              competitive pricing pressures;
      and
 ·
              general economic
      climate.






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





Risks
Related to Contracting with the United States Government





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




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





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




38


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





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




·
            changes
      in Government programs or
requirements;




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




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




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




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





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




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




39


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





Risks
Related To “Controlled Companies”





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





According
to the stock records of Technest, as of March 31, 2008, Southridge Partners LP,
together with its affiliates, were the largest stockholders of Technest, owning
approximately 65% of Technest’s outstanding common stock as the record holders
of 13,404,387 shares.  Recently, Southridge appointed three members to
Technest’s board of directors (currently, there are a total of six directors on
Technest’s board of directors).  As a result, Southridge possesses
significant influence over our affairs.  Southridge’s stock ownership
and relationships with members of Technest’s board of directors may have the
effect of delaying or preventing a future change in control, impeding a merger,
consolidation, takeover or other business combination or discouraging a
potential acquirer from making a tender offer or otherwise attempting to obtain
control of Technest, which in turn could materially and adversely affect the
market price of Technest’s common stock.




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




A very
small number of investors collectively owned more than 65% of Technest’s
outstanding common stock on a primary basis.  As a result, those investors
have the ability to control all matters submitted to the stockholders of
Technest for approval (including the election and removal of
directors).  A significant change to the composition of our board
could lead to a change in management and our business plan. Any such transition
could lead to, among other things, a decline in service levels, disruption in
our operations and departures of key personnel, which could in turn harm our
business.




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




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




Risks
Related To Capital Structure




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




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





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




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





40


Risks
Related To Investing In Low- Priced Stock




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




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




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




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




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





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




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




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




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




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




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





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




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





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





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





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




41





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




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




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




Our stock
price has been volatile. From January 2006 to April 2008, the trading price of
our common stock ranged from a low price of $0.32 per share to a high price of
$11.35 per share. Many factors may cause the market price of our common stock to
fluctuate, including:





·
              variations
      in our quarterly results of
operations;
 
 ·
              the
      introduction of new products by us or our
  competitors;
 
 ·
              acquisitions
      or strategic alliances involving us or our
  competitors;
 
 ·
              future
      sales of shares of common stock in the public market;
  and
 
 ·
              market
      conditions in our industries and the economy as a
  whole.


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




Risks
Relating to New Corporate Governance Standards




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




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





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




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




42


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.






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  March 31, 2008 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.





43





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.





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 May
12, 2008, 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.  The trial for this claim took place on April 8, 2008. A
decision has not been rendered as of May 12, 2008.





44










ITEM
6.  Exhibits




Exhibit
              No.
            Description
            Filed
      with this Quarterly Report
            Incorporated
      by referenceForm
            Filing
      Date
            Exhibit
      No.10.1
            Employment
      Agreement between Gino M. Pereira and Technest Holdings, Inc. dated
      January 14, 2008.
            
            8-K
            January
      18, 2008
            10.110.2
            Employment
      Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated January
      14, 2008.
            
            8-K
            January
      18, 2008
            10.210.3
            Restricted
      Stock Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated
      January 15, 2008.
            
            8-K
            January
      18, 2008
            10.310.4
            Restricted
      Stock Agreement between David R. Gust and Technest Holdings, Inc. dated
      January 15, 2008.
            
            8-K
            January
      18, 2008
            10.510.5
            Restricted
      Stock Agreement between Dr. Robert A. Curtis and Technest Holdings, Inc.
      dated January 15, 2008.
            
            8-K
            January
      18, 2008
            10.631.1
            Certification
      by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X31.2
            Certification
      by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X32.1
            Certification
      by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
      1350.
            X99.1
            Pro
      forma financial information.
            
            8-K
            January
      4, 2008
            99.2




45


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: May
      15, 2008
            By:
            /s/ Gino M.
      Pereira
              Gino
      M. Pereira
              Chief
      Executive Officer and PresidentDate:
      May 15, 2008
            By:
            /s/ Nitin V.
      KotakNitin
      V. Kotak
              Chief
      Financial Officer and Treasurer





46


EXHIBIT
INDEX





Exhibit
              No.
            Description
            Filed
      with this Quarterly Report
            Incorporated
      by referenceForm
            Filing
      Date
            Exhibit
      No.10.1
            Employment
      Agreement between Gino M. Pereira and Technest Holdings, Inc. dated
      January 14, 2008.
            
            8-K
            January
      18, 2008
            10.110.2
            Employment
      Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated January
      14, 2008.
            
            8-K
            January
      18, 2008
            10.210.3
            Restricted
      Stock Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated
      January 15, 2008.
            
            8-K
            January
      18, 2008
            10.310.4
            Restricted
      Stock Agreement between David R. Gust and Technest Holdings, Inc. dated
      January 15, 2008.
            
            8-K
            January
      18, 2008
            10.510.5
            Restricted
      Stock Agreement between Dr. Robert A. Curtis and Technest Holdings, Inc.
      dated January 15, 2008.
            
            8-K
            January
      18, 2008
            10.631.1
            Certification
      by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X31.2
            Certification
      by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            X32.1
            Certification
      by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
      1350.
            X99.1
            Pro
      forma financial information.
            
            8-K
            January
      4, 2008
            99.2