UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-KSB




x
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the Fiscal Year Ended June 30, 2008.o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




Commission
File Number 000-27023




Technest Holdings,
Inc.


(Exact name of Registrant as
specified in its Charter)




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





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




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




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





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




Common Stock, par value
$0.001 per share


(Title or
Class)




Check
whether the issuer is required to file reports pursuant to Section 13 or 15(d)
of the Exchange Act  x Yes  o No





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




Check if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. o




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





The
issuer’s revenues for the year ended June 30, 2008, excluding discontinued
operations in accordance with Statement of Financial Accounting Standard No.
144, were $2,469,085.















The
aggregate market value of the voting and non-voting common equity held by
non-affiliates* computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of
September 29, 2008 (See definition of affiliate in Rule 12b-2 of the Exchange
Act.) was: $.3,280,942




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




APPLICABLE
ONLY TO CORPORATE REGISTRANTS




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




20,676,211
shares as of September 29, 2008, all of one class of common stock, $0.001 par
value.




DOCUMENTS
INCORPORATED BY REFERENCE




Documents
Incorporated by reference:  Proxy Statement or Information Statement
for the 2008 annual meeting of stockholders




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







TECHNEST
HOLDINGS, INC.


FORM
10-KSB


TABLE
OF CONTENTS


June
30, 2008






Part
      IItem
      1.
            Description
      of Business
            1Item
      2.
            Description
      of Property
            6Item
      3.
            Legal
      Proceedings
            7Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            8Part
      IIItem
      5.
            Market
      for Common Equity and Related Stockholder Matters
            9Item
      6.
            Management’s
      Discussion and Analysis
            9Item
      7.
            Financial
      Statements
            25Item
      8.
            Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosures
            25Item
      8A(T).
            Controls
      and Procedures
            25Item
      8B.
            Other
      Information
            26Part
      IIIItem
      9.
            Directors
      and Executive Officers of the Registrant; Compliance with Section 16(a) of
      the Exchange Act
            26Item
      10.
            Executive
      Compensation
            26Item
      11.
            Security
      Ownership of Certain Beneficial Owners and Management
            26Item
      12.
            Certain
      Relationships and Related Transactions
            26Item
      13.
            Exhibits
            27Item
      14.
            Principal
      Accountant Fees and Services
            33




-i-


NOTE
REGARDING FORWARD-LOOKING STATEMENTS




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




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




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




-ii-





PART I





Item 1. Description of Business





Recent
Developments





Sale
of EOIR Technologies, Inc.





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.





The sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which is payable upon
the successful re-award to EOIR of the contract with the U.S. Army's Night
Vision and Electronics Sensors Directorate (NVESD). This transaction closed on
December 31, 2007. On August 4, 2008, EOIR was one of three companies awarded
the U.S. Army's Night Vision and Electronics Sensors Directorate (“NVESD”)
contract with a funding ceiling of $495 million. The Contingent Purchase Price
of $23 million was due as of August 21, 2008 in accordance with the Stock
Purchase Agreement.





On August
26, 2008, LLC notified Technest that, in their opinion, the conditions set forth
in the Stock Purchase Agreement triggering payment of the Contingent Purchase
Price had not been satisfied. LLC provided no explanation for its
contention.  Technest strongly believes that all conditions of the
Stock Purchase Agreement were met, and LLC’s position is without
merit.  Technest is aggressively pursuing payment of the Contingent
Purchase Price in accordance with the Stock Purchase
Agreement.  Accordingly on September 24, 2008, Technest notified LLC
that it has filed for final and binding arbitration of the matter in accordance
with the terms of the Stock Purchase Agreement.





In
accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141,
“Business Combinations”, the Company recorded the $23 million of contingent
consideration in the quarter ended March 31, 2008.  At that time, the
Company determined that the outcome of the contingency was determinable beyond a
reasonable doubt based on having received notification of award of the NVESD
contract pending review by the Small Business Administration.  In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets”, EOIR is presented as a discontinued operation in the
consolidated financial statements.




Small Business Status





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





General





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




-1-




Our
products leverage several core technology platforms, including:




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




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




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




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




Medical Devices
Division





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





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




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




The
Dental 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.




-2-




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





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





3D
SketchArtist is a three-dimensional composite sketch tool that uses our patented
three-dimensional morphing technology. The tool allows you to transform ordinary
two-dimensional sketches into rapidly evolving mock-ups that can be modified via
facial features, poses, expressions, and lighting in seconds. In August 2008,
the 3D SketchArtist was successfully introduced at the annual International
Association of Identification (IAI) show. The Company is
currently negotiating a distribution agreement with a nationally recognized law
enforcement distribution company.




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




Technest
Business Strategy





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




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




Technest
History





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




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




-3-




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


The
Merger Agreement provides for Mr. Geng to receive a six-month unsecured
promissory note in the principal amount of $550,000 that accrues interest at the
rate of 6% per year. Also, the Merger Agreement provides that if Genex meets
specified revenue goals at the end of each of the first three years following
February 14, 2005, Technest will pay to Mr. Geng contingent consideration of
additional shares of Technest common stock equal to the fair market value of 30%
of the difference in Genex's gross revenue during the year proceeding the
payment and its gross revenue in 2004. Finally, the Merger Agreement provides
that if the Intraoral Technologies are commercialized, Mr. Geng will be entitled
to 50% of all profits generated from the Intraoral Technologies for a period of
five years following February 14, 2005. Following the acquisition, it is
Technest’s opinion that Mr. Geng omitted material representations from the
Merger Agreement regarding the status of regulatory audits, the impact of
certain internal control deficiencies and the non-disclosure of ongoing
government investigations into certain conduct by Mr. Geng and Genex prior to
the acquisition of Genex by Technest, and as a result, Markland and Technest
have not issued and do not intend to issue the promissory note, the additional
Markland share consideration or the contingent payments of Technest common
stock. To date, Mr. Geng has not contested Technest's position, has not sought
payment and Technest believes that the possibility that it will have to issue
additional shares or other consideration is remote.





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





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





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





The sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which is payable upon
the successful re-award to EOIR of the contract with the U.S. Army's Night
Vision and Electronics Sensors Directorate (NVESD). This transaction closed on
December 31, 2007. On August 4, 2008, EOIR was awarded the NVESD contract with a
funding ceiling of $495 million. The Contingent Purchase Price of $23 million
was due as of August 21, 2008 in accordance with the Stock Purchase
Agreement.





-4-





Competition





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





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





Intellectual
Property





Our
ability to compete effectively depends to a significant extent on our ability to
protect our proprietary information. We rely primarily on patents and trade
secret laws and confidentiality procedures to protect our intellectual property
rights. We own 19 U.S. patents and have 16 patents pending. We enter into
confidentiality agreements with our consultants and key employees, and maintain
controls over access to and distribution of our technology, software and other
proprietary information. The steps we have taken to protect our technology may
be inadequate to prevent others from using what we regard as our technology to
compete with us.





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





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





Dependence
on U.S. Government Contracts





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





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




-5-




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




Government
Regulation





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





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





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





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





Sales
and Marketing





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





Manufacturing





Our
primary manufacturing facilities are located in Bethesda, Maryland.





Employees





As of
September 21, 2008, Technest had a total of 17 employees. We believe our future
success will depend upon the continued service of our key technical and senior
management personnel and upon our continued ability to attract and retain highly
qualified technical and managerial personnel. None of our employees is
represented by a labor union. We have never experienced a work stoppage and
consider our relationship with our employees to be good.





Item 2. Description of Property





Technest
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.




-6-




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%.





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





Item 3. Legal Proceedings





H&H





On or
about July 23, 1998, H & H Acquisition Corporation, individually and
purportedly on behalf of Technest Holdings, commenced an action in United States
District Court, Southern District of New York entitled H & H Acquisition
Corp., individually and on behalf of Technest Holdings, Inc. v. Financial
Intranet Holdings, Inc., Technest Holdings, Inc., F/K /A Financial Intranet,
Inc., Ben Stein, Interwest Transfer Co., Steven A. Sanders, Michael Sheppard,
Maura Marx, Henry A. Schwartz, Leonard Gotshalk, Gotshalk Enterprises, Law
Office of Steven A. Sanders, P.C. and Beckman, Millman & Sanders, LLP, 98
Civ. 5269. The plaintiffs are purporting to act on behalf of Technest in the
context of a shareholder’s derivative suit. The action’s principal basis appears
to be a claim that Ben Stein, a former director and Secretary of Technest,
wrongfully claims ownership of shares of common stock that Stein agreed to
purchase from H&H. According to H&H, these shares belong to it. 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 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 to the
court’s subject matter jurisdiction in this case has been rendered moot, thereby
depriving the court of continuing subject matter jurisdiction. On July 31, 2008,
the court denied the motion to dismiss for lack of subject matter jurisdiction.
On September 5, 2008, in accordance with the judge’s order of July 31, 2008,
Technest, Mr. Sheppard and Ms. Marx filed a motion for summary judgment to
dismiss all claims against them.





Deer Creek





On or
about May 30, 2006, Deer Creek Fund LLC (“Deer Creek”) 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 alleged misconduct on the part of Technest related to a proposed sale by
Deer Creek of 157,163 shares of Technest common stock at $7.00 per share and the
applicability of certain selling restrictions under a registration rights
agreement entered into between the parties.  The trial for this claim
took place on April 8, 2008. On August 12, 2008, a decision was rendered against
Technest.  As of September 22, 2008, the parties have agreed to settle
the judgment in lieu of further appeals in the amount of $600,000.





The
White Oak Group





On
September 10, 2007, Technest Holdings, Inc. and its wholly owned subsidiary,
EOIR Technologies, Inc. entered into a Stock Purchase Agreement with EOIR
Holdings 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 sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which is payable upon
the successful re-award to EOIR of the contract with the U.S. Army's Night
Vision and Electronics Sensors Directorate (NVESD). This transaction closed on
December 31, 2007. On August 4, 2008, EOIR was awarded the NVESD contract with a
funding ceiling of $495 million. The Contingent Purchase Price of $23 million
was due as of August 21, 2008 in accordance with the Stock Purchase
Agreement.




-7-




On August
26, 2008, LLC notified Technest that, in their opinion, the conditions set forth
in the Stock Purchase Agreement triggering payment of the Contingent Purchase
Price have not been satisfied. LLC provided no explanation for its
contention.  Technest strongly believes that all conditions of the
Stock Purchase Agreement were met, and LLC’s position is without merit. Technest
is aggressively pursuing payment of the Contingent Purchase Price in accordance
with the Stock Purchase Agreement.  Accordingly on September 24, 2008,
Technest notified LLC that it has filed for final and binding arbitration of the
matter in accordance with the terms of the Stock Purchase
Agreement.  Technest is seeking payment of approximately $22 million
from LLC representing the contingent portion of the purchase price to be paid by
LLC upon the successful re-award to EOIR of the contract with the NVESD less an
amount due to LLC for a final working capital adjustment.





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




We did
not submit any matters to a vote of security holders during the three months
ended June 30, 2008, which is the fourth quarter of our fiscal
year.




-8-





PART II




Item 5. Market for Common Equity and Related Stockholder
Matters





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





Calendar
      Year
            
            High
            
            
            Low2006First
      Quarter
            
            $
            11.35
            
            
            $
            4.40Second
      Quarter
            
            $
            4.80
            
            
            $
            2.20Third
      Quarter
            
            $
            3.52
            
            
            $
            1.60Fourth
      Quarter
            
            $
            2.22
            
            
            $
            1.422007First
      Quarter
            
            $
            2.10
            
            
            $
            1.31Second
      Quarter
            
            $
            1.50
            
            
            $
            0.31Third
      Quarter
            
            $
            0.53
            
            
            $
            0.31Fourth
      Quarter
            
            $
            0.65
            
            
            $
            0.322008First
      Quarter
            
            $
            0.62
            
            
            $
            0.31Second
      Quarter
            
            $
            0.51
            
            
            $
            0.31




The above
quotations reflect inter-dealer prices, without retail mark-up, markdown or
commission. These quotes are not necessarily representative of actual
transactions or of the value of our common stock, and are in all likelihood not
based upon any recognized criteria of securities valuation as used in the
investment banking community. As of September 19, 2008, there were approximately
323 record holders of our common stock.





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





Issuer
Purchases of Equity Securities





We did
not make any purchases of our common stock during the three months ended June
30, 2008, which is the fourth quarter of our fiscal year.





Item
6.  Management’s Discussion and Analysis





The
following discussion and analysis of our financial condition and results of
operations for the years ending June 30, 2008 and June 30, 2007 should be read
together with our financial statements and related notes included elsewhere in
this annual report on Form 10-KSB.




When
reviewing the discussion below, you should keep in mind the substantial risks
and uncertainties that characterize our business. In particular, we encourage
you to review the risks and uncertainties described in the section entitled
"Risk Factors” beginning on page 18 of this annual report on Form 10-KSB. These
risks and uncertainties could cause actual results to differ materially from
those forecasted in forward-looking statements or implied by past results and
trends. Forward-looking statements are statements that attempt to project or
anticipate future developments in our business; we encourage you to review the
examples of forward-looking statements under "Note Regarding Forward-Looking
Statements." These statements, like all statements in this annual report on Form
10-KSB, speak only as of June 30, 2008 and we undertake no obligation to update
or revise the statements in light of future developments.




-9-




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 
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 sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which is payable upon
the successful re-award to EOIR of the contract with the U.S. Army's Night
Vision and Electronics Sensors Directorate (NVESD). This transaction closed on
December 31, 2007. On August 4, 2008, EOIR was one of three companies awarded
the U.S. Army's Night Vision and Electronics Sensors Directorate (“NVESD”)
contract with a funding ceiling of $495 million. The Contingent Purchase Price
of $23 million was due as of August 21, 2008 in accordance with the Stock
Purchase Agreement.





On August
26, 2008, LLC notified Technest that, in their opinion, the conditions set forth
in the Stock Purchase Agreement triggering payment of the Contingent Purchase
Price have not been satisfied. LLC provided no explanation for its
contention.  Technest strongly believes that all conditions of the
Stock Purchase Agreement were met, and LLC’s position is without
merit.  Technest is aggressively pursuing payment of the Contingent
Purchase Price in accordance with the Stock Purchase
Agreement.  Accordingly on September 24, 2008, Technest notified LLC
that it has filed for final and binding arbitration of the matter in accordance
with the terms of the Stock Purchase Agreement.




In
accordance with Statement of SFAS No. 141, “Business Combinations”, the Company
recorded the $23 million of contingent consideration in the quarter ended March
31, 2008.  At that time, the Company determined that the outcome of
the contingency was determinable beyond a reasonable doubt based on having
received notification of award of the NVESD contract pending review by the Small
Business Administration.  In accordance with SFAS No. 144, “Accounting
for the Impairment or Disposal of Long-Lived Assets”, we have classified EOIR’s
results of operations as discontinued operations for all periods presented in
the accompanying consolidated financial statements.





Goodwill
Impairment Analysis





Technest
tests its goodwill for impairment annually in its fourth quarter. Accounting
principles generally accepted in the U.S. require additional testing if events
or circumstances indicate that impairment may exist. As a result of the very
light trading volume in the Company’s common stock, inefficiencies in investor
research of small capitalization companies and the relatively small amount of
shares in the public float, the Company’s book value exceeds its market
capitalization. Technest performed an impairment test of the goodwill as of
June 30, 2008. Based upon the impairment test performed, there was no
impairment indicated for Technest’s goodwill as of June 30,
2008.  The fair value of the Company (representing the only reporting
unit) was determined utilizing a discounted cash flow valuation
approach.  Technest also considered the valuation metrics of
comparable companies.





Year
ended June 30, 2008 compared with the year ended June 30, 2007




Revenues




Technest
had $2,469,085 in revenues from continuing operations during the year ended June
30, 2008 compared with $3,396,795 during the year ended June 30, 2007. These
revenues were largely generated by Small Business Innovation Research
Grants  in the field of 3-dimensional imaging. We use the revenue from
these grants to develop future potential products for our business. The decline
in revenues was primarily due to a drop in non-Department of Defense contracts.
At June 30, 2008, the Company’s backlog of funded contracts was approximately $2
million.





Gross
profit




The gross
profit from continuing operations for the year ended June 30, 2008 was
$1,078,558 or 44% of revenues. The gross profit for the year ended June 30, 2007
was $1,276,790 or 38% of revenues. Technest expects to expand its revenue base
to include commercial product revenues and, accordingly, gross profit on future
revenues may differ.  In the quarter ended June 30, 2008, as a result
of the conclusion of a DCAA audit, the Company determined that it had under
billed on a contract completed in 2005.  As a result, the Company
recorded revenue in the quarter ended June 30, 2008 of approximately $70,000
related to the final settlement of this contract increasing gross profit for the
year 7% and the gross profit margin from approximately 41% to 44%.




-10-




Selling,
general and administrative expenses




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





Selling,
general and administrative expenses for the year ended June 30, 2007 were
$3,600,562 and consisted primarily of legal and professional fees of
approximately $401,341 and amortization of stock-based compensation related
granted to directors and officers amounting to $1,170,432.





The
increase of $1,268,095 in selling, general and administrative expenses for the
year ended June 30, 2008 over the year ended June 30, 2007 was primarily due to
approximately $850,000 in legal fees and settlement of the Deer Creek judgment,
and the $1,380,000 charge related to the fair value of stock issued in
connection with the termination of certain sections of a stockholder agreement
and a licensing agreement as noted above offset by a reduction in the
amortization of stock compensation  of approximately
$870,000.





Certain
general and administrative expenses of the Company that are clearly associated
with EOIR totaling approximately $5,746,501 and $726,000 in the years ended June
30, 2008 and 2007, respectively, have been included in the net gain (loss) from
discontinued operations.





Amortization
of intangible assets




Amortization
of intangible assets for each of the years ended June 30, 2008 and 2007 was
$324,741. Amortization expense relates to the definite-lived intangible assets
acquired in conjunction with Genex Technologies.





Operating
loss





The
operating loss for the year ended June 30, 2008 was $4,160,842. The operating
loss for the year ended June 30, 2007 was $2,649,606.





Other
(expenses) income




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





In the
year ended June 30, 2007, Technest charged to interest expense $1,744,102,
including $1,531,430 paid in common stock related to liquidated damages incurred
for failure to have an effective registration statement.





Discontinued
Operations





The net
gain from discontinued operations was $8,997,149 in the year ended June 30, 2008
compared with a net loss of ($395,939) for the year ended June 30, 2007. The net
gain (loss) for the years ended June 30, 2008 and 2007 included costs of
$5,746,501 and $726,000 respectively for costs incurred by Technest that are
clearly associated with the discontinued operations.





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





Net
income (loss) applicable to common shareholders





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




-11-




The net
loss applicable to common stockholders for the year ended June 30, 2007 was
$4,786,696.





Liquidity
and Capital Resources




Cash
and Working Capital





On June
30, 2008, Technest had a positive working capital balance of $19,573,408. Net
cash used in operating activities for the year ended June 30, 2008 was
$1,505,637.





Cash
Used in Investing Activities





In the
year ended June 30, 2008, Technest used cash of $41,838 for the acquisition of
property and equipment.   In the year ended June 30, 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
year ended June 30, 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 year ended June 30, 2008, we satisfied our operating and investing cash
requirements primarily from financing activities and cash
reserves.  Subsequent to June 30, 2008, we entered into an arrangement
with Southridge Partners, LP for the sale of a newly authorized class of
preferred stock (“Series D Preferred”) which permits the Company to sell to
Southridge shares of Series D Preferred for gross proceeds totaling
$1,500,000.  Of this amount, approximately $600,000 will be paid to Deer
Creek.





A further
$23 million is due to the Company from the sale of EOIR. On August 26, 2008, LLC
notified Technest that, in their opinion, the conditions set forth in the Stock
Purchase Agreement triggering payment of the Contingent Purchase Price had not
been satisfied. LLC provided no explanation for its
contention.  Technest strongly believes that all conditions of the
Stock Purchase Agreement were met, and LLC’s position is without
merit.  Technest is aggressively pursuing payment of the Contingent
Purchase Price in accordance with the Stock Purchase
Agreement.  Accordingly on September 24, 2008, Technest notified LLC
that it has filed for final and binding arbitration of the matter in accordance
with the terms of the Stock Purchase Agreement.





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




Commitments
and Contingencies




Facilities




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%.




-12-


Legal
 
 H&H


On or
about July 23, 1998, H & H Acquisition Corporation, individually and
purportedly on behalf of Technest Holdings, commenced an action in United States
District Court, Southern District of New York entitled H & H Acquisition
Corp., individually and on behalf of Technest Holdings, Inc. v. Financial
Intranet Holdings, Inc., Technest Holdings, Inc., F/K /A Financial Intranet,
Inc., Ben Stein, Interwest Transfer Co., Steven A. Sanders, Michael Sheppard,
Maura Marx, Henry A. Schwartz, Leonard Gotshalk, Gotshalk Enterprises, Law
Office of Steven A. Sanders, P.C. and Beckman, Millman & Sanders, LLP, 98
Civ. 5269. The plaintiffs are purporting to act on behalf of Technest in the
context of a shareholder’s derivative suit. The action’s principal basis appears
to be a claim that Ben Stein, a former director and Secretary of Technest,
wrongfully claims ownership of shares of common stock that Stein agreed to
purchase from H&H. According to H&H, these shares belong to them.
H&H asserts sixteen causes of action. Only some 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 responded to
the court’s direction and believes that as a result of intervening corporate
actions, the injunctive relief sought by the plaintiff which gives rise the
court’s subject matter jurisdiction in this case has been rendered moot, thereby
depriving the court of continuing subject matter jurisdiction. On July 31, 2008,
the court denied the motion to dismiss for lack of subject matter jurisdiction.
On September 5, 2008, in accordance with the judge’s order of July 31, 2008,
Technest, Mr. Sheppard and Ms. Marx filed a motion for summary judgment to
dismiss all claims against them.





Deer Creek





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





The
White Oak Group





On
September 10, 2007, Technest Holdings, Inc. and its wholly owned subsidiary,
EOIR Technologies, Inc. entered into a Stock Purchase Agreement with EOIR
Holdings 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 sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which is payable upon
the successful re-award to EOIR of the contract with the U.S. Army's Night
Vision and Electronics Sensors Directorate (NVESD). This transaction closed on
December 31, 2007. On August 4, 2008, EOIR was awarded the NVESD contract with a
funding ceiling of $495 million. The Contingent Purchase Price of $23 million
was due as of August 21, 2008 in accordance with the Stock Purchase
Agreement.





On August
26, 2008, LLC notified Technest that, in their opinion, the conditions set forth
in the Stock Purchase Agreement triggering payment of the Contingent Purchase
Price have not been satisfied. LLC provided no explanation for its
contention.  Technest strongly believes that all conditions of the
Stock Purchase Agreement were met, and LLC’s position is without
merit.  Technest is aggressively pursuing payment of the Contingent
Purchase Price in accordance with the Stock Purchase
Agreement.  Accordingly on September 24, 2008, Technest notified LLC
that it has filed for final and binding arbitration of the matter in accordance
with the terms of the Stock Purchase Agreement.  Technest is seeking
payment of approximately $22 million from LLC representing the contingent
portion of the purchase price to be paid by LLC upon the successful re-award to
EOIR of the contract with the NVESD less an amount due to LLC for a final
working capital adjustment.




-13-




Off
Balance Sheet Arrangements


We have
no off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that is material to stockholders. As of June
30, 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.




Principles
of Consolidation and Discontinued Operation




Our
consolidated financial statements for the periods presented 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 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.





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





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




Impairment
of Goodwill




In
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," we review
goodwill 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”.




-14-




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




Estimated
Useful Lives of Amortizable Intangible Assets




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





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




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





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 Emerging Issues Task
Force (“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, including amortizable
intangible assets, may not be recoverable. We recognize an impairment loss when
the carrying value of an asset exceeds expected cash flows. Accordingly, when
indicators or impairment of assets are present, we evaluate the carrying value
of such assets in relation to the operating performance and future undiscounted
cash flows of the underlying business. Our policy is to record an impairment
loss when we determine that the carrying amount of the asset may not be
recoverable. No impairment charges were recorded in any of the periods
presented.





Revenue
Recognition




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




Revenues
from time and materials contracts are recognized as costs are incurred and
billed. Revenues from firm fixed price contracts are recognized on the
percentage-of-completion method, either measured based on the proportion of
costs recorded to date on the contract to total estimated contract costs or
measured based on the proportion of labor hours expended to date on the contract
to total estimated contract labor hours, as specified in the contract. Revenues
from firm fixed price contracts with payments tied to milestones are recognized
when all milestone requirements have been achieved and all other revenue
recognition criteria have been met.   Costs incurred on firm fixed
price contracts with milestone payments are recorded as work in process until
all milestone requirements have been achieved. During the year ended June 30,
2008, approximately 30% of our revenue has come from firm fixed price
contracts.




-15-




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





Receivable from Sale of
EOIR





The sale of EOIR to LLC was structured
as a stock sale in which LLC acquired all of the outstanding stock of EOIR in
exchange for approximately $34 million in cash, $11 million of which was paid at
closing and $23 million of which is payable upon the successful re-award to EOIR
of the contract with the U.S. Army's NVESD. This transaction closed on December
31, 2007. In the quarter ended March 31, 2008, the Company determined that
collection of the Contingent Purchase Price was collectible beyond a reasonable
doubt based on notification of award pending review by the Small Business
Administration.  As a result, the Company recorded a gain on disposal
of EOIR of approximately $14.8 million.  On August 4, 2008, EOIR was
one of three companies awarded the U.S. Army's NVESD contract with a funding
ceiling of $495 million. The Contingent Purchase Price of $23 million was due as
of August 21, 2008 in accordance with the Stock Purchase Agreement.





On August
26, 2008, LLC notified Technest that, in their opinion, the conditions set forth
in the Stock Purchase Agreement triggering payment of the Contingent Purchase
Price have not been satisfied. LLC provided no explanation for its
contention.  Technest strongly believes that all conditions of the
Stock Purchase Agreement were met, and LLC’s position is without
merit.  Technest is aggressively pursuing payment of the Contingent
Purchase Price in accordance with the Stock Purchase
Agreement.  Accordingly on September 24, 2008, Technest notified LLC
that it has filed for final and binding arbitration of the matter in accordance
with the terms of the Stock Purchase Agreement.  Any reduction in the
amount of the Contingent Purchase Price as a result of arbitration or settlement
would reduce the amount of the gain on disposal of EOIR.





In
accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141,
“Business Combinations”, the Company recorded the $23 million of contingent
consideration in the quarter ended March 31, 2008.  At that time, the
Company determined that the outcome of the contingency was determinable beyond a
reasonable doubt based on having received notification of award of the NVESD
contract pending review by the Small Business Administration.  EOIR is
presented as a discontinued operation in the consolidated financial statements
in accordance with SFAS No. 144,





Impact
of Recently Issued Accounting Standards





In July
2006, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes” (“FIN 48”).  FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an entity’s financial
statements in accordance with FASB Statement No. 109, “Accounting for Income
Taxes”.  FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return.  FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosures and transitions.  The
Company adopted FIN 48 on July 1, 2007 and this adoption did not have a material
impact on the Company’s consolidated financial statements.





In
September 2006, the FASB issued Statement No. 157, "Fair Value
Measurements."  This Statement defines fair value, establishes a
framework for measuring fair value in accordance with generally accepted
accounting principles, and expands disclosures about fair value
measurements.  The definition of fair value retains the exchange price
notion in earlier definitions of fair value. This Statement clarifies that the
exchange price is the price in an orderly transaction between market
participants to sell the asset or transfer the liability in the market in which
the reporting entity would transact for the asset or liability, that is, the
principal or most advantageous market for the asset or
liability.  Emphasis is placed on fair value being a market-based
measurement, not an entity-specific measurement, and therefore a fair value
measurement should be determined based on the assumptions that market
participants would use in pricing the asset or liability. As a basis for
considering these market participant assumptions, a fair value hierarchy has
been established to distinguish between (1) market participant assumptions
developed based on market data obtained from sources independent of the
reporting entity (observable inputs) and (2) the reporting entity's own
assumptions about market participant assumptions developed based on the best
information available in the circumstances (unobservable
inputs).  This Statement is effective for the Company on July 1, 2008
and is not expected to have a material impact on the Company’s consolidated
financial statements.





In
February 2007, the FASB issued Statement No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an amendment of FASB
Statement No. 115.”  This Statement permits entities to choose to
measure many financial instruments and certain other items at fair value, with
the objective of improving financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions, and is expected to expand the use of fair value
measurement.  An entity will report unrealized gains and losses on
items for which the fair value option has been elected in earnings at each
subsequent reporting date.  The fair value option may generally be
applied instrument by instrument and is irrevocable.  This Statement
is effective for the Company on July 1, 2008 and is not expected to have a
material impact on the Company’s consolidated financial statements.




-16-




In
December 2007, the FASB issued Statement No. 141 (revised), “Business
Combinations.”  This Statement replaces FASB Statement No. 141, and
applies to all business entities, including mutual entities that previously used
the pooling-of-interests method of accounting for some business
combinations.   Under Statement No. 141 (revised) an acquirer is
required to recognize at fair value the assets acquired, liabilities assumed,
and any non-controlling interest in the acquiree at the acquisition
date.  This replaces the cost-allocation process under Statement No.
141, which resulted in the non-recognition of some assets and liabilities at the
acquisition date, and in measuring some assets and liabilities at amounts other
than their fair values at the acquisition date.  This Statement
requires that acquisition costs and expected restructuring costs be recognized
separately from the acquisition, and that the acquirer in a business combination
achieved in stages recognize the identifiable assets and liabilities, as well as
the non-controlling interest in the acquiree, at the full amounts of their fair
values.  This Statement also requires an acquirer to recognize assets
acquired and liabilities assumed arising from contractual contingencies as of
the acquisition date, while Statement 141 allowed for the deferred recognition
of pre-acquisition contingencies until certain recognition criteria were met,
and an acquirer is only required to recognize assets or liabilities arising from
all other contingencies if it is more likely than not that they meet the
definition of an asset or a liability.  Under this Statement, an
acquirer is required to recognize contingent consideration at the acquisition
date, whereas contingent consideration obligations usually were not recognized
at the acquisition date under Statement 141.  Further, this Statement
eliminates the concept of negative goodwill and requires gain recognition in
instances in which the total acquisition-date fair value of the identifiable net
assets acquired exceeds the fair value of the consideration transferred plus any
non-controlling interest in the acquiree.  This Statement makes
significant amendments to other Statements and other authoritative guidance, and
applies prospectively to business combinations for which the acquisition date is
on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008.  An entity may not apply it before that
date.





In
December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51.”  This
Statement amends ARB No. 51 to establish accounting and reporting standards for
the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary.  It clarifies that a noncontrolling interest in a
subsidiary is an ownership interest in the consolidated entity that should be
reported as equity in the consolidated financial statements.  This
Statement is effective for fiscal years beginning on or after December 15,
2008.





In March
of 2008, the FASB issued Statement No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No.
133.”  This Statement changes the disclosure requirements for
derivative instruments and hedging activities.  Entities are required
to provide enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under SFAS 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows.  This Statement is
effective for fiscal years and interim periods beginning after November 15, 2008
and is not expected to have a material impact on the consolidated financial
statements of the Company.




-17-





RISK
FACTORS




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




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




Technest
has initiated arbitration proceedings for the payment of the $23,000,000
contingent purchase price under the Stock Purchase Agreement for the sale of
EOIR. If Technest is unsuccessful in the arbitration and the contingent purchase
price is not paid, Technest’s financial condition will be significantly
harmed.
 
 On
September 24, 2008, we commenced arbitration proceedings against EOIR Holdings
LLC (“LLC”) in accordance with the Stock Purchase Agreement dated September 10,
2007.  We are seeking payment of approximately $22 million from
Holdings, which acquired our former subsidiary, E-OIR Technologies, Inc.
(“EOIR”) on December 31, 2007.  The $22 million payment represents the
contingent portion of the purchase price to be paid by LLC upon the successful
re-award to EOIR of the contract with the U.S. Army's Night Vision and
Electronics Sensors Directorate (“NVESD”). On August 4, 2008, EOIR was awarded
the contract with the U.S. Army’s NVESD. We believe the payment became due and
payable on August 21, 2008.  If we are not successful in the
arbitration and the contingent purchase price is not paid, our financial
condition will be significantly harmed.




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 June 30, 2008,
our accumulated deficit was approximately $13 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;




-18-




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




·
            retaining
      key employees.





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




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




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




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





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




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




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





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




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




-19-




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




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




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




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





Risks
Related to Contracting with the United States Government





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




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





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




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





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




·
            changes
      in Government programs or
requirements;




·
            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.




-20-




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




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




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




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




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





Risks
Related To “Controlled Companies”





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





According
to the stock records of Technest, as of  June 30, 2008, Southridge
Partners LP, together with its affiliates, were the largest stockholders of
Technest, owning approximately 65% of Technest’s outstanding common stock as the
record holders of 13,404,387 shares.  Recently, Southridge appointed
three members to Technest’s board of directors (currently, there are a total of
six directors on Technest’s board of directors).  As a result, Southridge
possesses significant influence over our affairs.  Southridge’s stock
ownership and relationships with members of Technest’s board of directors may
have the effect of delaying or preventing a future change in control, impeding a
merger, consolidation, takeover or other business combination or discouraging a
potential acquirer from making a tender offer or otherwise attempting to obtain
control of Technest, which in turn could materially and adversely affect the
market price of Technest’s common stock.




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




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




-21-




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




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




Risks
Related To Capital Structure




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




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





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




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





Risks
Related To Investing In Low- Priced Stock




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




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




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




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




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





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




(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;




-22-




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




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




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




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





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




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





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





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





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




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




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




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




Our stock
price has been volatile. From January 2006 to June 2008, the trading price of
our common stock ranged from a low price of $0.31 per share to a high price of
$11.35 per share. Many factors may cause the market price of our common stock to
fluctuate, including:





·
            variations
      in our quarterly results of
operations;




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




·
            acquisitions
      or strategic alliances involving us or our
  competitors;




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




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




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




-23-




Risks
Relating to New Corporate Governance Standards
  We
expect our administrative costs and expenses resulting from certain regulations
to increase, adversely affecting our financial condition and results of
operations.


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





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




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




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




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





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




-24-


Item
7.  Financial Statements




TECHNEST
HOLDINGS, INC.


CONSOLIDATED
FINANCIAL STATEMENTS





INDEX






Page
      NumberTechnest
      Holdings, Inc. and SubsidiariesPeriods
      ended June 30, 2008 and June 30, 2007Report
      of Independent Registered Public Accounting Firm
            F-2Consolidated
      Balance Sheet
            F-3Consolidated
      Statements of Operations
            F-5Consolidated
      Statements of Changes in Stockholders’ Equity
            F-6Consolidated
      Statements of Cash Flows
            F-8Notes
      to Consolidated Financial Statements
            F-10




F-1


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors


Technest
Holdings, Inc. and Subsidiaries


Bethesda,
Maryland




We have
audited the accompanying consolidated balance sheet of Technest Holdings, Inc.
and subsidiaries as of June 30, 2008 and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for the years ended
June 30, 2008 and 2007. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.





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





In our
opinion, the financial statements referred to above present fairly, in all
material respects the financial position of Technest Holdings, Inc. and
subsidiaries as of June 30, 2008, and the results of its operations and its cash
flows for the years ended June 30, 2008 and 2007, in conformity with accounting
principles generally accepted in the United States of America.





As
discussed in Note 3 to the financial statements, the Company has completed the
sale of its primary subsidiary, EOIR Technologies, Inc. (“EOIR”).  As
a result, EOIR has been presented in these financial statements as a
discontinued operation. The Company recognized a $23 million receivable related
to the contingent consideration which was due on August 21, 2008 under the terms
of the Stock Purchase Agreement and remains unpaid as of October 1,
2008.  As discussed in Note 11 to the financial statements, in the
quarter ended June 30, 2008, the Company completed its analysis of the tax
impact of the sale of EOIR, including determining the amount and availability of
net operating loss carryforwards.  As a result, the Company recorded
an additional tax provision in the fourth quarter of fiscal
2008 related to the sale of EOIR.








/s/ Wolf
& Company, P.C.




Boston,
Massachusetts


October
1, 2008




F-2





TECHNEST
      HOLDINGS, INC. AND SUBSIDIARYCONSOLIDATED
      BALANCE SHEETAS
      OF JUNE 30, 2008




ASSETSCurrent
      AssetsCash
      and cash equivalents
            
            $
            76,761Accounts
      receivables
            
            
            600,908Unbilled
      receivables
            
            
            23,888Inventory
      and work in process
            
            
            36,542Restricted
      cash
            
            
            237,288Prepaid
      expenses and other current assets
            
            
            74,233Receivable
      from sale of EOIR
            
            
            23,000,000Total
      Current Assets
            
            
            24,049,620Property and Equipment–
      Net of accumulated depreciation of $109,467
            
            
            78,413Other
      AssetsDeposits
            
            
            28,525Definite-lived
      intangible assets – Net of accumulated amortization of
      $1,095,999
            
            
            635,111Goodwill
            
            
            4,876,038Total
      Other Assets
            
            
            5,539,674Total
      Assets
            
            $
            29,667,707LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      LiabilitiesAccounts
      payable
            
            $
            379,710Accrued
      expenses and other current liabilities
            
            
            3,796,502Accrued
      state income taxes
            
            
            127,000Deferred
      tax liability
            
            
            732,000Total
      Current Liabilities
            
            
            5,035,212Total
      Liabilities
            
            
            5,035,212




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 June 30, 2008)
            
            
            -Series
      C Convertible Preferred Stock - $.001 par value; 1,149,425
      sharesauthorized;
      402,301 issued and outstanding (preference in liquidationof
      $875,005 at June 30, 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
            
            
            37,792,582Accumulated
      deficit
            
            
            (13,180,993
            )Total
      Stockholders’ Equity
            
            
            24,632,495Total
      Liabilities and Stockholders’ Equity
            
            $
            29,667,707




See notes
to consolidated financial statements.




F-3





TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF OPERATIONSFOR
      THE YEARS ENDED JUNE 30, 2008 AND
2007




2008
            
            
            2007Revenues
            
            $
            2,469,085
            
            
            $
            3,396,795Cost
      of Revenues
            
            
            1,390,527
            
            
            
            2,120,005Gross
      Profit
            
            
            1,078,558
            
            
            
            1,276,790Operating
      ExpensesSelling,
      general and administrative
            
            
            4,868,657
            
            
            
            3,600,562Research
      and development
            
            
            46,002
            
            
            
            1,093Amortization
      of intangible assets
            
            
            324,741
            
            
            
            324,741Total
      Operating Expenses
            
            
            5,239,400
            
            
            
            3,926,396Operating
      Loss From Continuing Operations
            
            
            (4,160,842
            )
            
            
            (2,649,606
            )Other
      (Expenses) Income, NetOther
      income
            
            
            7,664
            
            
            
            2,951Interest
      expense
            
            
            (11,329
            )
            
            
            (1,744,102
            )Total
      Other Expenses, Net
            
            
            (3,665
            )
            
            
            (1,741,151
            )Net
      Loss From Continuing Operations Before Income Taxes
            
            
            (4,164,507
            )
            
            
            (4,390,757
            )Income
      tax benefit
            
            
            2,011,000
            
            
            
            --Net
      Loss From Continuing Operations
            
            
            (2,153,507
            )
            
            
            (4,390,757
            )Discontinued
      OperationsGain
      (loss) from operations of discontinued operations (including
      gainon disposal of $14,801,367 in
      the year ended June 30, 2008)
            
            
            11,867,149
            
            
            
            (395,939
            )Provision
      for income taxes
            
            
            (2,870,000
            )
            
            
            -Gain (Loss)
      From Discontinued Operations
            
            
            8,997,149
            
            
            
            (395,939
            )Net
      Income (Loss) Applicable to Common Shareholders
            
            $
            6,843,642
            
            
            $
            (4,786,696
            )Net
      Income (Loss) Per Common Share - basic and dilutedFrom
      continuing operations
            
            $
            (0.11
            )
            
            $
            (0.27
            )From
      discontinued operations
            
            $
            0.46
            
            
            $
            (0.02
            )Net
      Income (Loss) per share - basic and diluted
            
            $
            0.35
            
            
            $
            (0.29
            )Weighted
      Average Number of Common Shares OutstandingBasic
            
            
            19,752,017
            
            
            
            16,536,917Diluted
            
            
            19,752,017
            
            
            
            16,536,917




See notes
to consolidated financial statements.




F-4





TECHNEST
HOLDINGS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY


FOR
THE YEARS ENDED JUNE 30, 2008 AND 2007




Series
      A
            
            
            Series
      CConvertible
            
            
            ConvertibleCommon
      stock
            
            
            Preferred
      stock
            
            
            Preferred
      stockShares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalance
      - July 1, 2006
            
            
            15,867,911
            
            
            $
            15,867
            
            
            
            64
            
            
            $
            -
            
            
            
            632,185
            
            
            $
            632Stock
      issued in connection with settlement ofliquidated
      damages
            
            
            850,761
            
            
            
            850
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Stock
      issued to note holders in connection withsubordination
      of security interest for bank
              financing
            
            
            99,779
            
            
            
            100
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Issuance
      and amortization of stock-basedcompensation
      related to restricted stock
              grants
            
            
            60,000
            
            
            
            60
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Fair
      value of warrants issued in connection withbank
      financing
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Fair
      value of warrants issued in connection withindependent
      research report
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Balance
      - June 30, 2007
            
            
            16,878,451
            
            
            
            16,877
            
            
            
            64
            
            
            
            -
            
            
            
            632,185
            
            
            
            632Stock
      issued in connection with termination ofstockholder
      and license agreement
            
            
            3,000,000
            
            
            
            3,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Issuance
      and amortization of stock-basedcompensation
      related to restricted stock
              grants
            
            
            397,000
            
            
            
            397
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Stock
      issued in connection with conversion ofSeries
      C Convertible Preferred Stock
            
            
            229,884
            
            
            
            230
            
            
            
            -
            
            
            
            -
            
            
            
            (229,884
            )
            
            
            (230
            )Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Balance
      - June 30, 2008
            
            
            20,505,335
            
            
            $
            20,504
            
            
            
            64
            
            
            $
            -
            
            
            
            402,301
            
            
            $
            402




See notes
to consolidated financial statements.




F-5




TECHNEST
HOLDINGS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY


FOR
THE YEARS ENDED JUNE 30, 2008 AND 2007




Additional
            
            
            
            
            
            TotalPaid-In
            
            
            Accumulated
            
            
            Stockholders'Capital
            
            
            Deficit
            
            
            EquityAmount
            
            
            Amount
            
            
            AmountBalance
      - July 1, 2006
            
            $
            32,404,174
            
            
            $
            (15,237,939
            )
            
            $
            17,182,734Stock
      issued in connection with settlement ofliquidated
      damages
            
            
            1,725,576
            
            
            
            -
            
            
            
            1,726,426Stock
      issued to note holders in connection withsubordination
      of security interest for bank financing
            
            
            344,138
            
            
            
            -
            
            
            
            344,238Issuance
      and amortization of stock-basedcompensation
      related to restricted stock grants
            
            
            1,170,372
            
            
            
            -
            
            
            
            1,170,432Fair
      value of warrants issued in connection withbank
      financing
            
            
            217,732
            
            
            
            -
            
            
            
            217,732Fair
      value of warrants issued in connection withindependent
      research report
            
            
            253,038
            
            
            
            -
            
            
            
            253,038Net
      loss
            
            
            -
            
            
            
            (4,786,696
            )
            
            
            (4,786,696
            )Balance
      - June 30, 2007
            
            
            36,115,030
            
            
            
            (20,024,635
            )
            
            
            16,107,904Stock
      issued in connection with termination ofstockholder
      and license agreement
            
            
            1,377,000
            
            
            
            -
            
            
            
            1,380,000Issuance
      and amortization of stock-basedcompensation
      related to restricted stock grants
            
            
            300,552
            
            
            
            -
            
            
            
            300,949Stock
      issued in connection with conversion ofSeries
      C Convertible Preferred Stock
            
            
            -
            
            
            
            -
            
            
            
            -Net
      income
            
            
            -
            
            
            
            6,843,642
            
            
            
            6,843,642Balance
      - June 30, 2008
            
            $
            37,792,582
            
            
            $
            (13,180,993
            )
            
            $
            24,632,495




See notes
to consolidated financial statements.




F-6




TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF CASH FLOWSFOR
      THE YEARS ENDED JUNE 30, 2008 AND
2007




2008
            
            
            2007Cash
      Flows From Operating Activities:Net
      income (loss)
            
            $
            6,843,642
            
            
            $
            (4,786,696
            )Adjustment
      to reconcile net income (loss) to net cash provided by (used
      in)operating
      activities:Depreciation
      and amortization of property and equipment
            
            
            44,740
            
            
            
            427,673Amortization
      of intangible assets
            
            
            324,741
            
            
            
            1,586,046Non-cash
      interest expense
            
            
            1,538,276
            
            
            
            1,127,792Stock-based
      compensation related to restricted stock grants
            
            
            300,949
            
            
            
            1,170,432Stock
      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
            
            
            -
            
            
            
            253,038Deferred
      income tax expense
            
            
            859,000
            
            
            
            -Gain
      on disposal of discontinued operations
            
            
            (14,801,367
            )
            
            
            -Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            8,778,975
            
            
            
            (5,005
            )Unbilled
      receivables
            
            
            1,491,671
            
            
            
            538,563Inventory
      and work in process
            
            
            (25,289
            )
            
            
            8,982Restricted
      cash
            
            
            (237,288
            )
            
            
            250,000Deposits,
      prepaid expenses and other current assets
            
            
            118,667
            
            
            
            (39,426
            )Accounts
      payable
            
            
            (7,892,053
            )
            
            
            (4,973,676
            )Unearned
      revenue
            
            
            (267,309
            )
            
            
            -Accrued
      expenses and other current liabilities
            
            
            327,044
            
            
            
            (1,063,762
            )Due
      to related parties
            
            
            (290,036
            )
            
            
            (305,746
            )Net
      Cash Used In Operating Activities
            
            
            (1,505,637
            )
            
            
            (4,085,359
            )Cash
      Flows From Investing Activities:Purchase
      of property and equipment
            
            
            (41,838
            )
            
            
            (39,609
            )Proceeds
      from sale of discontinued operations, net of transaction
    costs
            
            
            10,269,615
            
            
            
            -Net
      Cash Provided by (Used In) Investing Activities
            
            
            10,227,777
            
            
            
            (39,609
            )




F-7





TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF CASH FLOWSFOR
      THE YEARS ENDED JUNE 30, 2008 AND
2007




2008
            
            
            2007Cash
      Flows From Financing Activities:Proceeds
      from term loan
            
            
            -
            
            
            
            3,000,000(Repayment
      of) proceeds from revolving line of credit, net
            
            
            (4,562,809
            )
            
            
            4,562,809Proceeds
      from note payable - Shelter Island
            
            
            -
            
            
            
            1,500,000Payment
      of debt issuance costs
            
            
            -
            
            
            
            (492,953
            )Payment
      of loan guarantee fee to Markland
            
            
            -
            
            
            
            (580,372
            )Repayment
      of term loan
            
            
            (2,166,667
            )
            
            
            (833,333
            )Repayment
      of notes payable
            
            
            (3,056,130
            )
            
            
            (5,253,166
            )Net
      Cash Provided by (Used In) Financing Activities
            
            
            (9,785,606
            )
            
            
            1,902,985Net
      Increase (Decrease) In Cash
            
            
            (1,063,466
            )
            
            
            (2,221,983
            )Cash and Cash Equivalents -
      Beginning of Period -including $1,028,539and
      $2,859,055, respectively, of cash related to discontinued
      operations
            
            
            1,140,227
            
            
            
            3,362,210Cash and Cash Equivalents - End
      of Period -including $0 and $1,028,539,respectively,
      of cash related to discontinued operations
            
            $
            76,761
            
            
            $
            1,140,227Supplemental
      Disclosures Of Cash Flow Information:Cash
      paid during the periods for:Interest
            
            $
            1,329,411
            
            
            $
            691,438Taxes
            
            $
            -
            
            
            $
            -Fair
      value of common stock and warrants issued asdeferred
      financing costs
            
            $
            -
            
            
            $
            561,970




See notes
to consolidated financial statements


F-8





TECHNEST
HOLDINGS INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2008 AND 2007




1. 
NATURE OF OPERATIONS





Business





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





Sale of EOIR Technologies,
Inc.





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





The sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which is payable upon
the successful re-award to EOIR of the contract with the U.S. Army's Night
Vision and Electronics Sensors Directorate (“NVESD”). This transaction closed on
December 31, 2007. On August 4, 2008, EOIR was one of three companies awarded
the U.S. Army's NVESD contract with a funding ceiling of $495 million. The
Contingent Purchase Price of $23 million was due as of August 21, 2008 in
accordance with the Stock Purchase Agreement.





On August
26, 2008, LLC notified Technest that, in their opinion, the conditions set forth
in the Stock Purchase Agreement triggering payment of the Contingent Purchase
Price had not been satisfied. LLC provided no explanation for its
contention.  Technest strongly believes that all conditions of the
Stock Purchase Agreement were met, and LLC’s position is without
merit.  Technest is aggressively pursuing payment of the Contingent
Purchase Price in accordance with the Stock Purchase
Agreement.  Accordingly on September 24, 2008, Technest notified LLC
that it has filed for final and binding arbitration of the matter in accordance
with the terms of the Stock Purchase Agreement.  Any reduction in the
amount of the Contingent Purchase Price as a result of arbitration or settlement
would reduce the amount of the gain on disposal of EOIR, net of
tax.





In
accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141,
“Business Combinations”, the Company recorded the $23 million of contingent
consideration in the quarter ended March 31, 2008.  At that time, the
Company determined that the outcome of the contingency was determinable beyond a
reasonable doubt based on having received notification of award of the NVESD
contract pending review by the Small Business Administration.  EOIR is
presented as a discontinued operation in the consolidated financial statements
in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets” (see Note 3).





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).




F-9




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, realizability of the receivable from the sale of EOIR,
allowance for doubtful accounts, the estimated useful lives of property and
equipment, carrying value of goodwill and long-lived assets, useful lives of
intangible assets, fair value of assets and liabilities presented as
discontinued operation, the amount due to contracting government agencies as a
result of their audits, the realizability of deferred tax assets and the fair
value of derivative liability and equity instruments issued.





Concentrations and
Risks





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





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





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





Cash and Cash
Equivalents





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




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





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





Inventory and Work in
Process




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




F-10




Property and
Equipment




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




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




Software
            
            
            3
      yearsComputer
      equipment
            
            
            3
      yearsFurniture
      and fixtures
            
            
            5
      years




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




Software
            
            $
            49,940Computer
      equipment
            
            
            26,655Furniture
      and fixtures
            
            
            111,285187,880Less
      accumulated depreciation
            
            
            (109,467
            )$
            78,413




Depreciation
expense from continuing operations for the years ended June 30, 2008 and 2007
was $44,741 and $40,590, 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.




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




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




Operating
Segments




The
Company operates in one Operating Segment 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.




F-11




Revenue
Recognition




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




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




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




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.




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.





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.





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




F-12




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





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





Income (Loss) Per
Share




Basic and
diluted net income (loss) 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 for
the year ended June 30, 2008 because their inclusion would have had the effect
of decreasing the net loss from continuing operations per share otherwise
computed (see Note 9).





Goodwill and
Impairment




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 years ended June 30, 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 years ended June 30, 2008 and 2007.




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 July
2006, the FASB issued FIN 48.  FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an entity’s financial statements in
accordance with SFAS No. 109, “Accounting for Income Taxes”.  FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return.  FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosures and transitions.  The Company adopted FIN 48 on
July 1, 2007 and this adoption did not have a material impact on the Company’s
consolidated financial statements.




F-13


In
September 2006, the FASB issued Statement No. 157, "Fair Value
Measurements."  This Statement defines fair value, establishes a
framework for measuring fair value in accordance with generally accepted
accounting principles, and expands disclosures about fair value
measurements.  The definition of fair value retains the exchange price
notion in earlier definitions of fair value. This Statement clarifies that the
exchange price is the price in an orderly transaction between market
participants to sell the asset or transfer the liability in the market in which
the reporting entity would transact for the asset or liability, that is, the
principal or most advantageous market for the asset or
liability.  Emphasis is placed on fair value being a market-based
measurement, not an entity-specific measurement, and therefore a fair value
measurement should be determined based on the assumptions that market
participants would use in pricing the asset or liability. As a basis for
considering these market participant assumptions, a fair value hierarchy has
been established to distinguish between (1) market participant assumptions
developed based on market data obtained from sources independent of the
reporting entity (observable inputs) and (2) the reporting entity's own
assumptions about market participant assumptions developed based on the best
information available in the circumstances (unobservable
inputs).  This Statement is effective for the Company on July 1, 2008
and is not expected to have a material impact on the Company’s consolidated
financial statements.


In
February 2007, the FASB issued Statement No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an amendment of FASB
Statement No. 115.”  This Statement permits entities to choose to
measure many financial instruments and certain other items at fair value, with
the objective of improving financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions, and is expected to expand the use of fair value
measurement.  An entity will report unrealized gains and losses on
items for which the fair value option has been elected in earnings at each
subsequent reporting date.  The fair value option may generally be
applied instrument by instrument and is irrevocable.  This Statement
is effective for the Company on July 1, 2008 and is not expected to have a
material impact on the Company’s consolidated financial statements.





In
December 2007, the FASB issued Statement No. 141 (revised), “Business
Combinations.”  This Statement replaces FASB Statement No. 141, and
applies to all business entities, including mutual entities that previously used
the pooling-of-interests method of accounting for some business
combinations.   Under Statement No. 141 (revised) an acquirer is
required to recognize at fair value the assets acquired, liabilities assumed,
and any non-controlling interest in the acquiree at the acquisition
date.  This replaces the cost-allocation process under Statement No.
141, which resulted in the non-recognition of some assets and liabilities at the
acquisition date, and in measuring some assets and liabilities at amounts other
than their fair values at the acquisition date.  This Statement
requires that acquisition costs and expected restructuring costs be recognized
separately from the acquisition, and that the acquirer in a business combination
achieved in stages recognize the identifiable assets and liabilities, as well as
the non-controlling interest in the acquiree, at the full amounts of their fair
values.  This Statement also requires an acquirer to recognize assets
acquired and liabilities assumed arising from contractual contingencies as of
the acquisition date, while Statement 141 allowed for the deferred recognition
of pre-acquisition contingencies until certain recognition criteria were met,
and an acquirer is only required to recognize assets or liabilities arising from
all other contingencies if it is more likely than not that they meet the
definition of an asset or a liability.  Under this Statement, an
acquirer is required to recognize contingent consideration at the acquisition
date, whereas contingent consideration obligations usually were not recognized
at the acquisition date under Statement 141.  Further, this Statement
eliminates the concept of negative goodwill and requires gain recognition in
instances in which the total acquisition-date fair value of the identifiable net
assets acquired exceeds the fair value of the consideration transferred plus any
non-controlling interest in the acquiree.  This Statement makes
significant amendments to other Statements and other authoritative guidance, and
applies prospectively to business combinations for which the acquisition date is
on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008.  An entity may not apply it before that
date.





In
December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51.”  This
Statement amends ARB No. 51 to establish accounting and reporting standards for
the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary.  It clarifies that a noncontrolling interest in a
subsidiary is an ownership interest in the consolidated entity that should be
reported as equity in the consolidated financial statements.  This
Statement is effective for fiscal years beginning on or after December 15,
2008.





In March
of 2008, the FASB issued Statement No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No.
133.”  This Statement changes the disclosure requirements for
derivative instruments and hedging activities.  Entities are required
to provide enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under SFAS No. 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows.  This Statement is
effective for fiscal years and interim periods beginning after November 15, 2008
and is not expected to have a material impact on the consolidated financial
statements of the Company.




F-14




3. 
DISCONTINUED OPERATIONS





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





The sale
of EOIR to LLC was structured as a stock sale in which LLC acquired all of the
outstanding stock of EOIR in exchange for approximately $34 million in cash, $11
million of which was paid at closing and $23 million of which is payable upon
the successful re-award to EOIR of the contract with the U.S. Army's Night
Vision and Electronics Sensors Directorate (“NVESD”). This transaction closed on
December 31, 2007. On August 4, 2008, EOIR was one of three companies awarded
the U.S. Army's NVESD contract with a funding ceiling of $495 million. The
Contingent Purchase Price of $23 million was due as of August 21, 2008 in
accordance with the Stock Purchase Agreement.





On August
26, 2008, LLC notified Technest that, in their opinion, the conditions set forth
in the Stock Purchase Agreement triggering payment of the Contingent Purchase
Price have not been satisfied. LLC provided no explanation for its
contention.  Technest strongly believes that all conditions of the
Stock Purchase Agreement were met, and LLC’s position is without
merit.  Technest is aggressively pursuing payment of the Contingent
Purchase Price in accordance with the Stock Purchase
Agreement.  Accordingly on September 24, 2008, Technest notified LLC
that it has filed for final and binding arbitration of the matter in accordance
with the terms of the Stock Purchase Agreement.  Any reduction in the
amount of the Contingent Purchase Price as a result of arbitration or settlement
would reduce the amount of the gain on disposal of EOIR.





In
accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141, the
Company recorded the $23 million of contingent consideration in the quarter
ended March 31, 2008.  At that time, the Company determined that the
outcome of the contingency was determinable beyond a reasonable doubt based on
having received notification of award of the NVESD contract pending review by
the Small Business Administration.  The Company continues to believe
the outcome of the contingency is determinable beyond a reasonable
doubt.





The
Company has also recorded a $2,870,000 current and deferred tax provision
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
      liabilities related to discontinued operations
            
            $
            27,352,972




F-15




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





The 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 LLC $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 earning of the $23,000,000 of
contingent consideration on the sale of EOIR of approximately
$1,572,000  These amounts are included in the Company’s accrued
expenses and other current liabilities at June 30, 2008.





For the
years ended June 30, 2008 and 2007, the operations of EOIR have been reported in
discontinued operations in the Statements of Operations in accordance with SFAS
No. 144. Revenues and net loss from discontinued operations were as
follows:




June
      30, 2008
            
            
            June
      30, 2007Revenues
      from discontinued operations
            
            $
            46,099,851
            
            
            $
            68,349,121Net
      (loss) from discontinued operations
            
            $
            (2,934,218
            )
            
            $
            (395,939
            )




4. 
DEFINITE-LIVED INTANGIBLE ASSETS




Definite-lived
intangible assets consist of the following at June 30, 2008:




Amount
            
            
            Useful
      life (years)Patents
      - commercialized technology
            
            $
            440,000
            
            
            
            5Patents
      – other
            
            
            161,110
            
            
            
            15Customer
      relationships and contracts
            
            
            1,130,000
            
            
            
            5Accumulated
      amortization
            
            
            (1,095,999
            )Net
      definite-lived intangible asset
            
            $
            635,111




Patents
are amortized over their estimated useful life but not to exceed the legal life
of the patent. Customer relationships and contracts are amortized over the
contractual term of the existing contracts plus anticipated contract renewals in
accordance with Emerging Issues Task Force No. 02-17, “Recognition of Customer
Relationship Intangible Assets Acquired in a Business Combination”. In
determining the estimate useful life of the customer relationships and
contracts, the Company considered a number of factors including, its history
with these customers which dates back to 1993, the remaining term of existing
contracts, the status of outstanding bids submitted for additional contracts or
contract extensions, the stage of development of the major tasks covered by
existing contracts, the likelihood of receiving additional contracts or contract
extensions and the term over which the Company could reasonably predict future
revenues from existing customers.




F-16




Amortization
expense was $324,741 for each of the years ended June 30, 2008 and 2007. Future
amortization expense related to the definite-lived intangible asset over the
next five years is $324,741 for the year ended June 30, 2009, $206,991 for the
year ended June 30, 2010 and $10,741 for each of the years ended June 30, 2011,
2012 and 2013.




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 June
30, 2008 and 2007, there were 64.325 shares of Series A Preferred Stock issued
and outstanding.





Series B and C Convertible
Preferred Stock




The
Series B Preferred Stock was convertible into Markland Technologies, Inc.
(“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.




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.





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.





In the
year ended June 30, 2008, 229,884 shares of Technest Series C Preferred
Stock were converted to 229,884 shares of common stock.




F-17




At June
30, 2008, the Company had -0- shares of Series B Preferred Stock and
402,301 shares of Series C Preferred Stock issued and
outstanding.




Common Stock
Issuances




During
the year ended June 30, 2008, the Company issued the following amounts of common
stock:




·
            155,000
      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.


·
            202,000
      shares of Technest common stock to three employees of the Company pursuant
      to performance bonuses.·
            229,884
      shares of Technest common stock to DKR Soundshore Oasis Holding Fund Ltd
      and DKR Soundshore Strategic Holding Fund Ltd upon conversion of 229,884
      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.




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”), a related party, 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.




·
            Consideration.  As
      consideration for the Release Agreement, Technest agreed to issue
      Southridge 3,000,000 shares of Technest Common Stock, $0.001 par value per
      share, with a value of $1,380,000.




F-18




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




The
Company has established the following reserves for the future issuance of common
stock as follows:




Reserve
      for the exercise of warrants
            
            
            649,286Reserve
      for conversion of Series A Convertible Preferred Stock
            
            
            306,047Reserve
      for conversion of Series C Convertible Preferred Stock
            
            
            402,301Total
      common stock reserves
            
            
            1,357,634




6. 
OPTIONS, WARRANTS AND STOCK-BASED COMPENSATION





Options





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




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




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




No
options were granted pursuant to the Plan during the years ended June 30, 2008
and 2007 and there are currently no options outstanding under the
Plan.





Warrants





Summary
information with respect to warrants granted is as follows:




Number
      of
              Shares
            
            
            Weighted
      Average
              Exercise
      PriceBalance,
      July 1, 2006
            
            
            374,286
            
            
            $
            6.50Issued
            
            
            275,000
            
            
            
            2.97Balance,
      June 30, 2007
            
            
            649,286
            
            
            
            5.00Issued
            
            
            --Balance,
      June 30, 2008
            
            
            649,286
            
            
            $
            5.00




F-19




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





Exercise
      price
            
            Number
            
            Expiration
      Date$6.50
            
            374,286
            
            02/14/2010$5.85
            
            75,000
            
            08/03/2013$1.89
            
            200,000
            
            07/17/2011649,286Weighted
      average remaining life
            2.5
      years





As of
June 30, 2008 all warrants are exercisable.





Stock Award
Plan





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





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





Summary
information with respect to the 2006 Plan is as follows:





Number
      of SharesIssued
            
            
            Granted
      but
              not
      issued
            
            
            TotalBalance,
      June 30, 2007
            
            
            159,779
            
            
            
            258,800
            
            
            
            418,579Shares
      issued in prior grants
            
            
            122,000
            
            
            
            (122,000
            )
            
            
            --Shares
      granted and issued
            
            
            275,000
            
            
            
            --
            
            
            
            275,000Forfeited/cancelled
            
            
            --
            
            
            
            (136,800
            )
            
            
            (136,800
            )Balance,
      June 30, 2008
            
            
            556,779
            
            
            
            --
            
            
            
            556,779





A summary
of the status of the Company’s nonvested shares as of June 30, 2008, and changes
during the year then ended is presented below:





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





During
the year ended June 30, 2008, an officer with an employment agreement with the
Company forfeited 120,000 shares of restricted stock and various employees
forfeited 16,800 shares.   During the year ended June 30, 2007,
an employee ceased employment with the Company and forfeited 25,000 shares of
restricted stock.




F-20




Total
stock-based compensation related to shares that vested in the years ended June
30, 2008 and 2007 was $300,949 and $1,170,432, respectively.  The fair
value of restricted stock granted in the years ended June 30, 2008 and 2007 was
$139,250 and $800,561, respectively.  As of June 30, 2008, there was
unrecognized compensation costs related to nonvested restricted stock of $38,443
which will be recognized through January 2009.





As of
June 30, 2008, the Company has 443,221 shares available for future grant under
the Plan.




9. 
NET (LOSS) INCOME PER SHARE




Securities
that could potentially dilute basic earnings per share ("EPS") and that were not
included in the computation of diluted EPS because to do so would have been
anti-dilutive for the year ended June 30, 2008, consist of the
following:




Shares
              PotentiallyIssuableSeries
      A Convertible Preferred Stock
            
            
            306,047Series
      C Convertible Preferred Stock
            
            
            402,301Warrants
            
            
            649,286Total
      as of June 30, 2007
            
            
            1,357,634




10.
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 years ended June 30, 2008 and 2007 was
$200,143 and $224,165, respectively.




The
future minimum rental payments required under operating leases that have
non-cancellable or original lease terms in excess of one year as of June 30,
2008 as are follows:




June 30,2009
            
            $
            209,9622010
            
            
            188,4232011
            
            
            144,4732012
      & 13
            
            
            --Total
            
            $
            542,858





Government
Contracts




In
the year ended June 30, 2008, the Defense Contract Audit Agency completed its
audit up to the end of fiscal 2004 and concluded that $65,831 is due to be
refunded to the Government. This amount is included in accrued
expenses.  In the year ended June 30, 2008 the Department of Health
and Human Services also contended that funds in excess of the grant award
authorization had been paid to the Company through  February
2008.  An amount of $28,932 is included in accrued expenses towards
this due refund.





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




F-21




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





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





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




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




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




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




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




Mr.
Pereira is entitled to receive a bonus of 5% of the Company’s EBITDA (Earning
Before Interest, Taxes, Depreciation and Amortization) calculated on an annual
basis at the end of the Company’s fiscal year, up to a maximum allowable cash
bonus of 300% of his annual salary (the EBITDA Bonus). In addition, Mr. Pereira
is eligible to receive equity bonus compensation under the Company’s 2006 Stock
Award Plan in the amounts determined as follows: shares of common stock
calculated by dividing 7% of the increase, if any, of the Market Capitalization
of the Company’s common stock as of the prior fiscal year end compared to the
following fiscal year end, by the closing price of the Company’s common stock on
the trading day immediately prior to the issuance of such shares (the Market Cap
Bonus Shares).  At June 30, 2008, the Company has not accrued any cash
or equity bonus for Mr. Pereira.





Mr. Kotak
is entitled to receive cash bonus and equity bonus compensation from time to
time as determined by the Board of Directors of the Company, or a compensation
committee of the Board of Directors of the Company, or subset of such committee,
composed in accordance with the corporate governance requirements of the listing
exchange.  Mr. Kotak has been granted an initial stock award of 50,000
shares of the Company’s common stock which shall vest on the first anniversary
of the agreement.  At June 30, 2008, the Company has not accrued any
cash bonus for Mr. Kotak.




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





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





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





F-22





11. 
INCOME TAXES




The
benefit from federal and state income taxes related to continuing operations for
the year ended June 30, 2008 was $2,011,000.  In the year ended June
30, 2007, there was no benefit or provision for federal or state income taxes
due to the Company's operating losses and a full valuation reserve on deferred
tax assets.





The
income tax provision (benefit) related to continuing operations for the years
ended June 30, 2008 and 2007 was as follows:




2008
            
            
            2007Current:U.S federal
            
            $
            --
            
            
            $
            --State and
local
            
            
            --
            
            
            
            ----
            
            
            
            --Deferred:U.S federal
            
            
            (1,748,000
            )
            
            
            --State and
local
            
            
            (263,000
            )
            
            
            --(2,011,000
            )
            
            
            --$
            (2,011,000
            )
            
            $
            --





The
income tax provision (benefit) differs from the amount of income tax determined
by applying the U.S. federal income tax rate to pretax income from continuing
operations for the years ended December 31, 2008 and 2007, due to the
following:





2008
            
            
            2007Computed
      “expected” tax provision (benefit)
            
            
            (35%
            )
            
            
            (35%
            )Increase
      (decrease) in income taxes resulting from:State taxes, net of federal
      benefit
            
            
            (3%
            )
            
            
            (2%
            )Stock-based
      compensation
            
            
            8%
            
            
            
            3%Other permanent
      differences
            
            
            1%
            
            
            
            12%Increase (decrease) in
      the valuation reserve
            
            
            (19%
            )
            
            
            22%(48%
            )
            
            
            --





Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities at June 30, 2008 and 2007 are as
follows:




2008
            
            
            2007Deferred
      tax assets:Net operating loss
      carryforward
            
            $
            3,370,000
            
            
            $
            4,420,000Stock-based
      compensation
            
            
            105,000
            
            
            
            535,000Intangibles
            
            
            302,000
            
            
            
            --Miscellaneous
      accruals
            
            
            601,000
            
            
            
            --Property and
      equipment
            
            
            2,000
            
            
            
            117,000Valuation
    allowance
            
            
            (2,369,000
            )
            
            
            (4,608,000
            )Net
      deferred tax assets
            
            
            2,011,000
            
            
            
            464,000Deferred
      tax liabilities:Non-deductible EOIR
      intangibles
            
            
            --
            
            
            
            (464,000
            )Deferred gain on sale of
      EOIR
            
            
            (2,743,000
            )
            
            
            --Deferred
      tax liabilities
            
            
            (2,743,000
            )
            
            
            ----$
            (732,000
            )
            
            $
            --





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




F-23




As of
June 30, 2008 and 2007, the Company had a valuation allowance of $2,369,000 and
$4,608,000, respectively.  The Company has recorded a valuation
allowance against deferred tax assets as management has determined certain net
operating loss carryforwards will not be available due to Internal Revenue Code
Section 382 ownership changes.  In the years ended June 30, 2008 and
2007, the valuation allowance (decreased) increased by ($2,239,000) and
$1,064,000, respectively.  The decrease in the valuation allowance in
the year ended June 30, 2008 related to the ability of the Company to utilize
net operating loss carryforwards against the deferred gain on the sale of EOIR
(see Note 3).  As of June 30, 2008, the Company has net operating loss
carryforwards not subject to IRC Section 382 limitations of $2,617,000 which
begin to expire in 2024.





The
Company increased its current and deferred tax liability during the quarter
ended June 30, 2008 by a net $559,000 as a result of completing an analysis of
the amounts and availability under IRC Section 382 of net operating loss
carrying forwards and overall tax impact of the sale of EOIR (see Note
3).





During
the years ended June 30, 2008 and 2007, the Company recognized approximately
$38,000 and $0 of interest and penalties, respectively. Tax years subsequent to
2004 are subject to examination by federal and state authorities. Tax returns
subsequent to 2004 have not yet but are in the process of being
filed.





12. 
RELATED PARTY TRANSACTIONS




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





During
the year ended June 30, 2008, Technest paid Southridge Partners LP, $250,000 in
satisfaction of a payable assigned from Markland in June
2007.  Southridge is a shareholder of the Company.  The
Company also issued Southridge 3,000,000 shares of its common stock with a fair
value of $1,380,000 in connection with the termination of certain sections of a
stockholder agreement and a licensing agreement both dated March 13, 2007 (see
Note 5).





13.
 EMPLOYEE BENEFIT PLANS




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




Contributions
and other costs of these plans in the years ended June 30, 2008 and 2007 were
$105,236 and $113,840, respectively.





14. 
LITIGATION





H&H





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




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





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




F-24




Deer Creek





On or
about May 30, 2006, Deer Creek Fund LLC filed a claim for interference with
contract and breach of the implied covenant of good faith and fair dealing
against Technest Holdings, Inc., seeking unspecified monetary damages. 
Deer Creek alleged misconduct on the part of Technest related to a proposed sale
by Deer Creek of 157,163 shares of Technest common stock at $7.00 per share and
the applicability of certain selling restrictions under a registration rights
agreement entered into between the parties.  The trial for this claim
took place on April 8, 2008. On August 12, 2008, a decision was rendered against
Technest.  As of September 22, 2008, the parties have agreed to settle
the judgment in lieu of further appeals in the amount of $600,000.  At
June 30, 2008 and for the year then ended, this amount is included in accrued
expenses and selling, general and administrative expenses.





The
White Oak Group





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




15.  SUBSEQUENT EVENTS




Common Stock
Issuances





On July
31, 2008, the Company issued the following amounts of its common
stock:





●
            63,125
      shares of its Common Stock to two non-employee directors of the company as
      compensation for service on the Company’s board of directors for the
      period January 1, 2008 to June 30,
2008





●
            32,751
      shares of its Common Stock to three non-employee directors of the company
      as compensation for service on the Company’s board of directors for the
      period April 1, 2008 to June 30,
2008





●
            75,000
      shares of its Common Stock to two employees of the Company pursuant to
      achieving milestones set out in employment
  agreements.





Southridge
Financing





Subsequent to June 30, 2008, the Company entered into an arrangement
with Southridge Partners, LP for the sale of a newly authorized class of
preferred stock (“Series D Preferred”).  The arrangement permits the
Company to sell to Southridge shares of Series D Preferred for gross proceeds
totaling $1,500,000.




The
Series D Preferred has a total face value of $3,000,000, is convertible into
common stock at any time at a price of $0.20 per share and shall be redeemed by
the Company upon receipt of the Contingent Purchase Price (see Note 3). 
Since the redemption of the Series D Preferred is not solely within the control
of the Company, it does not meet the requirements for classification as
equity.  As a result, it will be classified in the Balance Sheet in the
mezzanine, between liabilities and equity.  Since the Series D Preferred
will be issued at a discount to its face value, the Company expects there to be
a beneficial conversion feature at least equal to the proceeds received. 
Therefore, the Company expects to show a deemed dividend in arriving at net
income (loss) applicable to common stockholders equal to the proceeds received
in the period in which the Series D Preferred is issued.


F-25


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




None.




Item 8A(T). Controls and Procedures




Disclosure
Controls and Procedures





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





Our
management, with the participation of our Chief Executive Officer (“CEO”) and
our Chief Financial Officer (“CFO”), evaluated the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e)
promulgated under the Exchange Act) as of June 30, 2008, the end of our fiscal
year. In designing and evaluating disclosure controls and procedures, we and our
management recognize that any disclosure controls and procedures, no matter how
well designed and operated, can only provide reasonable assurance of achieving
the desired control objective. As of June 30, 2008 management concludes that our
disclosure controls and procedures are effective.





Management’s
Report on Internal Control over Financial Reporting





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





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




Our
management performed an assessment of the effectiveness of our internal control
over financial reporting as of June 30, 2008. Management based its assessment on
the criteria described in the “Internal Control - Integrated Framework” issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The objective of this assessment was to determine whether our internal control
over financial reporting was effective as of June 30, 2008. Management’s
assessment included evaluation of elements such as the design and operating
effectiveness of key financial reporting controls, process documentation,
accounting policies, and our overall control environment. Based on our
evaluation of internal control over financial reporting, our management
concluded that our internal control over financial reporting was effective as of
June 30, 2008.





Attestation
Report of the Registered Public Accounting Firm




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





Changes
in Internal Controls




There
were no changes in our internal controls over financial reporting during the
fourth quarter of fiscal 2008 that materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.




-25-




Limitations
on the Effectiveness of Controls





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




ITEM 8B. Other Information.




None.





PART III




Item 9. Directors and Executive Officers of the Registrant;
Compliance with Section 16(a) of the Exchange Act.




The
information called for by this item is incorporated by reference to our Proxy
Statement or our Information Statement pertaining to the 2008 annual meeting of
stockholders.




Item
10. Executive Compensation.




The
information called for by this item is incorporated by reference to our Proxy
Statement or our Information Statement pertaining to the 2008 annual meeting of
stockholders.




Item
11. Security Ownership of Certain Beneficial Owners and Management.




The
information called for by this item is incorporated by reference to our Proxy
Statement or our Information Statement pertaining to the 2008 annual meeting of
stockholders.




Item
12. Certain Relationships and Related Transactions.




The
information called for by this item is incorporated by reference to our Proxy
Statement or our Information Statement pertaining to the 2008 annual meeting of
stockholders.




-26-





Item 13.
Exhibits.





Exhibit
      No.
            Description
            Filed
      with this
              10-KSB
            Incorporated
              by reference
              From
            Filing
      Date
            Exhibit
      No.2.1
            Securities
      Purchase Agreement by and among Technest Holdings, Inc. and Southridge
      Partners LP, Southshore Capital Fund Limited, ipPartners, Inc, Verdi
      Consulting, Inc., DKR Soundshore Oasis Holding Fund, Ltd., DKR Soundshore
      Strategic Holding Fund, Ltd. and Deer Creek Fund LLC, dated February 14,
      2005
            
            8-K
            February
      15, 2005
            2.12.2
            Securities
      Purchase Agreement between Markland Technologies, Inc. and Technest
      Holdings, Inc., dated February 14, 2005
            
            8-K
            February
      15, 2005
            2.22.3
            Agreement
      and Plan of Merger by and between Technest Holdings, Inc., MTECH
      Acquisition, Inc., Genex Technologies, Inc. and Jason Geng, dated February
      14, 2005
            
            8-K
            February
      15, 2005
            2.32.4
            2001
      Stock Option Plan
            
            DEF
      14A
            June
      14, 2001
            C2.5
            Stock
      Purchase Agreement dated September 10, 2007 between Technest Holdings,
      Inc., EOIR Holdings, LLC and E-OIR Technologies, Inc.
            
            8-K
            September
      13, 2007
            2.12.6
            Form
      of Voting Agreement with a list of signatories.
            
            8-K
            September
      13, 2007
            2.22.7
            First
      Amendment to Stock Purchase Agreement dated December 31, 2007 among
      Technest Holdings, Inc., EOIR Holdings, LLC and EOIR Technologies,
      Inc.
            
            8-K
            January
      4, 2008
            2.33.1
            Restated
      Articles of Incorporation dated December 22, 1998
            
            SB-2
            February
      26, 1999
            3.13.2
            Restated
      Articles of Incorporation of Registrant, dated as of December 14, 2000, as
      filed with the Secretary of State of the State of Nevada on March 2,
      2001.
            
            10-KSB
            April
      16, 2001
            3.23.3
            Certificate
      of Amendment to Articles of Incorporation
            
            8-K
            August
      9, 2001
            3.13.4
            Amended
      and Restated By-Laws dated May 21, 2001.
            
            DEF
      14A
            June
      14, 2001
            B3.5
            Bylaw
      Amendments
            
            8-K
            December
      20, 2006
            3.13.6
            By-law
      Amendments
            
            8-K
            October
      4, 2007
            3.14.1
            Form
      of Common Stock Certificate
            
            SB-2
            February
      26, 1999
            4.14.2
            Series
      A Convertible Preferred Stock Certificate of Designations, filed with the
      Secretary of State of Nevada on February 8, 2005.
            
            8-K
            February
      14, 2005
            4.1




-27-




4.3
            Registration
      Rights Agreement between Markland Technologies, Inc. and Southridge
      Partners LP, Southshore Capital Fund Limited, ipPartners, Inc, Verdi
      Consulting, Inc., DKR Soundshore Oasis Holding Fund, Ltd., DKR Soundshore
      Strategic Holding Fund, Ltd. and Deer Creek Fund LLC for Markland Common
      Stock, dated February 14, 2005
            
            8-K
            February
      15, 2005
            4.1


4.4
            Registration
      Rights Agreement between Technest Holdings, Inc. and Markland
      Technologies, Inc., dated February 14, 2005
            
            8-K
            February
      15, 2005
            4.24.5
            Registration
      Rights Agreement between Technest Holdings, Inc. and Southridge Partners
      LP, Southshore Capital Fund Limited, ipPartners, Inc, Verdi Consulting,
      Inc., DKR Soundshore Oasis Holding Fund, Ltd., DKR Soundshore Strategic
      Holding Fund, Ltd. and Deer Creek Fund LLC for Technest Series C Preferred
      Stock and Warrants for Technest common stock, dated February 14,
      2005
            
            8-K
            February
      15, 2005
            4.34.6
            Registration
      Rights Agreement between Technest Holdings, Inc. and Jason Geng for
      registration of Earnout Shares, dated February 14, 2005
            
            8-K
            February
      15, 2005
            4.44.7
            Registration
      Rights Agreement between Markland Technologies, Inc. and Jason Geng, dated
      February 14, 2005
            
            8-K
            February
      15, 2005
            4.54.8
            Form
      of Technest Common Stock Purchase Warrant
            
            8-K
            February
      15, 2005
            4.64.9
            Technest
      Series B Convertible Preferred Stock Certificate of Designations filed
      with the Secretary of State of Nevada on February 14, 2005.
            
            8-K
            February
      15, 2005
            4.74.10
            Technest
      Series C Convertible Preferred Stock Certificate of Designations filed
      with the Secretary of State of Nevada on February 14, 2005
            
            8-K
            February
      15, 2005
            4.84.11
            Amendment
      No. 1 to the Registration Rights Agreement dated October 3, 2005 among
      Technest Holdings, Inc., Verdi Consulting, Inc., ipPartners, Inc.,
      Southridge Partners LP and Southshore Capital Fund, Ltd., amending the
      Registration Rights Agreement dated February 14, 2005 among these
      parties.
            
            8-K
            October
      7, 2005
            4.24.12
            Amendment
      No. 2 to Registration Rights Agreement dated February 27, 2006 among
      Technest Holdings, Inc., Verdi Consulting, Inc., ipPartners, Inc.,
      Southridge Partners LP and Southshore Capital Fund, Ltd., amending the
      Registration Rights Agreement dated February 14, 2005 among these
      parties.
            
            8-K
            March
      2, 2006
            4.24.13
            Technest
      Common Stock Warrant issued to Silicon Valley Bank dated August 4,
      2006.
            
            8-K
            August
      14, 2006
            4.1





-28-





4.14
            Registration
      Rights Agreement between Technest Holdings, Inc. and Silicon Valley Bank
      dated August 4, 2006.
            
            8-K
            August
      14, 2006
            4.24.15
            Technest
      Common Stock Warrant issued to Crystal Research Associates LLC dated July
      17, 2006
            
            10-KSB
            October
      13, 2006
            4.15





4.16
            Registration
      Rights Agreement between Technest Holdings, Inc. and Crystal Research
      Associates LLC dated July 17, 2006.
            
            10-KSB
            October
      13, 2006
            4.164.17
            $1,650,000
      Secured Original Issue Discount Debenture dated May 31, 2007.
            
            8-K
            June
      5, 2007
            4.14.18
            Technest
      Series D 5% Convertible Preferred Stock Certificate of Designations filed
      with the Secretary of State of Nevada on October
      1,  2008
            x10.1*
            Form
      of Option to be granted under the 2004 Markland Stock Incentive
      Plan
            
            8-K
            February
      15, 2005
            10.610.2
            Stock
      Purchase Agreement between Markland Technologies, Inc. and Technest
      Holdings, Inc. dated August 17, 2005
            
            8-K
            August
      18, 2005
            10.110.3
            Stock
      Purchase Agreement by and between Markland and EOIR, dated June 30,
      2004.
            
            10-QSB
            November
      21, 2005
            10.310.4
            Form
      of Promissory Note made by EOIR Technologies, Inc. and dated June 29,
      2004.
            
            10-QSB
            November
      21, 2005
            10.4




-29-





10.5
            Security
      Agreement by and between EOIR and sellers of EOIR stock, dated
      June 30, 2004.
            
            10-QSB
            November
      21, 2005
            10.510.6
            Pledge
      and Security Agreement, by and between Markland, EOIR and the Sellers
      thereon, dated June 29, 2004.
            
            10-QSB
            November
      21, 2005
            10.610.7
            Lease
      between Paul J Kingston, Trustee of M.P.A. Realty Trust, and Technest
      Holdings, Inc., dated December 31, 2005.
            
            10-QSB
            February
      21, 2006
            10.610.8
            Office
      Lease Agreement between Motor City Drive, LLC and Genex Technologies,
      Inc., dated December 20, 2005.
            
            10-QSB
            February
      21, 2006
            10.710.9
            Stockholders’
      Agreement between Markland Technologies, Inc. and Technest Holdings, Inc.
      dated March 13, 2006.
            
            8-K
            March
      17, 2006
            10.1





10.10*
            Form
      of Restricted Stock Agreement between Joseph P. Mackin and Technest
      Holdings, Inc.
            
            8-K
            March
      17, 2006
            10.510.11*
            Form
      of Restricted Stock Agreement between Gino M. Pereira and Technest
      Holdings, Inc.
            
            8-K
            March
      17, 2006
            10.610.12*
            Release
      and Indemnification Agreement between Robert Tarini and Technest Holdings,
      Inc. dated March 13, 2006.
            
            8-K
            March
      17, 2006
            10.710.13*
            Technest
      Holdings, Inc. 2006 Stock Award Plan.
            
            8-K
            March
      17, 2006
            10.810.14
            Loan
      and Security Agreement for Term Loan among Silicon Valley Bank, Technest
      Holdings, Inc., E-OIR Technologies, Inc. and Genex Technologies, Inc.
      dated August 4, 2006.
            
            8-K
            August
      14, 2006
            10.110.15
            Loan
      and Security Agreement for Working Capital Line of Credit among Silicon
      Valley Bank, Technest Holdings, Inc., E-OIR Technologies, Inc. and Genex
      Technologies, Inc. dated August 4, 2006.
            
            8-K
            August
      14, 2006
            10.210.16
            Intellectual
      Property Security Agreement among Silicon Valley Bank, Technest Holdings,
      Inc., E-OIR Technologies, Inc. and Genex Technologies, Inc. dated August
      4, 2006.
            
            8-K
            August
      14, 2006
            10.3





10.17
            Unconditional
      Guaranty by Markland Technologies, Inc. dated August 4, 2006.
            
            8-K
            August
      14, 2006
            10.410.18
            Stock
      Pledge Agreement between Markland Technologies, Inc. and Silicon Valley
      Bank dated August 4, 2006.
            
            8-K
            August
      14, 2006
            10.510.19*
            Agreement
      relating to Certain Promissory Notes between Technest Holdings, Inc. and
      Joseph P. Mackin dated August 4, 2006.
            
            8-K
            August
      14, 2006
            10.6




-30-




10.20*
            First
      Allonge to Promissory Note of Joseph P. Mackin dated August 4,
      2006.
            
            8-K
            August
      14, 2006
            10.710.21*
            Restricted
      Stock Grant Agreement between Technest Holdings, Inc. and Joseph P. Mackin
      dated August 4, 2006.
            
            8-K
            August
      14, 2006
            10.810.22
            Indemnification
      Agreement between Technest Holdings, Inc. and Markland Technologies, Inc.
      dated September 1, 2006.
            
            10-KSB
            October
      13, 2006
            10.3610.23
            Office
      Lease Agreement Amendment No. 1 by and among Genex Technologies,
      Incorporated, Technest Holdings, Inc. and Motor City Drive, LLC dated as
      of November 1, 2006.
            
            10-QSB
            February
      14, 2007
            10.1




10.24
            Asset
      Contribution Agreement between Technest Holdings, Inc. and Genex
      Technologies Incorporated dated November 1, 2006.
            
            10-QSB
            February
      14, 2007
            10.210.25
            First
      Loan Modification Agreement, dated February 14, 2007, to the Loan and
      Security Agreement for Term Loan among Silicon Valley Bank, Technest
      Holdings, Inc., E-OIR Technologies, Inc. and Genex Technologies, Inc.
      dated August 4, 2006.
            
            10-QSB
            May
      11, 2007
            10.310.26
            First
      Loan Modification Agreement, dated February 14, 2007, to the Loan and
      Security Agreement for Working Capital Line of Credit among Silicon Valley
      Bank, Technest Holdings, Inc., E-OIR Technologies, Inc. and Genex
      Technologies, Inc. dated August 4, 2006.
            
            10-QSB
            May
      11, 2007
            10.410.27
            Second
      Loan Modification Agreement, dated April 3, 2007, to the Loan and Security
      Agreement for Term Loan among Silicon Valley Bank, Technest Holdings,
      Inc., E-OIR Technologies, Inc. and Genex Technologies, Inc. dated August
      4, 2006.
            
            10-QSB
            May
      11, 2007
            10.510.28
            Second
      Loan Modification Agreement, dated April 3, 2007, to the Loan and Security
      Agreement for Working Capital Line of Credit among Silicon Valley Bank,
      Technest Holdings, Inc., E-OIR Technologies, Inc. and Genex Technologies,
      Inc. dated August 4, 2006.
            
            10-QSB
            May
      11, 2007
            10.610.29
            Securities
      Purchase Agreement dated May 31, 2007 between Technest Holdings, Inc. and
      Shelter Island Opportunity Fund, LLC.
            
            8-K
            June
      5, 2007
            10.110.30
            Security
      Agreement dated May 31, 2007 between Technest Holdings, Inc. and Shelter
      Island Opportunity Fund, LLC.
            
            8-K
            June
      5, 2007
            10.210.31
            Security
      Agreement dated May 31, 2007 between Technest Holdings, Inc. and Shelter
      Island Opportunity Fund, LLC.
            
            8-K
            June
      5, 2007
            10.3




-31-




10.32
            Security
      Agreement dated May 31, 2007 between Markland Technologies, Inc. and
      Shelter Island Opportunity Fund, LLC.
            
            8-K
            June
      5, 2007
            10.410.33
            Security
      Agreement dated May 31, 2007 between Genex Technologies Incorporated and
      Shelter Island Opportunity Fund, LLC.
            
            8-K
            June
      5, 2007
            10.510.34
            Guaranty
      by E-OIR Technologies, Inc. dated May 31, 2007.
            
            8-K
            June
      5, 2007
            10.6




10.35
            Guaranty
      by Genex Technologies Incorporated dated May 31, 2007.
            
            8-K
            June
      5, 2007
            10.710.36
            Agreement
      relating to Certain Promissory Notes among Technest Holdings, Inc., E-OIR
      Technologies, Inc. and Joseph P. Mackin dated May 31, 2007.
            
            8-K
            June
      5, 2007
            10.810.37
            Release
      Agreement dated August 31, 2007 between Technest Holdings, Inc. and
      Southridge Partners, LP
            
            8-K
            September
      7, 2007
            10.110.38
            Third
      Loan Modification Agreement, dated September 12, 2007, to the Loan and
      Security Agreement for Working Capital Line of Credit among Silicon Valley
      Bank, Technest Holdings, Inc., E-OIR Technologies, Inc. and Genex
      Technologies, Inc. dated August 4, 2006.
            
            10-KSB
            October
      1, 2007
            10.5410.39
            Form
      of Non-competition Agreement entered into between EOIR Technologies, Inc.
      and Technest Holdings, Inc. and Genex Technologies, Inc.
            
            Definitive
              Information
              Statement
      on Schedule 14C
            December
      7, 2007
            Annex
      D10.40
            Form
      of Release entered into by Technest Holdings, Inc. and Genex Technologies,
      Inc. and acknowledged by EOIR Holdings LLC
            
            Definitive
              Information
              Statement
      on Schedule 14C
            December
      7, 2007
            Annex
      C10.41*
            Employment
      Agreement between Gino M. Pereira and Technest Holdings, Inc. dated
      January 14, 2008.
            
            8-K
            January
      18, 2008
            10.110.42*
            Employment
      Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated January
      14, 2008.
            
            8-K
            January
      18, 2008
            10.210.43*
            Restricted
      Stock Agreement between Nitin V. Kotak and Technest Holdings, Inc. dated
      January 15, 2008.
            
            8-K
            January
      18, 2008
            10.310.44*
            Restricted
      Stock Agreement between David R. Gust and Technest Holdings, Inc. dated
      January 15, 2008.
            
            8-K
            January
      18, 2008
            10.510.45*
            Restricted
      Stock Agreement between Dr. Robert A. Curtis and Technest Holdings, Inc.
      dated January 15, 2008.
            
            8-K
            January
      18, 2008
            10.610.46*
            Severance
      Agreement between Joseph P. Mackin and Technest Holdings, Inc. dated
      December 31, 2007.
            
            10-QSB
            February
      19, 2008
            10.810.47*
            Agreement
      between Gino M. Pereira and Technest Holdings, Inc. dated December 31,
      2007.
            
            10-QSB
            February
      19, 2008
            10.910.48
            Asset
      Contribution Agreement between Technest Holdings, Inc. and Technest, Inc.
      dated September 17, 2008, effective as of October 1, 2008.
            x




-32-




16.1
            Letter
      from Sherb & Co.
            
            8-K/A
            August
      25, 2005
            16.121.1
            List
      of the Subsidiaries of Technest Holdings, Inc.
            x23.1
            Consent
      of Wolf & Company, PC
            x31.1
            Certification
      by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            x31.2
            Certification
      by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
      15d-14(a).
            x32.1
            Certification
      by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
      1350
            x




*
Indicates a management contract or compensatory plan.






Item 14. Principal Accountant Fees and Services




The
information called for by this item is incorporated by reference to our Proxy
Statement or our Information Statement pertaining to the 2008 annual meeting of
stockholders.


-33-





Signatures




In
accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused
this Report to be signed on its behalf by the undersigned, thereunto duly
authorized on October 2, 2008.







TECHNEST
      HOLDINGS, INC.
              
              By: /s/Gino Miguel PereiraGino
      Miguel Pereira

              Chief
      Executive Officer




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





Signature
            
            Title
            
            Date/s/
      Gino Miguel Pereira
            
            Chief
      Executive Officer, President and
            
            October
      2, 2008Gino
      Miguel Pereira
            
            Chairman
      of the Board of Directors/s/
      Nitin V. Kotak
            
            Chief
      Financial Officer and Principal
            
            October
      2, 2008Nitin
      V. Kotak
            
            Accounting
      Officer/s/
      Robert Curtis
            
            Director
            
            October
      2, 2008Robert
      Curtis/s/
      Lawrence Ditkoff
            
            Director
            
            October
      2, 2008Lawrence
      Ditkoff/s/
      David R. Gust
            
            Director
            
            October
      2, 2008David
      R. Gust/s/
      Stephen Hicks
            
            Director
            
            October
      2, 2008Stephen
      Hicks/s/
      Henry Sargent
            
            Director
            
            October
      2, 2008Henry
      Sargent