Summary of TECHNEST HOLDINGS INC

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.

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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%.

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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.

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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%.

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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.

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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".

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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.

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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 . . .