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


**Washington,
      D.C. 20549**




**FORM
      10-QSB**




(Mark
      One)




[X]
            QUARTERLY
                REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
                1934




For
                the quarterly period ended: December 31,
                2005




**OR**




[
                 ]
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
                ACT OF
                1934




For
                the transition period from ______________ to
                ______________






**Commission
      File Number 000-27023**







**TECHNEST
      HOLDINGS, INC.**


(Exact
      name of registrant as specified in its charter)




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





**276
      Washington Street, No. 367, Boston, MA 02108**


( *Address
      of principal executive offices and zip code* )




**(617)
      973-5104**


( *Registrant’s
      telephone number, including area code* )






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




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




As
      of
      February 8, 2006, there were 15,716,355 shares of common stock, $0.001 par
      value, of the registrant issued and outstanding.




Transitional
      Small Business Disclosure Format ( *Check
      one* ):  Yes ___  No X












**TECHNEST
      HOLDINGS, INC.**




**FORM
      10-QSB**


**TABLE
      OF CONTENTS**


**DECEMBER
      31, 2005**




PagePART
                I.      FINANCIAL INFORMATION:Item
                1.       Financial Statements
                (Unaudited)Condensed
                Consolidated Balance Sheet at December 31, 2005
            1Condensed
                Consolidated Statements of Loss for the Six Months Ended December
                31, 2005
                and 2004
            2Condensed
                Consolidated Statements of Loss for the Three Months Ended December
                31,
                2005 and 2004
            3Condensed
                Consolidated Statement of Stockholders’ Equity for the Six Months Ended
                December 31, 2005
            4Condensed
                Consolidated Statements of Cash Flows for the Six Months Ended December
                31, 2005 and 2004
            6Notes
                to Condensed Consolidated Financial Statements
            8Item
                2.       Management’s Discussion and
                Analysis or Plan of Operation
            24Item
                3.       Controls and
                Procedures
            46PART
                II.      OTHER INFORMATION
            47Item
                1.       Legal Proceedings
            47Item
                6.       Exhibits
            49Signatures
            50






STATEMENTS
      CONTAINED IN THIS FORM 10-QSB, WHICH ARE NOT HISTORICAL FACTS CONSTITUTE
      FORWARD-LOOKING STATEMENTS AND ARE MADE UNDER THE SAFE HARBOR PROVISIONS OF
      THE
      PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. FORWARD-LOOKING STATEMENTS
      INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. YOU CAN IDENTIFY THESE STATEMENTS
      BY FORWARD-LOOKING WORDS SUCH AS "MAY", "WILL", "EXPECT", "ANTICIPATE",
      "BELIEVE", "ESTIMATE", "CONTINUE", AND SIMILAR WORDS. YOU SHOULD READ STATEMENTS
      THAT CONTAIN THESE WORDS CAREFULLY. ALL FORWARD-LOOKING STATEMENTS INCLUDED
      IN
      THIS FORM 10-QSB ARE BASED ON INFORMATION AVAILABLE TO US ON THE DATE HEREOF,
      AND WE ASSUME NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS.
      EACH
      FORWARD-LOOKING STATEMENT SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL
      STATEMENTS AND NOTES THERETO IN PART I, ITEM 1, OF THIS QUARTERLY REPORT AND
      WITH THE INFORMATION CONTAINED IN ITEM 2 TOGETHER WITH MANAGEMENT'S DISCUSSION
      AND ANALYSIS OR PLAN OF OPERATION CONTAINED IN OUR **** ANNUAL
      REPORT ON FORM 10-KSB FOR THE PERIOD ENDED JUNE 30, 2005, INCLUDING, BUT NOT
      LIMITED TO, THE SECTION THEREIN ENTITLED "RISK FACTORS."










**PART
      I. FINANCIAL INFORMATION**


**Item
      1. Financial Statements**


**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEET**


**DECEMBER
      31, 2005**


(Unaudited)


**ASSETS**





**Current
                Assets**Cash
                and cash equivalents
            
            $
            4,013,396Accounts
                receivable
            
            
            6,918,338Inventory
                and work in process
            
            
            126,893Restricted
                cash
            
            
            250,000Prepaid
                expenses and other current assets
            
            
            118,071**Total
                Current Assets**
            
            
            11,426,698**Property
                and Equipment**-
                Net of accumulated depreciation of $475,172
            
            
            849,711**Other
                Assets**Deposits
            
            
            85,602Definite-lived
                intangible assets - Net of accumulated amortization of
                $2,592,502
            
            
            12,445,552Goodwill
            
            
            14,035,551**Total
                Other Assets**
            
            
            26,566,705**Total
                Assets**
            
            $
            38,843,114**LIABILITIES
                AND STOCKHOLDERS’ EQUITY****Current
                Liabilities**Accounts
                payable
            
            $
            9,230,409Accrued
                expenses and other current liabilities
            
            
            1,794,464Due
                to related parties, net
            
            
            991,416Current
                portion of long-term debt
            
            
            2,250,500**Total
                Current Liabilities**
            
            
            14,266,789**Non-Current
                Liabilities**Long-term
                debt, less current portion and discount of $949,026
            
            
            5,606,685**Total
                Liabilities**
            
            
            19,873,474**Commitments
                and Contingencies****Stockholders’
                Equity**Series
                A Convertible Preferred Stock - $.001 par value;
              150
                shares authorized; 64.631 shares issued and outstanding
              (preference
                in liquidation of $64,631 at December 31, 2005)
            
            
            --Series
                B Convertible Preferred Stock - $.001 par value;
              -0-
                shares authorized, issued and outstanding
            
            
            --Series
                C Convertible Preferred Stock - $.001 par value;
              1,149,425
                shares authorized; 747,127 shares issued and outstanding
              (preference
                in liquidation of $1,625,001 at December 31, 2005)
            
            
            747Common
                stock - par value $.001 per share;
              495,000,000
                shares authorized; 15,518,093 shares issued and
                outstanding
            
            
            15,518Additional
                paid-in capital
            
            
            24,523,365Accumulated
                deficit
            
            
            (5,569,990
            )**Total
                Stockholders’ Equity**
            
            
            18,969,640**Total
                Liabilities and Stockholders’ Equity**
            
            $
            38,843,114


See
      notes
      to condensed consolidated financial statements.


(Reflects
      reverse stock split of 1 for 211.18 on July 19, 2005)  1




**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**




**CONDENSED
      CONSOLIDATED STATEMENTS OF LOSS**


**** (Unaudited)




**For
                the Six Months**
              **Ended**
              **December
                31,**2005
            
            2004**Revenues**
            
            $
            37,285,917
            
            $
            --**Cost
                of Revenues**
            
            
            30,227,124
            
            
            --**Gross
                Profit**
            
            
            7,058,793
            
            
            --**Operating
                Expenses:**Selling,
                general and administrative
            
            
            6,311,234
            
            
            99,031Research
                and development
            
            
            138,448
            
            
            --Amortization
                of intangible assets
            
            
            893,122
            
            
            --**Total
                Operating Expenses**
            
            
            7,342,804
            
            
            99,031**Operating
                Loss**
            
            
            (284,011
            )
            
            (99,031
            )**Other
                Expenses (Income), Net**Interest
                expense
            
            
            1,595,820
            
            
            7,690Other
                income, net
            
            
            (83,178
            )
            
            --**Total
                Other Expenses, Net**
            
            
            1,512,642
            
            
            7,690**Net
                Loss**
            
            $
            (1,796,653
            )
            $
            (106,721
            )**Basic
                and Diluted Loss Per Common Share**
            
            $
            (0.12
            )
            $
            (0.79
            )**Weighted
                Average Number of Common Shares Outstanding**
            
            
            14,719,365
            
            
            135,495





See
      notes
      to condensed consolidated financial statements.


(Reflects
      reverse stock split of 1 for 211.18 on July 19, 2005)




THE
      PURCHASE METHOD OF ACCOUNTING WAS USED BY TECHNEST HOLDINGS, INC. TO RECORD
      THE
      ASSETS ACQUIRED AND LIABILITIES ASSUMED OF GENEX TECHNOLOGIES, INC. ON FEBRUARY
      14, 2005 (SEE NOTE 3).  ACCORDINGLY, THE ACCOMPANYING FINANCIAL STATEMENTS
      OF TECHNEST HOLDINGS, INC. AND GENEX TECHNOLOGIES, INC. AS OF AND FOR PERIODS
      ENDED SUBSEQUENT TO THE ACQUISITION ARE NOT COMPARABLE IN ALL MATERIAL RESPECTS
      TO THE FINANCIAL STATEMENTS OF TECHNEST HOLDINGS, INC. AS OF AND FOR PERIODS
      ENDED PRIOR TO THE ACQUISITION.


2


**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**




**CONDENSED
      CONSOLIDATED STATEMENTS OF LOSS**


**** (Unaudited)




**For
                the Three Months**
              **Ended**
              **December
                31,**2005
            
            
            2004**Revenues**
            
            $
            18,289,576
            
            
            $
            --**Cost
                of Revenues**
            
            
            14,636,669
            
            
            
            --**Gross
                Profit**
            
            
            3,652,907
            
            
            
            --**Operating
                Expenses:**Selling,
                general and administrative
            
            
            3,343,894
            
            
            
            7,499Research
                and development
            
            
            77,703
            
            
            
            --Amortization
                of intangible assets
            
            
            452,253
            
            
            
            --**Total
                Operating Expenses**
            
            
            3,873,850
            
            
            
            7,499**Operating
                Loss**
            
            
            (220,943
            )
            
            
            (7,499
            )**Other
                Expenses (Income), Net**Interest
                expense
            
            
            852,781
            
            
            
            7,690Other
                income, net
            
            
            (52,596
            )
            
            
            --**Total
                Other Expenses, Net**
            
            
            800,185
            
            
            
            7,690**Net
                Loss**
            
            $
            (1,021,128
            )
            
            $
            (15,189
            )**Basic
                and Diluted Loss Per Common Share**
            
            $
            (0.07
            )
            
            $
            (0.11
            )**Weighted
                Average Number of Common Shares Outstanding**
            
            
            15,141,121
            
            
            
            139,260





See
      notes
      to condensed consolidated financial statements.


(Reflects
      reverse stock split of 1 for 211.18 on July 19, 2005)




THE
      PURCHASE METHOD OF ACCOUNTING WAS USED BY TECHNEST HOLDINGS, INC. TO RECORD
      THE
      ASSETS ACQUIRED AND LIABILITIES ASSUMED OF GENEX TECHNOLOGIES, INC. ON FEBRUARY
      14, 2005 (SEE NOTE 3).  ACCORDINGLY, THE ACCOMPANYING FINANCIAL STATEMENTS
      OF TECHNEST HOLDINGS, INC. AND GENEX TECHNOLOGIES, INC. AS OF AND FOR PERIODS
      ENDED SUBSEQUENT TO THE ACQUISITION ARE NOT COMPARABLE IN ALL MATERIAL RESPECTS
      TO THE FINANCIAL STATEMENTS OF TECHNEST HOLDINGS, INC. AS OF AND FOR PERIODS
      ENDED PRIOR TO THE ACQUISITION.





3


**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY**


**FOR
      THE SIX MONTHS ENDED DECEMBER 31, 2005**


**(Unaudited)**




Series
                A Convertible
            
            Series
                B Convertible
            
            Series
                C ConvertibleCommon
                Stock
            
            Preferred
                Stock
            
            Preferred
                Stock
            
            Preferred
                StockShares
            
            Amount
            
            Shares
            
            Amount
            
            Shares
            
            Amount
            
            Shares
            
            AmountBalance
                - July 1, 2005
            
            
            2,302,193
            
            $
            2,302
            
            
            124
            
            $
            -
            
            
            517,243
            
            $
            517
            
            
            1,149,425
            
            $
            1,149Acquisition
                of EOIR
            
            
            12,000,000
            
            
            12,000
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Balance
                - July 1, 2005, restated
            
            
            14,302,193
            
            
            14,302
            
            
            124
            
            
            -
            
            
            517,243
            
            
            517
            
            
            1,149,425
            
            
            1,149Conversion
                of Series A convertible preferred stock into common stock
            
            
            282,669
            
            
            283
            
            
            (60
            )
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Conversion
                of Series C convertible preferred stock into common stock
            
            
            402,298
            
            
            402
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (402,298
            )
            
            (402
            )Common
                stock issued in connection with warrant exercises
            
            
            302,868
            
            
            303
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Common
                stock issued in connection with liquidated damages
            
            
            228,065
            
            
            228
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Stock-based
                compensation
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Exchange
                of Series B convertible preferred stock for Markland Series D preferred
                stock
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (517,243
            )
            
            (517
            )
            
            -
            
            
            -Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Balance
                - December 31, 2005
            
            
            15,518,093
            
            $
            15,518
            
            
            64
            
            $
            -
            
            
            -
            
            $
            -
            
            
            747,127
            
            $
            747







See
      notes
      to condensed consolidated financial statements.


(Reflects
      reverse stock split of 1 for 211.18 on July 19, 2005)





4





**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY**


**FOR
      THE SIX MONTHS ENDED DECEMBER 31, 2005**


(Unaudited)







Additional
            
            
            
            TotalPaid-in
            
            Accumulated
            
            Stockholders'Capital
            
            Deficit
            
            EquityAmount
            
            Amount
            
            AmountBalance
                - July 1, 2005
            
            $
            9,607,463
            
            $
            (2,726,389
            )
            $
            6,885,042Acquisition
                of EOIR
            
            
            13,669,860
            
            
            (1,046,948
            )
            
            12,634,912Balance
                - July 1, 2005, restated
            
            
            23,277,323
            
            
            (3,773,337
            )
            
            19,519,954Conversion
                of Series A convertible preferred stock into common stock
            
            
            (283
            )
            
            -
            
            
            -Conversion
                of Series C convertible preferred stock into common stock
            
            
            -
            
            
            -
            
            
            -Common
                stock issued in connection with warrant exercises
            
            
            (303
            )
            
            -
            
            
            -Common
                stock issued in connection with liquidated damages
            
            
            1,149,772
            
            
            -
            
            
            1,150,000Stock-based
                compensation
            
            
            96,339
            
            
            -
            
            
            96,339Exchange
                of Series B convertible preferred stock for Markland Series D preferred
                stock
            
            
            517
            
            
            -
            
            
            -Net
                loss
            
            
            -
            
            
            (1,796,653
            )
            
            (1,796,653
            )Balance
                - December 31, 2005
            
            $
            24,523,365
            
            $
            (5,569,990
            )
            $
            18,969,640







See
      notes
      to condensed consolidated financial statements


Reflects
      reverse stock split of 1 for 211.18 on July 19, 2005)




5


**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


(Unaudited)




**For
                  The Six Months Ended**
                **December
                  31,**2005
              
              
              2004**Cash
                  Flows From Operating Activities:**Net
                  loss
              
              $
              (1,796,653
              )
              
              $
              (106,721
              )Adjustment
                  to reconcile net loss to net cash provided (used) by operating
                  activities:Depreciation
                  and amortization of property and equipment
              
              
              179,492
              
              
              
              --Amortization
                  of intangible assets
              
              
              893,122
              
              
              
              --Common
                  stock issued in settlement of liquidated damages
              
              
              1,150,000
              
              
              
              --Non-cash
                  interest expense
              
              
              146,797
              
              
              
              --Stock-based
                  compensation
              
              
              96,339
              
              
              
              90,000Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              678,525
              
              
              
              --Inventory
                  and work in process
              
              
              279,768
              
              
              
              --Prepaid
                  expenses and other current assets
              
              
              399,644
              
              
              
              --Restricted
                  cash
              
              
              (250,000
              )
              
              
              --Accounts
                  payable
              
              
              (1,479,238
              )
              
              
              15,526Accrued
                  expenses and other current liabilities
              
              
              129,375
              
              
              
              --Due
                  to related parties
              
              
              (1,476,521
              )
              
              
              --**Net
                  Cash Used In Operating Activities**
              
              
              (1,049,350
              )
              
              
              (1,195
              )**Cash
                  Flows From Investing Activities:**Purchase
                  of property and equipment
              
              
              (166,429
              )
              
              
              --**Net
                  Cash Used In Investing Activities**
              
              
              (166,429
              )
              
              
              --**Cash
                  Flows From Financing Activities:**Repayment
                  of long-term debt
              
              
              (633,433
              )
              
              
              --**Net
                  Cash Used In Financing Activities**
              
              
              (633,433
              )
              
              
              --**Net
                  Decrease In Cash**
              
              
              (1,849,212
              )
              
              
              (1,195
              )**Cash
                  and Cash Equivalents - Beginning of Period**
              
              
              5,862,608
              
              
              
              1,334**Cash
                  and Cash Equivalents - End of Period**
              
              $
              4,013,396
              
              
              $
              139
 
 **(Continued)**
 
  6
  
 
 **TECHNEST
        HOLDINGS, INC. AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS (concluded)**
 (UNAUDITED)
 
 
 **For
                  The Six Months Ended**
                **December
                  31**,2005
              
              
              2004**Supplemental
                  Disclosures Of Cash Flow Information:**Cash
                  paid during the periods for:Interest
              
              $
              225,631
              
              
              $
              7,690Taxes
              
              $
              --
              
              
              $
              --
  See
        notes
        to condensed consolidated financial statements.
  THE
          PURCHASE METHOD OF ACCOUNTING WAS USED BY TECHNEST HOLDINGS, INC. TO RECORD
          THE
          ASSETS ACQUIRED AND LIABILITIES ASSUMED OF GENEX TECHNOLOGIES, INC. ON
          FEBRUARY
          14, 2005 (SEE NOTE 3).  ACCORDINGLY, THE ACCOMPANYING FINANCIAL STATEMENTS
          OF TECHNEST HOLDINGS, INC. AND GENEX TECHNOLOGIES, INC. AS OF AND FOR PERIODS
          ENDED SUBSEQUENT TO THE ACQUISITION ARE NOT COMPARABLE IN ALL MATERIAL
          RESPECTS
          TO THE FINANCIAL STATEMENTS OF TECHNEST HOLDINGS, INC. AS OF AND FOR PERIODS
          ENDED PRIOR TO THE ACQUISITION.
 7


**TECHNEST
      HOLDINGS, INC AND SUBSIDIARIES**


**NOTES
      TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS**




**For
      the Six Months Ended December 31, 2005 and 2004**


(Unaudited)









**1.
      NATURE OF OPERATIONS**




Business
      History




Technest
      Holdings, Inc. (“Technest” or “the Company”) had no operations between October
      10, 2003 and February 14, 2005.




On
      February 14, 2005, Technest became a majority owned subsidiary of Markland
      Technologies, Inc. (“Markland”), a homeland defense, armed services and
      intelligence contractor. Markland is a public company with a class of equity
      securities registered pursuant to Section 12(g) of the Exchange Act. Technest
      issued to Markland 1,954,023 shares of its common stock, representing at the
      time of the acquisition a 93% ownership interest in Technest’s common stock on a
      primary basis, 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. (“Genex”) (see Note 3).




Genex
      Technologies, Inc. offers imaging products and complete solutions for
      three-dimensional (3D) imaging and display, intelligent surveillance, and
      three-dimensional facial recognition.




In
      connection with these acquisitions, the accounts of Technest and Genex have
      been
      adjusted using the push-down basis of accounting to recognize the allocation
      of
      the consideration paid to the respective net assets acquired (see Note
      3).




Reorganization
      and Restatement




On
      August
      17, 2005, pursuant to a Stock Purchase Agreement with Markland Technologies,
      Inc., our majority stockholder, Technest purchased all of the outstanding stock
      of E-OIR Technologies, Inc., (“EOIR”), formerly one of Markland’s wholly-owned
      subsidiaries. As consideration for the stock of EOIR, Technest issued 12 million
      shares of its common stock to Markland. 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 convertible securities and the exercise of
      all
      warrants to purchase Technest common stock). Accordingly, this reorganization
      did not result in a change of control of EOIR and Technest did not need
      stockholder consent in order to complete this reorganization.  Since
      this is a transaction between entities under common control, in accordance
      with
      Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business
      Combinations”, Appendix D, the Company recognized the net assets of EOIR at
      their carrying amounts in the accounts of Markland at the date of transfer.
      Additionally, the Company restated its financial statements and has reported
      the
      results of operations and cash flows as though the transfer of EOIR occurred
      at
      the date Technest became part of Markland’s control group, which occurred on
      February 14, 2005.  EOIR was acquired by Markland on June 30,
      2004.




EOIR
      offers products: (i) design and fabrication of customized remote sensor systems
      and platforms for DOD, INTEL and Homeland Security applications; (ii) remote
      sensor data collection, data signal processing and data exploitation; and (iii)
      training in the use of remote sensor systems and data. These efforts involve
      systems engineering, system integration, prototyping, manufacturing and field
      data collections as well as data analysis and processing.




Basis
      of Presentation




The
      accompanying unaudited condensed consolidated financial statements of Technest
      have been prepared in accordance with accounting principles generally accepted
      in the United States of America for interim financial information, without
      being
      audited, pursuant to the rules and regulations of the Securities and Exchange
      Commission. Accordingly, they do not include all of the information and
      footnotes required by accounting principles generally accepted in the United
      States of America for complete financial statements. In the opinion of
      management, all adjustments (consisting of normal recurring accruals) considered
      necessary to make the financial statements not misleading have been included.
      Operating results for the six months ended December 31, 2005 are not necessarily
      indicative of the result that may be expected for the year ending June 30,
      2006.
      The unaudited condensed consolidated financial statements should be read in
      conjunction with the consolidated financial statements and footnotes included
      in
      the Company's Annual Report on Form 10-KSB for the period ended June 30, 2005
      filed with the Securities and Exchange Commission on October 12, 2005 (see
      Note
      3 regarding (a) the use of push down accounting and the lack of comparability
      to
      prior periods as a result and (b) the restatement of prior periods for the
      transaction between entities under common control).







8




**2.
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**




Principles
      of Consolidation




The
      condensed consolidated financial statements include the accounts of Technest
      and
      its wholly-owned subsidiaries, Genex Technologies, Inc. and EOIR Technologies,
      Inc. The condensed consolidated financial statements include the results of
      Genex from the date of acquisition of February 15, 2005 (see Note 3). As
      indicated in Note 1 above, as a result of the reorganization, the
      Company has restated its financial statements and reported the results of
      operations and cash flows as though the transfer of EOIR occurred at the date
      Technest became part of Markland’s control group, which occurred on February 14,
      2005. All
      significant inter-company balances and transactions have been eliminated in
      consolidation.




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 of completion method on firm fixed
      price
      contracts, allowance for doubtful accounts, the estimated useful lives of
      property and equipment, the estimated useful lives of definite-lived intangible
      assets, impairment of definite-lived intangible assets and goodwill, the
      valuation of reserves on deferred tax assets, the amount due to contracting
      government agencies as a result of their audits, the allocation of consideration
      paid to the net assets of businesses acquired and the fair value of equity
      instruments.




Concentrations




A
      significant portion of revenue is generated from contracts with Federal
      government agencies. Consequently, a significant portion of all accounts
      receivable are due from Federal government agencies either directly or through
      other government contractors.




Cash
      and Cash Equivalents




The
      Company considers all highly liquid investments with maturities of ninety days
      or less to be cash equivalents. Cash equivalents consist of money market funds
      as of December 31, 2005.  The Company has cash balances in banks in excess
      of the maximum amount insured by the FDIC as of December 31, 2005.




Restricted
      Cash




Restricted
      cash represents a one year certificate of deposit, maturing January 2006,
      collateralizing a letter of credit in the amount of $250,000 issued in favor
      of
      a bank in conjunction with the Company’s corporate credit cards.




Accounts
      Receivable




Accounts
      receivable represent the amount invoiced for product shipped and 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 December 31, 2005. If management
      determines amounts to be uncollectible, they will be charged to operations
      when
      that determination is made.






9




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 contracts.




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. 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 using straight-line methods over the estimated
      useful lives of assets as follows:




Software
            3
                yearsComputer
                equipment
            3
                yearsFurniture
                and fixtures
            5-7
                yearsLeasehold
                improvements
            Shorter
                of useful life and lease termVehicles
            5
                years




Property
      and equipment consisted of the following at December 31, 2005:




Software
            
            $
            167,079Computer
                equipment
            
            
            618,511Furniture
                and fixtures
            
            
            238,612Leasehold
                improvements
            
            
            222,338Vehicles
            
            
            78,3431,324,883Less
                accumulated depreciation
            
            
            (475,172
            )$
            849,711




Depreciation
      expense for the six months ended December 31, 2005 and 2004 was $179,492 and
      $-0-, respectively.




Definite-lived
      Intangible Assets




Included
      in definite-lived intangible assets are the amounts assigned to customer
      relationships and contracts and patents acquired in connection with business
      combinations (see Note 3). 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 3D imaging, intelligent surveillance and
      3D
      facial recognition technologies.




With
      the
      acquisition of Genex, Technest 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
      U.S. Department of Defense. The amounts assigned to these definite-lived
      intangible assets were determined by management based on a number of factors
      including an independent purchase price allocation analysis. These assets are
      being amortized over their estimated useful life of five years.




10


Contracts
      and Customer Relationships acquired as a result of business combinations (see
      Note 3) 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”, Financial Accounting Standards Board (“FASB”)
      Concepts Statement Number 7 and Emerging Issued 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.




Operating
      Segments




The
      Company operates in two Operating Segments as defined in paragraph 10 of SFAS
      No. 131, “Disclosures about Segments of an Enterprise and Related Information”.
      These are (1) the business of EOIR which primarily consists of products and
      services in the remote sensing technology and (2) the business of Genex which
      primarily consists of research and development, design and fabrication of 3D
      imaging and of intelligent surveillance products. Further, since both these
      operating segments have similar economic characteristics, as well as similar
      products and services, production processes, customers, distribution methods
      and
      regulatory environment, the Company concluded that they meet the aggregation
      criteria outlined in paragraph 17 of SFAS No. 131. Therefore, the Company
      aggregates the two operating segments into a single reportable segment in
      accordance with paragraph 16 of SFAS No. 131.




Revenue
      Recognition




We
      recognize revenue when the following criteria are met: (1) we have persuasive
      evidence of an arrangement, such as contracts, purchase orders or written
      requests; (2) we have completed delivery and no significant obligations remain,
      (3) our price to our customer is fixed or determinable, and (4) collection
      is
      probable. We recognize revenues at the time we perform services related to
      border security logistic support.




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




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




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




EOIR
      participates in teaming agreements where they are the primary contractor and
      they participate with other organizations to provide complex integrated remote
      sensor product and technology development services to the Federal government.
      EOIR has managerial and oversight responsibility for all team members as well
      as
      the responsibility for the ultimate acceptability of all integrated technical
      performance criteria under the contracts for deliverable services and products.
      EOIR, as the prime contractor who accepts risks for these customer funded tasks,
      includes as revenues the amounts that they bill under these teaming arrangements
      and include as direct costs amounts that are reimbursable or paid to team
      members because these teaming arrangements meet the criteria for gross revenue
      reporting as discussed in EITF Issue No. 99-19, “Reporting Revenue Gross as a
      Principal versus Net as an Agent”. This policy on revenue recognition is also
      supported by paragraph 60 of the AICPA’s
      Statement of Position 81-1 “Accounting for Performance of Construction-Type and
      Certain Production-Type Contracts”.




Research
      and Development




The
      Company charges research and development costs to expense as incurred. The
      Company capitalizes costs related to acquired technologies that have achieved
      technological feasibility and have alternative uses. The Company expenses as
      research and development costs the technologies we acquire if they are in
      process at the date of acquisition or have no alternative uses.






11




Income
      Taxes




The
      Company accounts for income taxes using the asset and liability method. 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.




Loss
      Per Share




Basic
      and
      diluted net loss per common share has been computed based on the weighted
      average number of shares of common stock outstanding during the periods
      presented.




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




For
      purposes of computing the weighted average number of common shares outstanding,
      the Company assumed that the 12,000,000 shares of common stock issued to
      Markland in conjunction with the reorganization (see Note 1) were issued on
      February 14, 2005.




Fair
      Value of Financial Instruments




The
      financial statements include various estimated fair value information at
      December 31, 2005, as required by Statement of Financial Accounting Standards
      No. 107, "Disclosures about Fair Value of Financial Instruments." Financial
      instruments are initially recorded at historical cost. If subsequent
      circumstances indicate that a decline in the fair value of a financial asset
      is
      other than temporary, the financial asset is written down to its fair
      value.




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




The
      fair
      value of cash, accounts receivable and long-term debt approximate their recorded
      amounts because of their relative market and settlement terms. The fair value
      of
      the notes payable issued to the former owners of EOIR (see Note 3) have been
      recorded at their fair value. Management was primarily responsible for
      determining this fair value and in making its determination, management
      considered a number of factors, including an independent valuation.




Shipping
      Costs




Delivery
      and shipping costs are included in cost of revenue in the accompanying
      consolidated statements of loss.






12




Impairment
      of Intangible Assets




The
      Company records as goodwill the excess of the 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
      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 units are its
      operating segments 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 indicators of impairment were identified in the six months ended
      December 31, 2005.




Impairment
      of Long-Lived Assets




Pursuant
      to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived
      Assets", Technest continually monitors events and changes in circumstances
      that
      could indicate carrying amounts of long-lived assets may not be recoverable.
      An
      impairment loss is recognized when expected cash flows are less than the asset's
      carrying value. Accordingly, when indicators of impairment are present, Technest
      evaluates the carrying value of such assets in relation to the operating
      performance and future undiscounted cash flows of the underlying assets.
      Technest’s policy is to record an impairment loss when it is determined that the
      carrying amount of the asset may not be recoverable. No impairment charges
      were
      recorded in the three and six months ended December 31, 2005.




Stock-Based
      Compensation




At
      December 31, 2005 , as permitted under SFAS No. 148, "Accounting for Stock-Based
      Compensation - Transition and Disclosure", which amended SFAS No. 123,
      "Accounting for Stock-Based Compensation", Technest has elected to continue
      to
      follow the intrinsic value method in accounting for its stock-based employee
      compensation arrangements as defined by Accounting Principles Board Opinion
      ("APB") No. 25, "Accounting for Stock Issued to Employees", and related
      interpretation including FASB Interpretation No. 44, "Accounting for Certain
      Transactions Involving Stock Compensation", an interpretation of APB No. 25.
      Had
      the Company followed the fair value method in accounting for its stock-based
      employee compensation it would have had the following effect on the net loss
      for
      the six months ended December 31, 2005 and 2004. There was no effect for the
      three months ended December 31, 2005 and 2004.




Six
                months endedDecember
                31,2005
            
            2004Net
                loss as reported
            
            $
            (1,796,653)
            
            $
            (106,721
            )Add:
                stock-based employee compensation under intrinsic value method included
                in
                net loss
            
            
            96,339
            
            
            --Deduct:
                stock-based employee compensation under fair value method
            
            
            (196,958
            )
            
            --Pro
                forma net loss to applicable to common stockholders
            
            $
            (1,897,272
            )
            $
            (106,721
            )Basic
                and diluted loss per share - as reported
            
            $
            (0.12
            )
            $
            (0.79
            )Basic
                and diluted loss per share - pro forma
            
            $
            (0.13
            )
            $
            (0.79
            )





The
      assumptions used and weighted average information for the six months ended
      December 31, 2005 were as follows:




Fair
                value of stock
            $0.03
                - $0.75Exercise
                price
            $0.015
                - $0.38Expected
                dividend yield
            0%Expected
                lives (in years)
            10Risk-free
                interest rate
            2.87%
                - 3.53%




Recent
      Accounting Pronouncements




In
      December 2004, the FASB issued SFAS No. 123(R) (revised 2004), Share-Based
      Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based
      Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for
      Stock Issued to Employees, and Amends SFAS No. 95, Statement of Cash Flows.
      Generally, the approach in SFAS No. 123(R) is similar to the approach described
      in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments
      to
      employees, including grants of employee stock options, to be recognized in
      the
      income statement based on their fair values. Pro forma disclosure is not an
      alternative. SFAS No. 123(R) must be adopted no later than the first interim
      period for fiscal years beginning after December 15, 2005. Technest expects
      to
      adopt SFAS No. 123(R) on July 1, 2006.






13




SFAS
        No.
        123(R) permits public companies to adopt its requirements using one of two
        methods: a “modified prospective” approach or a “modified retrospective”
approach. Under the modified prospective approach, compensation cost is
        recognized beginning with the effective date based on the requirements of
        SFAS
        123(R) for all share-based payments granted after the effective date and
        the
        requirements of SFAS No. 123(R) for all awards granted to employees prior
        to the
        effective date of SFAS No. 123(R) that remain unvested on the effective date.
        The modified retrospective approach includes the requirements of the modified
        prospective approach but also permits entities to restate based on the amounts
        previously recognized under SFAS No. 123 for purposes of pro forma disclosures
        either for all prior periods presented or prior interim periods of the year
        of
        adoption. The Company is evaluating which method to adopt.




As
      permitted by SFAS No. 123, the Company currently accounts for the share-based
      payments to employees using APB Opinion No. 25’s intrinsic value method and, as
      such, generally recognize no compensation cost for employee stock options.
      However, grants of stock to employees have always been recorded at fair value
      as
      required under existing accounting standards. The Company does not expect the
      adoption of SFAS No. 123(R) to have a material effect on its results of
      operations. However, the Company’s results of operations could be materially
      affected by share-based payments issued after the adoption of SFAS 123(R).
      The
      impact of the adoption of SFAS No. 123(R) cannot be predicted at this time
      because it will depend on levels of share-based payments granted in the future.
      However, had the Company adopted SFAS No. 123(R) in prior periods, the impact
      of
      that standard would have approximated the impact of SFAS No. 123 as described
      in
      the pro forma financial information above.




SFAS
      No.
      123(R) also requires the benefits of tax deductions in excess of recognized
      compensation cost to be reported as a financing cash flow, rather than an
      operating cash flow under current accounting literature. Since the Company
      does
      not have the benefit of tax deductions in excess of recognized compensation
      cost, because of its net operating loss position, the change will have no
      immediate impact on our consolidated financial statements.




**3.
      ACQUISITIONS**




Purchase
      by Markland Technologies, Inc.




On
      February 14, 2005, in conjunction with a Securities Purchase Agreement between
      Technest and Markland, Technest issued 1,954,023 shares of common stock to
      Markland Technologies, Inc. in exchange for 10,168,764 shares of Markland’s
      common stock (“the Markland Investment”). The common stock issued to Markland
      represented a 93% interest in Technest’s common stock at the time of the
      purchase. Consequently, Technest became a majority owned subsidiary of Markland
      on that date. The Securities Purchase Agreement contains provisions for Markland
      to deliver additional shares of its common stock to Technest in conjunction
      with
      the acquisition of Genex Technologies, Inc. (see below) and conversion of the
      Series B Convertible Preferred Stock (see Note 6).




Purchase
      of Genex Technologies, Inc.




The
      acquisition of Genex was effected pursuant to an Agreement and Plan of Merger
      dated February 14, 2005 (the "Merger Agreement"), by and among Markland,
      Technest, MTECH Acquisition, Inc. ("MTECH"), a wholly-owned subsidiary of
      Technest, Genex and Jason Geng, the sole stockholder of Genex.




In
      accordance with the terms of the Merger Agreement, on February 14, 2005, MTECH,
      a wholly-owned subsidiary of Technest, merged with and into Genex, with Genex
      surviving the merger as a wholly-owned subsidiary of Technest. As a result
      of
      the merger, all of the outstanding shares of the capital stock of Genex were
      automatically converted into the right to receive in the aggregate (i) $3
      million in cash; (ii) 10,168,764 shares of Markland's common stock (the shares
      of Markland common stock issued to Technest in the Markland Investment); and
      (iii) if earned, contingent payments in the form of additional shares of
      Technest common stock. A brokerage fee in connection with this acquisition
      of
      $300,000 was also paid. In addition, Mr. Geng was to receive a twelve month
      unsecured promissory note in the principal amount of $550,000 that paid interest
      at the rate of 6% per annum. Mr. Geng's share consideration was to be adjusted
      to reflect changes in the closing bid price of Markland common stock in the
      10
      trading days following February 14, 2005, subject to limitations set forth
      in
      the Merger Agreement. Following the acquisition, the Company discovered what
      it
      believes were material misrepresentations made by Mr. Geng in the Merger
      Agreement. As a result of damages arising in connection with these breaches,
      the
      Company has refused to issue the promissory note, the additional Markland share
      consideration, the contingent payments of Technest common stock or the
      additional cash payments of profits from the commercialization of Intraoral
      Technologies. 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. As a result of its
      contingent nature, Technest excluded these amounts from the purchase price
      and
      initial allocation of the purchase price as described below.




14


A
      summary
      of the initial allocation of the purchase price to the estimated fair value
      of
      the assets acquired and liabilities assumed is as follows:




Cash
            
            $
            3,300,000Shares
                of Markland Technologies, Inc. common stock
            
            
            6,101,259Total
                Purchase Price
            
            $
            9,401,259Fair
                value allocation to net assets acquired:Fair
                value of assets acquired -Current
                assets, including cash of $784,484
            
            $
            1,199,401Property
                and equipment
            
            
            44,000Fair
                value of liabilities assumed -Accounts
                payable & accrued expenses
            
            
            (544,290)Fair
                value of identifiable net tangible assets acquired
            
            
            699,111Intangible
                assets - intellectual property
            
            
            161,110In-process
                research and development
            
            
            2,095,000Commercialized
                patents
            
            
            440,000Contracts
                and customer relationships
            
            
            1,130,000Goodwill
            
            
            4,876,038Total
            
            $
            9,401,259





As
      a
      result of the transaction being structured as a stock acquisition, Technest
      does
      not expect any goodwill resulting from the transaction to be deductible for
      tax
      purposes.




In
      connection with the Genex acquisition, Technest also raised gross proceeds
      of
      $5,000,000 through a private placement of units consisting of 1,149,425 shares
      of Series B Convertible Preferred Stock, 1,149,425 shares of Series C
      Convertible Preferred Stock and warrants to purchase 1,149,425 shares of
      Technest’s common stock (see note 6).




Push
      Down Accounting




Based
      on
      the substantial change in ownership and control of Technest, as well as the
      fact
      that the investors in the Technest financing (see Note 6) represented a
      collaborative group brought together to accomplish the acquisition of Genex,
      the
      push down basis of accounting has been applied to the acquisition of Technest
      by
      Markland and the acquisition of Genex by Technest. In accordance with the push
      down basis of accounting, Technest’s and Genex’s net assets were adjusted to
      their estimated fair values as of the date of acquisition which resulted in
      the
      basis of the net assets acquired being adjusted as disclosed above and
      accumulated deficit was reset to zero as of the acquisition date.




Acquisition
      of EOIR




On
      August
      17, 2005, pursuant to a Stock Purchase Agreement with Markland Technologies,
      Inc., Technest’s majority stockholder, Technest purchased all of the outstanding
      stock of E-OIR Technologies, Inc., (“EOIR”), formerly one of Markland’s
      wholly-owned subsidiaries. As consideration for the stock of EOIR, Technest
      issued 12 million shares of its common stock to Markland. 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 convertible securities and the exercise
      of
      all warrants to purchase Technest common stock). Accordingly, this
      reorganization did not result in a change of control of EOIR and Technest did
      not need stockholder consent in order to complete this
      reorganization.  Since this is a transaction between entities under
      common control, in accordance with SFAS No. 141, “Business Combinations”,
      Appendix D, the Company recorded the net assets of EOIR at their carrying value
      on the date of transfer. Additionally, the Company has restated its financial
      statements and reported the results of operations and cash flows as though
      the
      transfer of EOIR occurred at the date Technest became part of Markland’s control
      group, February 14, 2005. Markland acquired EOIR on June 30, 2004.  EOIR
      generated approximately 97% of Markland’s revenue for its latest fiscal year
      ended June 30, 2005.






15




EOIR
      offers products and services which include: (i) design and fabrication of
      customized remote sensor systems and platforms for U.S. Department of Defense,
      United States intelligence agencies and U.S. Department of Homeland Security
      applications; (ii) remote sensor data collection, data signal processing and
      data exploitation; and (iii) training in the use of remote sensor systems and
      data.




Unaudited
      pro forma financial information for the three months and six months ended
      December 31, 2004, had the acquisition of Genex and EOIR been completed as
      of
      July 1, is as follows:




3
                  months
              
              6
                  monthsRevenues
              
              $
              17,720,205
              
              $
              34,560,602Operating
                  profit (loss)
              
              $
              27,792
              
              $
              (196,427
              )Net
                  loss
              
              $
              (222,764
              )
              $
              (769,120
              )Net
                  loss per common share
              
              $
              (0.02
              )
              $
              (0.05
              )





**4.
      DEFINITE-LIVED INTANGIBLE ASSETS**




Definite-lived
      intangible assets consist of the following at December 31, 2005:








Amount
            
            
            Useful
                life (years)Patents
                - Genex - commercialized technology
            
            $
            440,000
            
            
            5Patents
                - Genex - other
            
            
            161,111
            
            
            15Customer
                relationships and contracts - Genex
            
            
            1,130,000
            
            
            5Customer
                relationships and contracts - EOIR- Sensor Technologies
            
            
            11,755,000
            
            
            9Customer
                relationships and contracts - EOIR- Chemical Detection
            
            
            1,551,943
            
            
            10Accumulated
                amortization
            
            
            (2,592,502
            )Net
                definite-lived intangible asset
            
            $
            12,445,552





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.




Amortization
      expense was $893,123 and $-0- for the six months ended December 31, 2005 and
      2004, respectively.




**5.
      LONG-TERM DEBT**




Notes
      Payable - EOIR Acquisition




On
      June
      30, 2004, EOIR issued notes guaranteed by Markland in the face amount of
      $11,000,000 in connection with the acquisition of EOIR's common stock. These
      notes accrue interest at 6% compounded monthly and are payable in quarterly
      installments over 60 months. The fair market value of these notes was $9,532,044
      as determined by management based on a number of factors including an
      independent valuation. The discount of $1,467,956 will be amortized to interest
      expense over the life of the note. During the six months ended December 31,
      2005, $146,797 was amortized to interest expense. The face value of the note
      and
      the unamortized discount at December 31, 2005 was $8,721,458 and $949,026,
      respectively.




16




Other
      Long-Term Bank Debt




EOIR's
      other long-term bank debt consists of the following as of December 31,
      2005:




First
                Market Bank, secured by research equipment, dated October, 2002
              with
                monthly payments of $3,715 including interest at LIBOR plus
              2.75%
                (7.30% December 31, 2005)
            
            $
            29,598First
                Market Bank, dated July, 2002 with monthly payments of $15,278
              plus
                interest at LIBOR plus 2.75%, (7.30% at December 31, 2005)
            
            
            43,576First
                Market Bank, secured by leasehold improvements, dated March 19, 2003
              with
                monthly payments of $3,514 including interest at 5.05%
            
            
            1,046A
                American Honda Finance, secured by vehicle, dated March 24, 2003
              with
                monthly payments of $406 including interest at 4.70%
            
            
            10,533$
            84,753







**6.
      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
      shares of common stock provided that, following such conversion, the total
      number of shares of common stock then beneficially owned by such holder and
      its
      affiliates and any other persons whose beneficial ownership of common stock
      would be aggregated with the holder's for purposes of Section 13(d) of the
      Exchange Act, does not exceed 4.999% of the total number of issued and
      outstanding shares of common stock. The Series A Preferred Stock ranks pari
      passu with the Company's Series B and C Preferred Stock.




During
      the quarter ended December 31, 2005, 59.694 shares of Series
      A
      Preferred Stock were converted into 282,669 shares of the Company’s common
      stock.




At
      December 31, 2005, there were 64.631 shares of Series A Preferred Stock issued
      and outstanding.




Series
      B and C Convertible Preferred Stock




On
      February 14, 2005, immediately after the acquisition by Markland of a
      controlling interest in Technest (see Note 3), Southridge Partners LP,
      Southshore Capital Fund Limited, Verdi Consulting, Inc., ipPartners, Inc.,
      DKR
      Soundshore Oasis Holding Fund, Ltd., DKR Soundshore Strategic Holding Fund,
      Ltd.
      and Deer Creek Fund, LP (collectively, the "Investors") paid $5,000,000 in
      cash
      to Technest for 1,149,425 shares of Series B Convertible Preferred Stock
      (“Series B Preferred Stock”), 1,149,425 shares of Series C Convertible Preferred
      Stock (“Series C Preferred Stock), and five-year warrants to purchase up to
      1,149,425 shares of Technest’s common stock at an exercise price of $6.50 per
      share (“the Investor Financing”) after adjusting for a 211.18 for one reverse
      stock split on July 19, 2005.




These
      securities were sold in units for a price of $4.35 per unit. Each unit consists
      of one share of Series B Preferred Stock; one share of Series C Preferred Stock
      and a warrant to purchase up to one share of Technest's common stock. Gross
      proceeds received from the sale of the units was $5,000,000. From these
      proceeds, the Company paid a finder’s fee of $1,200,000 and legal fees related
      to the financing of $287,578.




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






17




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 $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
      and the Investors 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 related to the Investor Financing 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.




Technest
      agreed to issue additional shares of its common stock to the Investors if the
      combined market prices of Markland and Technest’s common stock do not equal or
      exceed $6.525 at the end of one year from the purchase date and assuming such
      Investors are still holding all the securities comprising the units. At December
      31, 2005 there were no units left outstanding and no additional shares will
      be
      issued.




On
      August
      19, 2005, Markland entered into a definitive exchange agreement with the Deer
      Creek Fund LLC, pursuant to which Markland exchanged 500 shares of Markland
      Series D Preferred Stock for 114,942 shares of Technest Series B Convertible
      Preferred Stock.




On
      October 4, 2005, Markland entered into a definitive exchange agreement with
      Southshore Capital Fund and Southridge Partners pursuant to which Markland
      exchanged 1,750 shares of Markland Series D Preferred Stock for 402,301 shares
      of Technest Series B Convertible Preferred Stock. Subsequently, the Technest
      Series B Convertible Preferred shares held by Markland were cancelled. The
      Company recorded this as a contribution of capital from Markland with no net
      impact on equity.




In
      October 2005, 402,298 shares of Technest Series C preferred stock were converted
      to 402,298 shares of common stock.




On
      December 31, 2005, the Company had -0- shares of Series B Preferred Stock
      and 747,127 shares of Series C Preferred Stock issued and
      outstanding.




In
      the
      six months ended December 31, 2005, the Company had incurred liquidated damages
      of $1,150,000 which was charged to interest expense related to the Company's
      failure to file a registration statement and settled by the issuance of 228,065
      shares of Technest common stock.




Common
      Stock Issuances




On
      August
      17, 2005, pursuant to a Stock Purchase Agreement with Markland Technologies,
      Inc., our majority stockholder, Technest purchased all of the outstanding stock
      of EOIR, formerly one of Markland’s wholly-owned subsidiaries. As consideration
      for the stock of EOIR, Technest issued 12 million shares of its common stock
      to
      Markland. Since this was a transaction between entities under common control,
      the Company has reported this stock issuance as though the transfer of EOIR
      occurred at the date Technest became part of Markland’s control group, February
      14, 2005.




During
      the six months ended December 31, 2005, the company issued the following amounts
      of common stock:




-
            282,669
                shares on conversion of Series A Preferred
                Stock




-
            402,298
                shares on conversion of Series C Preferred
                Stock




-
            302,868
                shares in connection with the net share exercise of
                warrants




-
            228,065
                shares with a fair value of $1,150,000 in connection with liquidated
                damages, included in non-cash interest expense.







18




In
      the
      six months ended December 31, 2004, Technest issued 10,654 shares of common
      stock to certain non-employees for consulting services with a fair value of
      $90,000.




Reverse
      stock split




On
      June
      2, 2005, our Board of Directors and the holder 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 our authorized shares of common
      stock, which will remain at 495,000,000 shares. All share and per share
      information has been retroactively restated to reflect the Reverse Stock Split.




**7.
      OPTIONS AND WARRANTS**




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




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




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




No
      options were granted pursuant to the Plan during the periods ended December
      31,
      2005 and 2004.




Summary
      information with respect to stock options and warrants granted is as follows:




Number
                  of
                Shares
              
              Weighted
                average
                Exercise
                  PriceBalance,
                  June 30, 2005
              
              
              894,660
              
              $
              8.12Exercised
              
              
              (402,294
              )
              $
              6.50Expired
              
              
              (3,138
              )
              $
              3,259.17Balance,
                  December 31, 2005
              
              
              489,228
              
              $
              6.50




The
      following table summarizes the Company's stock options and warrants outstanding
      at December 31, 2005:







19




Options
      and warrants outstanding and exercisable




Exercise
                price
            
            Number
            
            Expiration
                Date$   
                6.50
            
            489,228
            
            02/14/2010Weighted
                average remaining life
            4.25
                years





As
      of
      December 31, 2005 all options and warrants are exercisable.




In
      connection with the acquisition of Genex (see Note 3), Markland agreed to
      replace options to purchase 312,000 shares of Genex common stock with fully
      vested options for the purchase of the same number of shares of Markland common
      stock with an exercise price equal to the fair value of Markland’s common stock
      on the grant date. The fair value of these options was considered to be
      immaterial for purposes of determining the total consideration paid for
      Genex.




Certain
      employees of EOIR were granted options for the purchase of Markland common
      stock
      on the original acquisition of EOIR on June 30, 2004, by Markland, Technest’s
      parent company. The amortization of stock-based compensation under these options
      exercisable for Markland common stock was $96,339 for the three months ended
      September 30, 2005, and is included in selling, general and administrative
      expense and as additional paid-in capital. As of December 31, 2005 all these
      options were cancelled. The expense recognized through the cancellation dates
      approximated the portion of the options that were fully vested upon
      cancellation. Therefore, there was no reversal of expense upon
      cancellation.




**8.
      NET LOSS PER SHARE**




Securities
      that could potentially dilute basic earnings per share ("EPS") in the future,
      and that were not included in the computation of diluted EPS because to do
      so
      would have been anti-dilutive consists of the following:




Shares
              PotentiallyIssuableSeries
                A Convertible Preferred Stock
            
            
            306,028Series
                C Convertible Preferred Stock
            
            
            747,127Warrants
            
            
            489,228Total
                as of December 31, 2005
            
            
            1,542,383






**9.
      COMMITMENTS AND CONTINGENCIES**




Facility
      Rental




The
      Company has its executive office in Boston, Massachusetts. The monthly lease
      amount for this facility is approximately $6,000




EOIR,
      our
      wholly owned subsidiary, holds a three-year lease for its executive and
      administrative offices of approximately 5,420 square feet in Woodbridge,
      Virginia. The lease expires on September 30, 2008. EOIR leases approximately
      10,000 square feet in Spotsylvania, Virginia, where it houses its software
      development unit. The lease expires on October 31, 2009. EOIR also holds a
      five-year lease for 6,951 square feet in Spotsylvania, Virginia. The lease
      expires on October 15, 2010. EOIR also has several offices located in
      Fredericksburg, Virginia - one office with 1,200 square feet, with a two-year
      lease that expires on October 31, 2006, and one with 4,200 square feet, with
      a
      three-year lease that expires on June 30, 2007. Monthly lease amounts for these
      facilities total approximately $36,600.






20




Genex
      leases office space under the terms of a non-cancelable operating lease that
      expires in January 2006. The office space lease provides for annual increases
      of
      3% to the base rent and requires the Company to reimburse the landlord for
      its
      pro rata share of the increases in annual operating expenses and real estate
      taxes. Monthly lease amounts for this facility total approximately
      $10,100.




Rent
      expense for the six months ended December 31, 2005 was $294,798.




Government
      Contracts - Genex




The
      Company's billings and revenue on time and material contracts are based on
      provisional fringe, general & administrative and overhead rates which are
      subject to audit by the contracting government agency.  During an audit
      conducted in November 2004 covering the fiscal year 2002, the Defense Contract
      Audit Agency (“DCAA”) discovered significant deficiencies in Genex’s accounting
      system that resulted in misclassified and unallowable costs. Their
      examination disclosed eight significant deficiencies in Genex’s accounting
      system that resulted in misclassified costs. They were:




1.
            Contractor
                does not follow policies and procedures concerning accounting for
                unallowable costs.





2.
            Contractor
                does not follow policies and procedures concerning accounting for
                material
                costs.





3.
            Contractor
                lacks adequate written policies and procedures concerning capitalization
                of assets.





4.
            Contractor
                does not have adequate policies and procedures to ensure proper
                segregation of duties in handling its labor
                costs.





5.
            Contractor’s
                procedure for calculating the proposed hourly labor rate of its employees
                results in overstated labor costs.





6.
            Contractor
                fails to maintain policies and procedures for classifying the labor
                categories of its employees.





7.
            Employees
                fail to follow the contractor’s policies and procedures in regards to
                maintaining timesheets on a current
                basis.





8.
            Contractor’s
                policy of billing labor costs results in billing the Government for
                employees that are not employees of Genex.




Since
      the
      acquisition of Genex, the management of Technest has terminated the Genex
      employees responsible for this function and rapidly installed appropriate
      internal controls and oversight over Genex’s accounting system to ensure that
      they comply with applicable laws and regulations and are adequate and operating
      effectively. The DCAA has since re-audited the Genex financial systems and
      has
      communicated to Genex that the revised procedures are satisfactory. Genex will
      be allowed to complete certain previous contacts awarded by the Department
      of
      Defense but may be required to refund amounts overbilled to its
      customers.




The
      Company accrued $68,017 for overpayments for 2002 and extended the analysis
      of
      misclassified and unallowed costs to June 30, 2005. T he
      Company determined that $102,228 is the total amount repayable to the government
      (inclusive of $68,017 accrued for 2002 overpayments). This amount is included
      in
      accrued expenses at December 31, 2005.




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.




**10.
      INCOME TAXES**




There
      was
      no provision for federal or state income taxes for the six months ended December
      31, 2005 and 2004, due to the Company's operating losses and a full valuation
      reserve against deferred tax assets. Since its acquisition by Markland, the
      Company and its subsidiaries file a consolidated tax return with Markland.




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




The
      Company has provided a full valuation reserve against the deferred tax asset
      because of the Company's loss history and significant uncertainty surrounding
      the Company's ability to utilize its net operating loss and tax credit
      carryforward.




Prior
      to
      its acquisition by Technest, Genex had elected to have its earnings taxed under
      Subchapter S of Chapter 1 of the Internal Revenue Code of 1986, as amended.
      On
      the effective date of the acquisition, Genex forfeited its status as a
      Subchapter S corporation.







21




**11.
      RELATED PARTY TRANSACTIONS**




With
      the
      exception of Deer Creek Fund LP, ipPartners, Inc., and Southshore Capital Fund
      Limited, all of the Investors in the Investor Financing on February
      14,  2005
      are
      either shareholders, officers and/or directors of Markland. ipPartners, Inc.
      is
      a corporation wholly owned and controlled by Mr. Tarini, Markland's Chief
      Executive Officer and Chairman. The Investor Financing was negotiated on behalf
      of Markland by senior management of Markland, including Mr. Tarini. The Markland
      Investment was approved by a unanimous vote of the Board of Directors of
      Markland including, Mr. Mackin and Mr. Ducey (a then director of Markland),
      neither of whom has an interest in the transaction.




During
      the six months ended December 31, 2005, Technest paid Markland $500,000 for
      administrative support services, engineering services and services rendered
      by
      executive officers of Markland who also function as executive officers of
      Technest. During the six months ended December 31, 2005, EOIR paid Markland
      $1,500,000 in cash for amounts accrued at June 30, 2005 related to the above
      mentioned services for the year ended June 30, 2005.




At
      December 31, 2005, Technest had amounts due from Markland for cash advances
      for
      payment of shared expenses in the amount of $61,821. The net amount due to
      Markland is $991,416 at December 31, 2005.




The
      Company believes that all transactions described above were made on terms no
      less favorable to it than those obtainable from unaffiliated third parties.
      All
      future transactions, if any, with its executive officers, directors and
      affiliates will be on terms no less favorable to it than those that will be
      obtainable from unrelated third parties at the time such transactions are made.




**12.
      EMPLOYEE BENEFIT PLANS**




EOIR
      has
      adopted a 401(k) plan for the benefit of certain employees. Essentially all
      EOIR
      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 contributed 6%, excluding bonuses on an annual basis, to those who
      have
      been employed by EOIR for more than one year and remain employed on the last
      day
      of the fiscal year.




Genex
      maintains a Simplified Employee Pension for all employees who have attained
      the age of 21 and have completed three years of service. Participants may make
      voluntary contributions up to the maximum amount allowed by law, but not to
      exceed 15% of each participant's eligible compensation. The combined totals
      of participant and Genex contributions may not exceed $30,000 by law. Genex
      contributions vest immediately to the participants.




Genex
      also maintains a defined contribution 401(k) profit sharing plan for all
      employees except those who are non-resident aliens or are covered by a
      collective bargaining agreement. Participants may make voluntary contributions
      up to the maximum amount allowable by law but not to exceed 20% of the
      participant's eligible compensation. Genex contributions to the 401(k) Plan
      are at the discretion of management and vest to the participants ratably
      over a five-year period, beginning with the second year of
      participation.




Contributions
      and other costs of these plans in the six months ended December 31, 2005 were
      $406,794.




**13.
      LITIGATION**




H&H
      Acquisition Corp.




On
      July
      23, 1998, H & H Acquisition Corp., individually and purportedly on behalf of
      Technest, commenced an action in federal court in the Southern District of
      New
      York against Technest, the founder and certain officers, among others. The
      complaint is an action to recover shares of common stock of the Company and
      unspecified damages. Management believes that the claims against the Company
      and
      certain officers are without merit and is vigorously defending the action.
      The
      Company cannot make any assurances about the litigation's outcome. However,
      the
      Company could be adversely affected if the plaintiff prevails.




In
      September 2002 the Company was served with a Summary Judgment Motion regarding
      H
& H Acquisition Corp. and the Company answered the motion in November 2002.
      On January 3, 2005, the court denied the motion for summary judgment. On
      November 23, 2005 the Company was informed that the trial date of this matter,
      which had been scheduled to begin on January 4, 2006, had been postponed. As
      of
      February 9, 2006, the Company has not been informed of a new date for the
      beginning of the trial.






22




Joseph
      R. Moulton




On
      or
      about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the
      Circuit Court of Spotsylvania County, Virginia, against Markland, EOIR, and
      our
      Chief Executive Officer and Director, Robert Tarini, in his capacity as
      Markland’s Chief Executive Officer. Mr. Moulton was the largest single
      shareholder of EOIR prior to its acquisition by Markland, owning approximately
      67% of the EOIR capital stock. Mr. Moulton received approximately $5,863,000
      in
      cash and a promissory note of EOIR in the approximate principal amount of
      $6,967,000 for his shares of EOIR at the closing of the acquisition of EOIR
      by
      Markland.




In
      his
      complaint Mr. Moulton asserts, among other things, that Markland and EOIR
      breached their obligations under the stock purchase agreement, dated June 30,
      2004, pursuant to which Markland acquired EOIR, by terminating Mr. Moulton's
      employment with EOIR and removing him from the EOIR board of
      directors.




Mr.
      Moulton is seeking damages allegedly suffered by his loss of employment, extreme
      emotional distress, and costs incurred to enforce his contractual rights. In
      addition, he is seeking some other equitable relief including, the appointment
      of a receiver to oversee the management of EOIR until the promissory notes
      issued to former EOIR shareholders at the closing of the acquisition are paid
      in
      full and a declaratory judgment that Markland and EOIR's actions constitute
      an
      event of default under these promissory notes allowing for the acceleration
      of
      all amounts due thereunder. As Mr. Moulton is suing in his personal capacity
      rather than as a representative of the former EOIR shareholders, he is asking
      the court to accelerate the payment of the outstanding principal amount of
      his
      note, which as of February 9, 2006, was $5,300,000. Markland is a guarantor
      of
      these notes.




Markland
      and EOIR believe that the allegations in this lawsuit are entirely without
      merit. Markland and EOIR have filed an answer denying Mr. Moulton's allegations
      and opposing vigorously all equitable relief sought. Markland and EOIR have
      also
      filed a counterclaim against Mr. Moulton seeking damages resulting from alleged
      misconduct and misrepresentations on the part of Mr. Moulton related to EOIR’s
      relationship with certain banks.




On
      April
      4, 2005 a hearing was held in the Spotsylvania County Circuit Court on Markland
      and EOIR's demurrer to certain claims brought by Mr. Moulton. As a result of
      that hearing, the claim by Mr. Moulton that his employment was terminated in
      violation of public policy was dismissed by the court, and the Court dismissed
      those aspects of Mr. Moulton's complaint suggesting that he was pursuing his
      claims on behalf of other unnamed sellers of EOIR shares. Mr. Moulton was not
      given leave to amend or refile these claims.




On
      December 16, 2005, the start of the trial of this matter was continued from
      January 17, 2006 to September 5, 2006. In addition on that day, Mr. Moulton
      was
      permitted by the Court to amend his complaint to add an additional cause of
      action.




On
      February 3, 2006, a hearing was held in the Spotsylvania County Circuit Court
      on
      Markland and EOIR’s demurrer to certain claims brought by Mr. Moulton. As a
      result of that hearing, Mr. Moulton’s cause of action alleging breach of an
      employment contract by EOIR was dismissed with prejudice by the
      Court.




Greg
      & Mary Williams




Markland
      and EOIR were notified on July 11, 2005 by counsel for Greg and Mary Williams,
      former shareholders and employees of EOIR and, in the case of Mr. Williams,
      a
      former director of Markland, that the Williamses filed a lawsuit in the
      Commonwealth of Virginia, naming EOIR and Markland as defendants, regarding
      a
      number of contractual disputes involving the registration of shares of Markland
      common stock underlying certain options issued to the Williamses in connection
      with the acquisition of EOIR by Markland and severance payments called for
      pursuant to severance agreements by and among the Williamses, EOIR and Markland.
      On August 3, 2005, EOIR and Markland filed an answer and a demurrer denying
      all
      liability.




**14.**  **SUBSEQUENT
      EVENTS**




Since
      December 31, 2005, we have issued (i) 31,267 shares of common stock in
      satisfaction of liquidated damages arising under our Registration Rights
      Agreement dated February 14, 2005, as amended on October 3, 2005, (ii) 114,942
      shares of common stock upon conversion of 114,942 shares of Series C convertible
      preferred stock, and (iii) 52,053 shares of common stock upon the net exercise
      of a warrant.







23







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




*The
      following discussion and analysis of our financial condition and results of
      operations for our financial quarter ending December 31, 2005 should be read
      together with our financial statements and related notes included elsewhere
      in
      this report.*





**FORWARD
      LOOKING STATEMENTS**




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




**OVERVIEW**




**General**




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




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




On
      August
      17, 2005, pursuant to a Stock Purchase Agreement with Markland Technologies,
      Inc., our majority stockholder, we purchased all of the outstanding stock of
      E-OIR Technologies, Inc., (“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.




**Technest
      Business**




Through
      our acquisition of EOIR and Genex, we offer remote sensing technology products
      and services, providing complete solutions for three-dimensional (3D) Imaging
      and Display, Intelligent Surveillance, and three-dimensional Facial Recognition
      mainly to the United States Department of Defense ("DOD"), various other United
      States Intelligence Agencies ("INTEL"), and the National Institute of Health.
      These acquisitions are a very important part of our ongoing business strategy
      of
      creating a world class integrated portfolio of solutions for the Homeland
      Security, DOD and INTEL marketplaces.




We
      have
      undergone material changes to our business and our financial structure during
      the period covered by the financial statements included in this quarterly report
      on Form 10-QSB. Our business, as it exists today, consists primarily of
      providing advanced engineering and research and development services in the
      areas of remote sensor systems and technologies, intelligent surveillance,
      chemical and explosives detection, and advanced technologies research and
      development. Our sources of operating revenue are from our wholly-owned
      subsidiaries, EOIR and Genex.






24




Genex
      offers (i) design and fabrication of customized remote sensor systems and
      platforms for DOD, INTEL and Homeland Security applications; (ii) design and
      fabrication of 3D facial recognition products tools for law enforcement; and
      (iii) design and fabrication of non-invasive 3D medical imaging tools. EOIR
      offers (i) design and fabrication of customized remote sensor systems and
      platforms for DOD, INTEL and Homeland Security applications; (ii) remote sensor
      data collection, data signal processing and data exploitation; and (iii)
      training in the use of remote sensor systems and data. These efforts of EOIR
      and
      Genex involve systems engineering, system integration, prototyping,
      manufacturing and field data collections as well as data analysis and
      processing. The Company has developed a number of proprietary products from
      its
      engineering and research and development services which we expect will be
      launched in the next twelve months as the next phase of the Company’s strategic
      plan.




Remote
      Sensor Systems and Technologies For Military And Intelligence
      Applications




EOIR
      provides advanced remote sensing technology products and services to the DOD
      and
      to various other United States intelligence agencies. EOIR’s remote sensor
      systems are a very important core function in our ongoing business strategy
      of
      creating a world-class integrated portfolio of solutions for the Homeland
      Security, DOD and INTEL marketplaces.




EOIR's
      most significant source of revenues is an Omnibus Contract with the United
      States Army Night Vision and Electronic Sensors Directorate. The Omnibus
      Contract has an extensive and varied scope that requires us to provide a very
      broad range of products and technical services. For those products and technical
      services that EOIR does not possess in-house, we subcontract to our team members
      and other subcontractors as necessary. As a prime contractor, EOIR is
      responsible for the technical performance of all of its products and services
      delivered to the customer. Primary revenue streams are derived from the delivery
      of services which provide the customer with: advanced development product
      concepts; low volume produced prototypes; advanced signal processing algorithms
      and software; advanced systems integration; engineering and evaluation services;
      data collection and processing capabilities and other highly differentiated
      and
      proprietary products and services.




EOIR
      intellectual property lies in trade secrets and the experience and capabilities
      of its technical staff whom support these government contracts. We protect
      EOIR
      intellectual property and our competitive position through patent applications,
      non-disclosure agreements with our business partners, and non-compete agreements
      with our employees. **




*Services*




EOIR
      has
      been providing highly differentiated services to government customers for nearly
      20 years. Our scientific support spans a wide range of services, including
      the
      full spectrum of sensor sciences, systems integration, system support and
      software development, as more fully described below:




·
            *Sensor
                Science*.
                Sensor science services at EOIR involve a multitude of spectral regions,
                ranging from visible to far infrared, developing, using and interpreting
                data from a number of different sensors including acoustic, radar,
                thermal, multi-spectral and hyper-spectral calibrated imagers.




·
            *Systems
                Integration*.
                EOIR has the electrical and mechanical engineering design experience
                necessary to integrate laboratory prototypes into existing military
                sensor
                systems.




·
            *Technical
                Training*.
                EOIR has the ability to develop classroom courses and computer-based
                and
                web-based trainers to satisfy unique customer requirements. EOIR
                is able
                to train on the use of sensor and detection equipment as well as
                teaching
                students how to interpret sensor signature data.




·
            *Software
                Development*.
                EOIR develops customized sensor and data collection software platforms
                to
                satisfy a variety of unique customer
                requirements.




*Products*




EOIR
      develops and produces highly advanced remote sensing hardware and software
      system products for our government customer base. Our products extend the range
      of our remote sensor services, encompassing the full spectrum of sensor science,
      systems integration, and system support. Below is a list of our current products
      in development:




·
            ACADA
                (Automatic Chemical Agent Detection and Alarm) - Man portable chemical
                agent point detector sensor system which utilizes Ion Mobility
                Spectroscopy technology to detect chemical agents such as Tabun,
                Sarin,
                and classic nerve agents. This unit has been mass produced and deployed
                throughout the US Navy.






25




·
            SERTSTM
                (Safety Evaluation Range Training System) - Audio and video recording
                system that allows instructors to instruct, review, and qualify trainees.
                SERTS is a minimally intrusive, multi-platform compatible, audio/video
                monitoring system that brings range evaluators to the action inside
                a host
                of live fire exercise vehicles. It transmits live audio and video
                from the
                exercise vehicle directly to a range tower for exercise monitoring,
                recording, and post exercise
                review.




·
            USRD
                (Universal Sensor Remoting Device) - Embedded system that allows
                multiple
                sensors to be remotely controlled. USRD is designed to remotely control
                and retrieve data from multiple sensors and transfer data to a base
                station through wired and wireless communications.




·
            Pelco
                Camera Translators - Embedded system that allows non-Pelco cameras
                to be
                integrated into Pelco networks, that is, it****allows
                non-Pelco cameras to be controlled by a standard Pelco control
                network**.**




·
            WinProcTM
                - A thermal imaging display and analysis software based tool****designed
                for viewing and analyzing thermal images. It offers a range of features
                including Fourier analysis, high and low pass filters, thermal image
                calibration, image statistics, and advanced digital display
                algorithms.




·
            IProcTM
                - An interferogram processing and analysis software based tool****that
                permits analysis of interferograms from spectrometers. Designed for
                the
                analysis of remotely captured chemical emission spectral information,
                the
                analysis tool enables the recognition of targeted chemical signatures.




·
            GPS
                Groundtruthre - A software based tool that can be used to keep accurate
                positioning information for multiple vehicles during field tests.




·
            TTAASPTM
                and EOIRTATM - A software based tool that assists predictive modeling of
                thermal targets and is used to calculate detection probabilities
                of
                targets at arbitrary angles and ranges.




The
      intellectual property relating to R & D funded by our customers remains with
      our customers. Technest may in certain circumstances require the approval of
      our
      customers to sell these products to other agencies.




Intelligent
      Surveillance




Genex’s
      intelligent surveillance portfolio is anchored by its real-time embedded image
      processing technology and its 3D facial recognition technology. Our products
      include OmniEyeTM Wellcam, OmniEyeTM Cerberus, Smart Optical Sensor (SOS), Smart
      SuiteTM and Omnivision.




The
      OmniEyeTMWellcam 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.
      The
      OmniEyeTM Cerberus is a re-configurable multi-sensor system that is designed for
      long distance infrared and visible light detection. The OmniEyeTM Cerberus
      delivers this flexibility while still maintaining seamless panoramic coverage
      up
      to 360 degrees.




The
      Smart
      Optical Sensor high speed image processing platform powers Genex’s 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 by Genex are a portfolio of advanced
      video analysis and augmentation modules. The SOS is a powerful system that
      allows multiple cameras to be deployed easily in a distributed, scaleable
      network that provides autonomous surveillance.




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




26


Genex
      currently is engaged in development programs with the U.S. Army Night Vision
      Lab, the U.S. Army Picatinny Arsenal, the U.S. Army Armament Research,
      Development and Engineering Center, the U.S. Navy Office of Naval Research,
      and
      the U.S. Navy Naval Surface Warfare System.




Chemical
      and Explosive Detection




We
      are
      targeting key sensing technologies that are critical to both DOD and Homeland
      Security missions: Chemical/Biological (Chem/Bio) and Improvised Explosive
      Devices (IED) detection sensors. Our Chem/Bio and IED group concentrates on
      the
      research and development of technologies that can reliably detect the presence
      of chemical, biological, and explosive devices or components from a stand-off
      distance utilizing multi spectral electro optical sensing methods. Under a
      Phase 2 Small Business Innovation Research (“SBIR”) grant from the U.S. Army,
      Genex is developing a new and unique sensor that can remotely detect the
      presence of chemical and biological weapons. We intend to offer these standoff
      detection sensors in an integrated system solution approach which also includes
      point detection capability provided by the EOIR manufactured ACADA system.
      The
      ACADA system utilizes Ion Mobility Spectroscopy cell based point detection
      chemical sensor technology.




Advanced
      Technologies Research and Development




The
      Advanced Technologies Research and Development group of Genex is focused on
      developing our imaging technology portfolio via advanced research in 3D facial
      recognition, intelligent surveillance 3D imaging, and medical imaging. By
      integrating our marketing pursuits with our R&D efforts, we can bring to
      market technological advances that have enhanced customer value. Some of our
      targeted research areas include: (i) fully integrated SurematchTM suite of 3D
      facial recognition software application programs; (ii) intelligent surveillance
      using two- and three-dimensional image processing to support homeland
      security, military, and commercial applications; (iii) detection of concealment
      of intent using thermal and 3D imaging to support anti-terrorist efforts; (iv)
      early detection of cancer using non-invasive and non-radiological diffuse
      optical tomography; and (v) more effective and less risky radiation treatment
      for cancer by use of 3D imaging for patient positioning.




Currently,
      we have nine funded SBIR ongoing programs. The R & D efforts include
      maintenance and capture of intellectual property in the form of patents and
      licensing agreements. Presently, we have a patent portfolio covering the areas
      of 3D imaging. Our strategy is to transform our captive intellectual property
      into proprietary products and services, which will create recurring revenue
      streams derived from our government customer base.




In
      addition, we are targeting manufacturers of products who would benefit
      strategically by adopting our technology to produce custom fitted products
      for
      their customers. We believe this strategy has the potential to generate a
      sustainable competitive advantage based on Genex’s ability to generate accurate
      3D measurement data.






**RESULTS
      OF OPERATIONS**




The
      push
      down basis of accounting has been applied to the February 14, 2005 acquisition
      of Technest by Markland and the acquisition of Genex by Technest. In accordance
      with the push down basis of accounting, Technest’s and Genex’s net assets were
      adjusted to their estimated fair values as of the date of acquisition.




Since
      the
      acquisition of EOIR was a transaction between entities under common control,
      Technest recorded the net assets of EOIR at their carrying value on the date
      of
      transfer. Additionally, Technest has reported the results of operations and
      cash
      flows as though the transfer of EOIR occurred at the date Technest became part
      of Markland’s control group, which occurred on February 14, 2005. As a result of
      these transactions, the results for the three months and six months ended
      December 31, 2004 are not comparable.




**Revenue**




Technest
      had $37,285,917 in revenue during the six months ended December 31, 2005. The
      same period in 2004 is not comparable as Technest had no operations. Technest
      had $18,289,576 in revenue during the three months ended December 31, 2005.
      Revenues from EOIR’s omnibus contract were $31,533,192 and $15,214,904 for the
      six and three months ended December 31, 2005, respectively.







27




The
      increase in revenue was due to the acquisition of Genex in February 2005 and
      the
      acquisition of EOIR from Markland in August 2005.




**Gross
      profit**




The
      gross
      profit for the six months ended December 31, 2005 was $7,058,793, or 19% of
      revenue. The same period in 2004 is not comparable as Technest had no
      operations. The gross profit for the three months ended December 31, 2005 was
      $3,652,907 or 20% of revenue.




**Selling,
      general and administrative expenses**




Selling,
      general and administrative expenses for the six months ended December 31, 2005
      was $6,311,234 and consisted primarily of payroll. The same period in 2004
      is
      not comparable as Technest had no operations. Selling, general and
      administrative expenses for the three months ended December 31, 2005 was
      $3,343,894. Included in selling, general and administrative expenses, the
      amortization of compensatory element of stock issuances for the six months
      ended
      December 31, 2005 was $96,339. This represents the amortization of stock-based
      compensation related to options for the purchase of Markland common stock
      granted to EOIR employees by Markland in conjunction with the original
      acquisition of EOIR in June 2004. Also included in selling general and
      administrative expenses are management fees paid to Markland. These amounted
      to
      $500,000 and $250,000 for the six and three months ended December 31, 2005,
      respectively. These management fees are expected to terminate by March 31,
      2007
      as Technest develops its own internal resources.




**Research
      and development**




Research
      and development expenses for the six months and three months ended December
      31,
      2005 were $138,448 and $77,703, respectively. This expenditure consisted
      primarily of unfunded research for new product development. Funded research
      and
      development is part of the Company’s revenue base and the associated costs are
      included in cost of revenues. There were no equivalent expenses for the same
      periods in 2004.




**Amortization
      of intangible assets**




Amortization
      of intangible assets for the six and three months ended December 31, 2005 were
      $893,122 and $452,253, respectively. Amortization expense increased in 2005
      because of the amortization of definite-lived intangible assets acquired in
      conjunction with Genex and EOIR in February and August of 2005,
      respectively.




**Operating
      loss**




The
      operating loss for the six and three months ended December 31, 2005 were
      $284,011 and $220,943, respectively. The same periods in 2004 are not comparable
      as Technest had no operations




**Interest
      expense and other income**




Interest
      expense for the six months and three months ended December 31, 2005 were
      $1,595,820 and $852,781, respectively.




In
      connection with the acquisition of EOIR by Markland, EOIR issued $11,000,000
      in
      original principal amount of notes due to the former stockholders of EOIR.
      The
      fair market value of these notes was $9,532,044 as determined by Markland’s
      management based on a number of factors including an independent valuation.
      The
      discount of $1,467,956 is being amortized to interest expense over the life
      of
      the note. Non-cash interest expense related to the amortization of this discount
      was $146,797 and $73,399 in the six and three months ended December 31, 2005,
      respectively. These notes bear interest at the rate of six (6%) percent per
      annum and must be repaid within the next four years.




In
      the
      six and three months ended December 31, 2005, Technest charged to interest
      expense $1,170,000 and $530,000, respectively, related to liquidated damages
      paid in cash and common stock for failure to have an effective registration
      statement.




Other
      income for the six and three months ended December 31, 2005 were $83,178 and
      $52,596, respectively, and represents interest received on cash
      balances.






28




**Net
      loss**




The
      net
      loss for the six months ended December 31, 2005 was $1,796,653. The net loss
      for
      the three months ended December 31, 2005 was $1,021,128.






**LIQUIDITY
      AND CAPITAL RESOURCES**




**Cash
      and Working Capital**




On
      December 31, 2005, Technest had a negative working capital balance of
      $2,840,091. Technest’s current liabilities include $991,416 due to
      Markland, Technest’s parent company. Net cash used in operating activities was
      $1,049,350 for the six months ended December 31, 2005. Non-cash expenses
      included in the net loss totaled $2,465,750 while changes in the components
      of
      working capital used cash of $1,718,447. Most of this change in working capital
      was related to a reduction of amounts due to related parties and trade payables
      by $2,955,759 in 2005.




**Cash
      Used in Investing Activities**




Technest
      used cash of $166,429 for the acquisition of equipment.




**Cash
      Used in Financing Activities**




In
      the
      six months ended December 31, 2005, $633,433 was used for loan
      repayments.




**Sources
      of Liquidity**




During
      the six months ended December 31, 2005, we have satisfied our cash requirements
      primarily through operating cash flows and our cash reserves. 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 its executive office in Boston, Massachusetts. The monthly lease amount
      for
      this facility is approximately $6,000.




EOIR,
      our
      wholly owned subsidiary, holds a three-year lease for its executive and
      administrative offices of approximately 5,420 square feet in Woodbridge,
      Virginia. The lease expires on December 31, 2008. EOIR leases approximately
      10,000 square feet in Spotsylvania, Virginia, where it houses its software
      development unit. The lease expires on October 31, 2009. EOIR also holds a
      five-year lease for 6,951 square feet in Spotsylvania, Virginia. The lease
      expires on October 15, 2010. EOIR also has several offices located in
      Fredericksburg, Virginia - one office with 1,200 square feet, with a two-year
      lease that expires on October 31, 2006, and one with 4,200 square feet, with
      a
      three-year lease that expires on June 30, 2007. Monthly lease amounts for these
      facilities total approximately $36,600.




Genex
      leases office space under the terms of a non-cancelable operating lease that
      expires in January 2006. The office space lease provides for annual increases
      of
      3% to the base rent and requires Genex to reimburse the landlord for its pro
      rata share of the increases in annual operating expenses and real estate taxes.
      Monthly lease amounts for this facility total approximately $10,100. Genex
      has
      entered into a five-year lease for approximately 6,800 square feet in Bethesda,
      Maryland with a monthly lease amount of approximately $14,250.




Rent
      expense for the six months ended December 31, 2005 was $294,798.







29




Legal




H&H
      Acquisition Corp.




On
      July
      23, 1998, H & H Acquisition Corp., individually and purportedly on behalf of
      Technest, commenced an action in federal court in the Southern District of
      New
      York against Technest, the founder and certain officers, among others. The
      complaint is an action to recover shares of common stock of Technest and
      unspecified damages. Management believes that the claims against Technest and
      certain officers are without merit and is vigorously defending the action.
      Technest cannot make any assurances about the litigation's outcome. However,
      Technest could be adversely affected if the plaintiff prevails.




In
      September 2002 Technest was served with a Summary Judgment Motion regarding
      H
& H Acquisition Corp. and Technest answered the motion in November 2002. On
      January 3, 2005, the court denied the motion for summary judgment. On November
      23, 2005 Technest was informed that the trial date of this matter, which had
      been scheduled to begin on January 4, 2006, had been postponed. As of February
      9, 2006, Technest has not been informed of a new date for the beginning of
      the
      trial.




Joseph
      R. Moulton




On
      or
      about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the
      Circuit Court of Spotsylvania County, Virginia, against Markland, EOIR, and
      our
      Chief Executive Officer and Director, Robert Tarini, in his capacity as
      Markland’s Chief Executive Officer. Mr. Moulton was the largest single
      shareholder of EOIR prior to its acquisition by Markland, owning approximately
      67% of the EOIR capital stock. Mr. Moulton received approximately $5,863,000
      in
      cash and a promissory note of EOIR in the approximate principal amount of
      $6,967,000 for his shares of EOIR at the closing of the acquisition of EOIR
      by
      Markland.




In
      his
      complaint Mr. Moulton asserts, among other things, that Markland and EOIR
      breached their obligations under the stock purchase agreement, dated June 30,
      2004, pursuant to which Markland acquired EOIR, by terminating Mr. Moulton's
      employment with EOIR and removing him from the EOIR board of
      directors.




Mr.
      Moulton is seeking damages allegedly suffered by his loss of employment, extreme
      emotional distress, and costs incurred to enforce his contractual rights. In
      addition, he is seeking some other equitable relief including, the appointment
      of a receiver to oversee the management of EOIR until the promissory notes
      issued to former EOIR shareholders at the closing of the acquisition are paid
      in
      full and a declaratory judgment that Markland and EOIR's actions constitute
      an
      event of default under these promissory notes allowing for the acceleration
      of
      all amounts due thereunder. As Mr. Moulton is suing in his personal capacity
      rather than as a representative of the former EOIR shareholders, he is asking
      the court to accelerate the payment of the outstanding principal amount of
      his
      note, which as of February 9, 2006, was $5,300,000. Markland is a guarantor
      of
      these notes.




Markland
      and EOIR believe that the allegations in this lawsuit are entirely without
      merit. Markland and EOIR have filed an answer denying Mr. Moulton's allegations
      and opposing vigorously all equitable relief sought. Markland and EOIR have
      also
      filed a counterclaim against Mr. Moulton seeking damages resulting from alleged
      misconduct and misrepresentations on the part of Mr. Moulton related to EOIR’s
      relationship with certain banks.




On
      April
      4, 2005 a hearing was held in the Spotsylvania County Circuit Court on Markland
      and EOIR's demurrer to certain claims brought by Mr. Moulton. As a result of
      that hearing, the claim by Mr. Moulton that his employment was terminated in
      violation of public policy was dismissed by the court, and the Court dismissed
      those aspects of Mr. Moulton's complaint suggesting that he was pursuing his
      claims on behalf of other unnamed sellers of EOIR shares. Mr. Moulton was not
      given leave to amend or refile these claims.




On
      December 16, 2005, the start of the trial of this matter was continued from
      January 17, 2006 to September 5, 2006. In addition on that day, Mr. Moulton
      was
      permitted by the Court to amend his complaint to add an additional cause of
      action.




On
      February 3, 2006, a hearing was held in the Spotsylvania County Circuit Court
      on
      Markland and EOIR’s demurrer to certain claims brought by Mr. Moulton. As a
      result of that hearing, Mr. Moulton’s cause of action that alleging breach of an
      employment contract by EOIR was dismissed with prejudice by the
      Court.









30







Greg
      & Mary Williams




Markland
      and EOIR were notified on July 11, 2005 by counsel for Greg and Mary Williams,
      former shareholders and employees of EOIR and, in the case of Mr. Williams,
      a
      former director of Markland, that the Williams’ filed a lawsuit in the
      Commonwealth of Virginia, naming EOIR and Markland as defendants, regarding
      a
      number of contractual disputes involving the registration of shares of Markland
      common stock underlying certain options issued to the Williams’ in connection
      with the acquisition of EOIR by Markland and severance payments called for
      pursuant to severance agreements by and among the Williams’, EOIR and Markland.
      On August 3, 2005, EOIR and Markland filed an answer and a demurrer denying
      all
      liability.




**Off
      Balance Sheet Arrangements**




We
      have a
      letter of credit in the amount of $250,000 issued in favor of a bank in
      conjunction with our corporate credit cards. Other than this letter of credit,
      we have no other 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.
      Technest has warrants outstanding for the purchase of 489,228 shares of common
      stock. However, due to the net share settlement provisions of these warrants,
      Technest does not expect any material cash proceeds upon exercise.




**Effect
      of inflation and changes in prices**




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




**CRITICAL
      ACCOUNTING POLICIES**




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




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




**PRINCIPLES
      OF CONSOLIDATION**




Our
      consolidated financial statements as of December 31, 2005 include the accounts
      of Technest, and our wholly-owned subsidiaries- Genex and EOIR. We have
      eliminated all significant inter-company balances and transactions.




**CONCENTRATIONS**




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




As
      of
      December 31, 2005, we had 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.






31




**RESEARCH
      AND DEVELOPMENT**




We
      charge
      research and development costs to expense as incurred. We capitalize costs
      related to acquired technologies that have achieved technological feasibility
      and have alternative uses. We expense as research and development costs the
      technologies we acquire if they are in process at the date of acquisition or
      have no alternative uses.




No
      new
      technologies were acquired during the six months ended December 31, 2005 and
      as
      such there are no capitalized or expensed in-process research and development
      costs during this period relating thereto. During the year ended June 30, 2005
      we had, however, acquired in-process technology as a part of our acquisition
      of
      Genex. These technologies had neither achieved technological feasibility nor
      had
      alternative uses and as such the research and development costs of $ 2,095,000
      were expensed in the year ended June 30, 2005.




The
      amount recorded as expense for in-process research and development (IPR&D)
      was arrived at by management after considering a number of factors, including
      an
      independent valuation by a leading valuation and financial advisory firm serving
      the business, legal and financial communities throughout New England. For this
      purpose, the various research and development projects were identified and
      the
      Income, Expenses and the resulting Net Income from the identified projects
      was
      projected for five fiscal years from 2006 to 2010. Given the nature of the
      technology embodied in the IPR&D and the potential for technological
      obsolescence, a projection period of five years was deemed appropriate. Charges
      for use of contributory assets, including working capital, fixed assets and
      assembled workforce, were applied as a reduction to net income. The resultant
      economic income was discounted at 24% to arrive at the cumulative present value.




**IMPAIRMENT
      OF GOODWILL AND AMORTIZABLE INTANGIBLES**




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




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




**ESTIMATED
      USEFUL LIVES OF AMORTIZABLE INTANGIBLE ASSETS**




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




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




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




Contracts
      and Customer relationships acquired as a result of business combinations (see
      Note 3) have been valued by management considering various factors including
      independent appraisals done by valuation and financial advisory firms in
      accordance with SFAS No. 141, “Business Combinations”, SFAS No. 142, “Goodwill
      and Other Intangible Assets”, FASB Concepts Statement Number 7 and EITF Issue
      No. 02-17, “Recognition of Customer Relationship Assets Acquired in a Business
      Combination”. These assets are being amortized over the contractual terms of the
      existing contracts plus anticipated contract renewals in accordance with EITF
      Issue No. 02-17.






32




**IMPAIRMENT
      OF LONG-LIVED ASSETS**




Pursuant
      to SFAS No. 144, we continually monitor events and changes in circumstances
      that
      could indicate carrying amounts of long-lived assets may not be recoverable.
      We
      recognize an impairment loss when the carrying value of an asset exceeds
      expected cash flows. Accordingly, when indicators or impairment of assets are
      present, we evaluate the carrying value of such assets in relation to the
      operating performance and future undiscounted cash flows of the underlying
      business. Our policy is to record an impairment loss when we determine that
      the
      carrying amount of the asset may not be recoverable. No impairment charges
      were
      recorded in the six months ended December 31, 2005 and 2004.




**REVENUE
      RECOGNITION**




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




Revenues
      from time and materials contracts are recognized as costs are incurred. Revenues
      from firm fixed price contracts are recognized on the percentage-of-completion
      method, either measured based on the proportion of costs recorded to date on
      the
      contract to total estimated contract costs or measured based on the proportion
      of labor hours expended to date on the contract to total estimated contract
      labor hours, as specified in the contract. However, during the six months ended
      June 30, 2005 less than 2% of Technest’s revenue has come from firm fixed price
      contracts.




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




**IMPACT
      OF RECENTLY ISSUED ACCOUNTING STANDARDS**




In
      December 2004, the FASB issued SFAS No. 123(R) (revised 2004), Share-Based
      Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based
      Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for
      Stock Issued to Employees, and Amends SFAS No. 95, Statement of Cash Flows.
      Generally, the approach in SFAS No. 123(R) is similar to the approach described
      in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments
      to
      employees, including grants of employee stock options, to be recognized in
      the
      income statement based on their fair values. Pro forma disclosure is not an
      alternative. SFAS No. 123(R) must be adopted no later than the first interim
      period for fiscal years beginning after December 15, 2005. We expect to adopt
      SFAS No. 123(R) on July 1, 2006.




SFAS
      No.
      123(R) permits public companies to adopt its requirements using one of two
      methods: a “modified prospective” approach or a “modified retrospective”
approach. Under the modified prospective approach, compensation cost is
      recognized beginning with the effective date based on the requirements of SFAS
      123(R) for all share-based payments granted after the effective date and the
      requirements of SFAS No. 123(R) for all awards granted to employees prior to
      the
      effective date of SFAS No. 123(R) that remain unvested on the effective date.
      The modified retrospective approach includes the requirements of the modified
      prospective approach but also permits entities to restate based on the amounts
      previously recognized under SFAS No. 123 for purposes of pro forma disclosures
      either for all prior periods presented or prior interim periods of the year
      of
      adoption. We are evaluating which method to adopt.




As
      permitted by SFAS No. 123, we currently account for the share-based payments
      to
      employees using APB Opinion No. 25’s intrinsic value method and, as such,
      generally recognize no compensation cost for employee stock options. However,
      grants of stock to employees have always been recorded at fair value as required
      under existing accounting standards. We expect the adoption of SFAS No. 123(R)
      to have a material effect on its results of operations. Additionally, Our
      results of operations could be materially effected by share-based payments
      issued after the adoption of SFAS 123(R). The impact of the adoption of SFAS
      No.
      123(R) cannot be predicted at this time because it will depend on levels of
      share-based payments granted in the future. However, had we adopted SFAS No.
      123(R) in prior periods, the impact of that standard would have approximated
      the
      impact of SFAS No. 123 as described in Note 2 to our financial statements.




SFAS
      No.
      123(R) also requires the benefits of tax deductions in excess of recognized
      compensation cost to be reported as a financing cash flow, rather than an
      operating cash flow under current accounting literature. Since we do not have
      the benefit of tax deductions in excess of recognized compensation cost, because
      of our net operating loss position, the change will have no immediate impact
      on
      our consolidated financial statements.




33




**RISK
      FACTORS**




*Any
      investment in our common stock involves a high degree of risk. You should
      consider carefully the risks and uncertainties described below, and all other
      information contained in this report, before you decide whether to purchase
      our
      common stock. Additional risks and uncertainties not currently known to us
      or
      that we currently deem immaterial may also become important factors that may
      harm our business. The occurrence of any of the following risks could harm
      our
      business. 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.
      In addition, our future operating results could differ materially from the
      results described in this report due to the risks and uncertainties related
      to
      our business, including those discussed below.*




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




**We
      have no operating history on which investors may evaluate our operations and
      prospects for profitable operations and ability to produce a return on Genex
      or
      EOIR.**




Technest
      does not have operating history on which a potential investor may base an
      evaluation of us nor of our prospects and ability to operate Genex or EOIR
      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 December
      31,
      2005, our accumulated deficit was $5,569,990. 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. We reported
      net
      losses applicable to our common stockholders of $1,796,653 for the six months
      ended December 31, 2005 and $4,903,487 for the fiscal year ended June 30, 2005
      before our acquisition of EOIR. 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 would render us unable to possibly 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.




Although
      we have been successful in the past in obtaining financing for working capital
      and acquisitions, 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.




**We
      have grown quickly; if we cannot effectively manage our growth, our business
      may
      suffer.**




We
      have
      rapidly and significantly expanded operations through the acquisitions of EOIR
      in August 2005 and Genex in February 2005.  This growth has placed, and is
      expected to continue to place, a strain on our personnel, management, financial
      and other resources.  Some of our officers have no prior senior management
      experience at public companies.  Our new employees include a number of key
      managerial, technical and operations personnel who have not yet been fully
      integrated into our operations. To manage our growth effectively, we must,
      among
      other things:




·
            upgrade
                and expand our contract support, manufacturing facilities and capacity
                in
                a timely manner;






34




·
            successfully
                attract, train, motivate and manage a larger number of employees
                for
                contract support, manufacturing, sales and customer support
                activities;




·
            control
                higher inventory and working capital requirements;
                and




·
            improve
                the efficiencies within our operating, administrative, financial
                and
                accounting systems, procedures and
                controls.




To
      meet
      our growth objectives, we must attract and retain highly skilled technical,
      operational, managerial and sales and marketing personnel.  If we fail to
      attract and retain the necessary personnel, we may be unable to achieve our
      business objectives and may lose our competitive position, which could lead
      to a
      significant decline in net sales.  We face significant competition for
      these skilled professionals from other companies, research and academic
      institutions, government entities and other organizations.




If
      we
      fail to manage our growth properly, we may incur unnecessary expenses and the
      efficiency of our operations may decline, adversely affecting our business
      and
      the price of our stock.




**Future
      acquisitions of other companies, if any, may disrupt our business and additional
      expenses. As a result, our business could suffer.**




We
      have
      completed the acquisitions of EOIR and Genex.  We plan to review potential
      acquisition candidates, and our business and our strategy may include building
      our business through acquisitions. However, acceptable acquisition candidates
      may not be available in the future or may not be available on terms and
      conditions acceptable to us.




Acquisitions
      involve numerous risks including among others, difficulties and expenses
      incurred in the consummation of acquisitions and assimilations of the
      operations, personnel, and services and products of the acquired companies.
      Additional risks associated with acquisitions include the difficulties of
      operating new businesses, the diversion of management's attention from other
      business concerns and the potential loss of key employees of the acquired
      company. If we do not successfully integrate the businesses we may acquire
      in
      the future, our business will suffer.




**If
      we fail to realize some or all of the anticipated benefits from our acquisition
      of EOIR, our business will suffer.**




Our
      combined company may fail to realize some or all of the anticipated benefits
      and
      synergies of the transaction as a result of, among other things, lower than
      expected order rates from customers of EOIR, unanticipated costs, deterioration
      in the U.S. economy and other factors. There can be no assurance that we will
      receive new orders under EOIR’s existing contract with the United States Army
      Night Vision and Electronic Sensors Directorate.




**Some
      of our competitors are much larger than we are, have better name recognition
      than we do and have far greater financial and other resources than we do. If
      we
      cannot effectively compete, our business may suffer and the price of our stock
      would decrease.**




With
      the
      U.S. government's large appropriation of money for homeland security programs,
      many companies are competing for the same homeland security contracts and there
      can be no assurance that Technest will effectively compete with large companies
      who have more resources and funds than we do. Several companies have been
      working on issues relevant to the safety of the American people for the past
      several years. Because of the services and additional human and financial
      resources that these larger companies can provide, they may be more attractive
      to the U.S. Government. Lockheed Martin and Northrop Grumman are providers
      of
      hardware engineering and systems engineering solutions. Computer Sciences
      Corporation and EDS provide computer and computer software solutions. Defense
      companies, such as General Dynamics, Boeing and Raytheon, are solutions
      providers that could easily expand their businesses into the homeland security
      business and are currently allocating resources to develop programs in this
      area.




**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.






35




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




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




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




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




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




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




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




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




·
            timing
                of orders from our largest customers - the DOD, Homeland Security,
                various
                INTEL and the United States Night Vision and Electronic Sensors
                Directorate;




·
            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.




36


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 and future expected revenues are derived from a small number of
      customers within the U.S. government such that the loss of any one ultimate
      customer could materially reduce our revenues. As a result, our financial
      condition and our stock price would be adversely affected.**




We
      currently derived substantially all of our revenue from contracts with the
      U.S.
      Government, including the DOD, Homeland Security and various INTEL within the
      U.S. Government. We have a contract with the United States Army Night Vision
      and
      Electronic Sensors Directorate that may provide for revenues of up to
      approximately $406 million depending upon the U.S. Army's needs of which our
      subsidiary, EOIR, recognized in excess of approximately $56.2 million in
      revenues for the year ended June 30, 2005.  For the six months ended
      December 31, 2006, we recognized $31.5 million in revenues under this contract.
      We expect this contract to account for a substantial portion of our revenues
      going forward.




The
      loss
      of this customer due to cutbacks, competition, or other reasons would materially
      reduce our revenue base. Annual or quarterly losses may occur if there are
      material gaps or delays in orders from one of our largest customers that are
      not
      replaced by other orders or other sources of income.




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




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




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




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




·
            contain
                onerous procurement procedures; and




·
            be
                subject to cancellation if government funding becomes
                unavailable.




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




37


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




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




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




**Our
      Government contracts may be terminated by the government at any time and may
      contain other provisions permitting the government not to continue with contract
      performance. If lost contracts are not replaced, our operating results may
      differ materially from those anticipated.**




We
      derive
      substantially all of our revenue from Government contracts that typically span
      one or more base years and one or more option years. The option periods
      typically cover more than half of the contract’s potential duration. Government
      agencies generally have the right not to exercise these option periods. In
      addition, our contracts typically also contain provisions permitting a
      government client to terminate the contract for its convenience. A decision
      not
      to exercise option periods or to terminate contracts could result in significant
      revenue shortfalls from those anticipated.




**We
      derive significant revenue from contracts and task orders awarded through a
      competitive bidding process. If we are unable to consistently win new awards
      over any extended period, our business and prospects will be adversely affected.**




Substantially
      all of our contracts and task orders with the Government are awarded through
      a
      competitive bidding process. We expect that much of the business that we will
      seek in the foreseeable future will continue to be awarded through competitive
      bidding. Budgetary pressures and changes in the procurement process have caused
      many Government clients to increasingly purchase goods and services through
      indefinite delivery/indefinite quantity, or ID/IQ, contracts, GSA schedule
      contracts and other government-wide acquisition contracts. These contracts,
      some
      of which are awarded to multiple contractors, have increased competition and
      pricing pressure, requiring that we make sustained post-award efforts to realize
      revenue under each such contract. In addition, in consideration of recent
      publicity regarding the practice of agencies awarding work under such contracts
      that is arguably outside their intended scope, both the GSA and the DOD have
      initiated programs aimed to ensure that all work fits properly within the scope
      of the contract under which it is awarded. The net effect of such programs
      may
      reduce the number of bidding opportunities available to us. Moreover, even
      if we
      are highly qualified to work on a particular new contract, we might not be
      awarded business because of the Government’s policy and practice of maintaining
      a diverse contracting base.




The
      competitive bidding process presents a number of risks, including the following:




·
            
            we
                bid on programs before the completion of their design, which may
                result in
                unforeseen technological difficulties and cost overruns;




·
            
            we
                expend substantial cost and managerial time and effort to prepare
                bids and
                proposals for contracts that we may not win;




·
            
            we
                may be unable to estimate accurately the resources and cost structure
                that
                will be required to service any contract we win; and




·
            
            we
                may encounter expense and delay if our competitors protest or challenge
                awards of contracts to us in competitive bidding, and any such protest
                or
                challenge could result in the resubmission of bids on modified
                specifications, or in the termination, reduction or modification
                of the
                awarded contract.




If
      we are
      unable to win particular contracts, we may be foreclosed from providing to
      clients services that are purchased under those contracts for a number of years.
      If we are unable to consistently win new contract awards over any extended
      period, our business and prospects will be adversely affected and that could
      cause our actual results to differ materially from those anticipated. In
      addition, upon the expiration of a contract, if the client requires further
      services of the type provided by the contract, there is frequently a competitive
      re-bidding process. There can be no assurance that we will win any particular
      bid, or that we will be able to replace business lost upon expiration or
      completion of a contract, and the termination or non-renewal of any of our
      significant contracts could cause our actual results to differ materially from
      those anticipated.






38




**Our
      business may suffer if we or our employees are unable to obtain the security
      clearances or other qualifications we and they need to perform services for
      our
      clients.**




Many
      of
      our Government contracts require us to have security clearances and employ
      personnel with specified levels of education, work experience and security
      clearances. High-level security clearances can be difficult and time-consuming
      to obtain. If we or our employees lose or are unable to obtain necessary
      security clearances, we may not be able to win new business and our existing
      clients could terminate their contracts with us or decide not to renew them.
      To
      the extent we cannot obtain or maintain the required security clearances for
      our
      employees working on a particular contract, we may not derive the revenue
      anticipated from the contract, which could cause our results to differ
      materially from those anticipated.




**The
      Government may change its procurement or other practices in a manner adverse
      to
      us.**




The
      Government may change its procurement practices or adopt new contracting rules
      and regulations, such as cost accounting standards. It could also adopt new
      contracting methods relating to GSA contracts or other government-wide
      acquisition contracts, or adopt new socio-economic requirements. These changes
      could impair our ability to obtain new contracts or win re-competed contracts.
      New contracting requirements could be costly or administratively difficult
      for
      us to satisfy, and, as a result could cause actual results to differ materially
      from those anticipated.




**Restrictions
      on or other changes to the Government’s use of service contracts may harm our
      operating results.**




We
      derive
      a significant amount of revenue from service contracts with the Government.
      The
      Government may face restrictions from new legislation, regulations or union
      pressures, on the nature and amount of services the Government may obtain from
      private contractors. Any reduction in the Government’s use of private
      contractors to provide services could cause our actual results to differ
      materially from those anticipated.




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




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





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




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






39




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




**Employee
      misconduct, including security breaches, could result in the loss of clients
      and
      our suspension or disbarment from contracting with the Government.**




We
      may be
      unable to prevent our employees from engaging in misconduct, fraud or other
      improper activities that could adversely affect our business and reputation.
      Misconduct could include the failure to comply with procurement regulations,
      regulations regarding the protection of classified information and legislation
      regarding the pricing of labor and other costs in government contracts. Many
      of
      the systems we develop involve managing and protecting information involved
      in
      national security and other sensitive functions. A security breach in one of
      these systems could prevent us from having access to such critically sensitive
      systems. Other examples of employee misconduct could include time card fraud
      and
      violations of the Anti-Kickback Act. The precautions we take to prevent and
      detect this activity may not be effective, and we could face unknown risks
      or
      losses. As a result of employee misconduct, we could face fines and penalties,
      loss of security clearance and suspension or debarment from contracting with
      the
      Government, which could cause our actual results to differ materially from
      those
      anticipated.





**If
      our subcontractors or vendors fail to perform their contractual obligations,
      our
      performance as a prime contractor and our ability to obtain future business
      could be materially and adversely impacted and our actual results could differ
      materially from those anticipated.**




Our
      performance of Government contracts may involve the issuance of subcontracts
      or
      purchase orders to other companies upon which we rely to perform all or a
      portion of the work we are obligated to deliver to our clients. A failure by
      one
      or more of our subcontractors or vendors to satisfactorily deliver on a timely
      basis the agreed-upon supplies and/or perform the agreed-upon services may
      materially and adversely impact our ability to perform our obligations as a
      prime contractor.




A
      performance deficiency by a subcontractor or a vendor could result in the
      Government terminating our contract for default. A default termination could
      expose us to liability for excess costs of re-procurement by the Government
      and
      have a material adverse effect on our ability to compete for future contracts
      and task orders.




Depending
      upon the level of problem experienced, such problems with subcontractors could
      cause our actual results to differ materially from those anticipated.




**Risks
      Related To “Controlled Companies”**




**We
      are a majority owned subsidiary of Markland. As a result, the ability of
      minority shareholders to influence our affairs is extremely
      limited.**




As
      of
      February 10, 2006, Markland controlled approximately 90% of outstanding Technest
      common stock on a primary basis.  As a result, Markland has the ability to
      control all matters submitted to the stockholders of Technest for approval
      (including the election and removal of directors) and to control Technest’s
      management and affairs.




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 long as Markland or any other party retains a controlling
      interest.




**Technest’s
      executive officers and directors currently do not spend full time operating
      our
      business, thereby potentially delaying the development of Technest’s business.**




Technest’s
      Chief Executive Officer, President, Chief Financial Officer and both of its
      directors are also officers and directors of other companies, including
      Markland.  As a result, they may not be able to devote their full time to
      Technest. As a result of their participation in business activities of other
      companies, their limited attention to Technest may delay the development of
      Technest’s **** business.







40




**Robert
      Tarini is the Chief Executive Officer and Chairman of the Board of Directors
      of
      Technest and Markland.  In addition, Mr. Tarini, has an investment in
      Technest. Dr. Mackin and Mr. Pereira also serve as directors and officers of
      Technest and Markland. Conflicts of interest could arise as a result of these
      overlapping positions.**




Technest
      and Markland share similar investment objectives and policies. However,
      potential conflicts of interest may occur should these investment objectives
      diverge.




Technest’s
      shares that are owned by Markland are available to settle various claims and
      liabilities that Markland has.




There
      may
      be instances where the business of these companies overlap or compete although
      they currently do not do so.




Mr.
      Tarini, Dr. Mackin and Mr. Pereira may disproportionately allocate time and
      resources between these other entities and us. Neither our organizational
      documents nor our policies specify a minimum standard of time and attention
      that
      these officers and directors are required to devote to us. However, we do not
      believe that having the same board of directors will present a conflict of
      interest. There can be no assurances that there will be no conflicts of
      interest. The board will endeavor to act in the best interests of each company.
      Technest intends to have a board of directors in which the majority of board
      members are independent of Technest and Markland management.




In
      addition, Mr. Tarini, through his wholly-owned company ipPartners, Inc., is
      one
      of the investors that participated in the Genex transactions. On February 14,
      2005, ipPartners, Inc. received 143,678 shares of Technest Series B preferred
      stock, 143,678 shares of Technest Series C preferred stock convertible into
      143,678 shares of Technest common stock and warrants to purchase 143,678
      Technest common stock in exchange for $625,000.  On June 20, 2005,
      ipPartners, Inc. exchanged all of its Technest Series B preferred stock for
      625
      shares of Markland Series D preferred stock. On August 23, 2005, ipPartners
      converted its 625 shares of Markland Series D preferred stock into 6,510,417
      shares of Markland common stock. The resale of these shares of common stock
      were
      registered pursuant to a Markland registration statement on Form SB-2 that
      was
      effective on August 10, 2005.




**Risks
      Related To Capital Structure**




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




Pursuant
      to the terms of the Merger Agreement and the Registration Rights Agreements
      executed on February 14, 2005, Technest is obligated to file registration
      statements with the Securities and Exchange Commission within 75 to 105 days
      from February 14, 2005. As of February 10, 2006, we have filed one registration
      statement which has not yet been declared effective by the Securities and
      Exchange Commission. Our common stock is thinly traded.  The market may not
      be able to absorb all of the shares that we have registered and are obligated
      to
      register for resale.  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 registered 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.




**Technest
      does not foresee paying cash dividends in the foreseeable
      future.**




Technest
      has not paid cash dividends on our stock and does not plan to pay cash dividends
      on our stock in the foreseeable future.




41


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




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




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




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




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




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




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




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




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




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




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




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




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




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




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




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




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




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.






42




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 2003 to February 10, 2006, the trading
      price of our common stock ranged from a low price of $0.02 per share to a high
      price of $63.29 per share. Many factors may cause the market price of our common
      stock to fluctuate, including:




·
            variations
                in our quarterly results of
                operations;




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




·
            acquisitions
                or strategic alliances involving us or our
                competitors;




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




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




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




**Risks
      Related to the Homeland Security and Defense Industries**




**The
      homeland security and defense industries are characterized by rapid
      technological change and evolving industry standards, and unless we keep pace
      with the changing technologies, we could lose customers and fail to win new
      customers.**




Our
      future success will depend, in part, upon our ability to develop and introduce
      a
      variety of new products and services and enhancements to these new product
      and
      services in order to address the changing and sophisticated needs of the
      homeland security marketplace. Delays in introducing new products, services
      and
      enhancements, the failure to choose correctly among technical alternatives
      or
      the failure to offer innovative products and services at competitive prices
      may
      cause customers to forego purchases of our products and services and purchase
      those of our competitors. Frequently, technical development programs in the
      homeland security industry require assessments to be made of the future
      directions of technology and technology markets generally, which are inherently
      risky and difficult to predict.




**We
      face intense competition, which could result in lower revenues and higher
      research and development expenditures and could adversely affect our results
      of
      operations.**




Current
      political tensions throughout the world have heightened interest in the homeland
      security industry, and we expect competition in this field, which is already
      substantial, to intensify. If we do not develop new and enhanced products,
      or if
      we are not able to invest adequately in our research and development activities,
      our business, financial condition and results of operations could be negatively
      impacted. Many of our competitors have significantly more cash and resources
      than we have. Our competitors may introduce products that are competitively
      priced, have increased performance or functionality, or incorporate
      technological advances that we have not yet developed or implemented. To remain
      competitive, we must continue to develop, market and sell new and enhanced
      systems and products at competitive prices, which will require significant
      research and development expenditures.






43




We
      cannot
      assure you that we will be able to compete successfully against current and
      future competitors.




**Risks
      Relating to New Corporate Governance Standards**




**We
      are not subject to the same corporate governance standards as listed companies.
      This may affect market confidence and company performance. As a result, our
      business could be harmed and the price of our stock could
      decrease.**




Registered
      exchanges and the Nasdaq National Market have adopted enhanced corporate
      governance requirements that apply to issuers that list their securities on
      those markets. These standards deal with the rights and responsibilities of
      a
      company's management, its board, shareholders and various stakeholders. How
      well
      companies are run may affect market confidence as well as company performance.
      Our common stock is quoted on the OTC Bulletin Board, which does not have
      comparable requirements. As a result, our business and the price of our stock
      may be adversely affected.




For
      instance, we are not required to have any independent directors and we do not
      have independent directors. Therefore management has significant influence
      over
      decisions made by the Board on behalf of the stockholders.




In
      some
      circumstances, management may not have the same interests as the shareholders
      and conflicts of interest may arise. We do not have a policy to resolve
      conflicts of interest and we are not required to have one. Notwithstanding
      the
      exercise of their fiduciary duties as directors and executive officers and
      any
      other duties that they may have to us or our other stockholders in general,
      these persons may have interests different than yours.




**Our
      administrative costs and expenses resulting from new regulations have increased,
      adversely affecting our financial condition and results of
      operations.**




We
      face
      new corporate governance requirements under the Sarbanes-Oxley Act of 2002
      and
      SEC rules adopted there under. These regulations increased our legal and
      financial compliance and made some activities more difficult, time-consuming
      and
      costly. Our expenses will continue to increase as we continue to implement
      these
      new regulations.




**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
      will make it more difficult and more expensive for us to obtain director and
      officer liability insurance. We may be required to accept reduced coverage
      or
      incur significantly higher costs to obtain 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.




44


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




Rules
      adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002
      require annual assessment of our internal control over financial reporting,
      and
      attestation of this assessment by our independent registered public accountant.
      We expect that this requirement will first apply to our annual report for the
      fiscal year ending June 30, 2007. The standards that must be met for management
      to assess the effectiveness of the internal control over financial reporting
      are
      new and complex, and require significant documentation, testing and possible
      remediation to meet the detailed standards. We may encounter problems or delays
      in completing activities necessary to make an assessment of its internal control
      over financial reporting. In addition, we may encounter problems or delays
      in
      completing the implementation of any requested improvements and receiving an
      attestation of its assessment by our independent registered public accountants.
      If management cannot assess our internal control over financial reporting as
      effective, or our independent registered public accounting firm is unable to
      issue an unqualified attestation report on such assessment, investor confidence
      and share value may be negatively impacted.









45


**Item
      3. Controls and Procedures**




**Evaluation
      of Disclosure Controls and Procedures.**




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




**Changes
      in Internal Control Over Financial Reporting.**




Our
      internal control over financial reporting during the six months ended December
      31, 2005 has materially changed with the acquisition of Technest by Markland
      and
      the acquisition of Genex and EOIR by Technest. We have integrated the accounting
      and controls for these companies into our group accounting function at EOIR
      in
      Virginia. The larger scale of this operation allows for more timely recording
      of
      transactions and greater separation of duties than would otherwise be possible.
      It should be noted that any system of controls, however well designed and
      operated, can provide only reasonable, and not absolute, assurance that the
      objectives of the system are met. In addition, the design of any control system
      is based in part upon certain assumptions about the likelihood of future events.
      Because of these and other inherent limitations of control systems, there can
      be
      no assurance that any design will succeed in achieving its stated goals under
      all potential future conditions, regardless of how remote.









46


**PART
      II.**  **OTHER
      INFORMATION**




**ITEM
      1. Legal Proceedings.**




*Technest
      Holdings, Inc.*




On
      or
      about July 23, 1998, H & H Acquisition Corporation, individually and
      purportedly on behalf of Technest, commenced an action in United States District
      Court, Southern District of New York entitled H & H Acquisition Corp.,
      individually and on behalf of Technest v. Financial Intranet Holdings, Inc.
      Technest, 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 Judge is Judge Barbara S.
      Jones. The action’s principal basis appears to be plaintiff’s claim that Ben
      Stein wrongfully claims ownership of shares of common stock that Stein agreed
      to
      purchase from plaintiff. According to plaintiff, these shares belong to the
      plaintiff. The plaintiff asserts sixteen causes of action. Only some make
      allegations against Technest, Michael Sheppard and Maura Marx, former officers.
      The plaintiff alleges:




·
            that
                Mr. Sheppard and Ms. Marx assisted defendants Stein and Financial
                Intranet
                Holdings (a company owned by Mr. Stein) in converting stock which
                plaintiff allegedly owns. Plaintiff seeks damages allegedly sustained
                because of the alleged conversion.




·
            that
                Mr. Sheppard and Ms. Marx assisted in defrauding plaintiff with respect
                to
                the stock plaintiff claims. Plaintiff seeks damages allegedly sustained
                because of the alleged fraud.




·
            in
                a derivative claim, purportedly on behalf of Technest, that Mr. Sheppard
                and Ms. Marx permitted issuance of shares to defendant Gotshalk without
                proper consideration and at a price lower than that offered to a
                company
                introduced by Plaintiff; that they refused to allow plaintiff to
                purchase
                additional shares; that Mr. Sheppard and Ms. Marx permitted Technest
                to
                pay defendant Schwartz monies which should not have been paid, and
                authorized issuance of stock to Schwartz without proper authority;
                and
                that Mr. Sheppard and Ms. Marx caused the issuance of stock to themselves
                without proper authority. Plaintiff seeks damages allegedly sustained
                for
                these alleged wrongful acts.




·
            in
                a derivative claim, purportedly on behalf of Technest, that actions
                taken
                at a December 1998 shareholders meeting were improper. The plaintiff
                seeks
                an order directing the rescission of actions determined by the Court
                or
                its designee.




·
            that
                Technest and its former transfer agent wrongfully transferred shares
                belonging to plaintiff to a third party. The transfer agent has asserted
                a
                claim against us seeking indemnification for any liabilities incurred
                by
                the transfer agent in this action.




Plaintiff
      also seeks an accounting from Mr. Sheppard, among other defendants, for damages
      Technest allegedly suffered.




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. If the plaintiff prevails
      against us, we could be adversely affected.




On
      November 23, 2005 Technest was informed that the trial date of this matter,
      which had been scheduled to begin on January 4, 2006, had been postponed. As
      of
      February 9, 2006, Technest has not been informed of a new date for the beginning
      of the trial.




*EOIR
      Technologies, Inc.*




On
      or
      about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the
      Circuit Court of Spotsylvania County, Virginia, against Markland, EOIR, and
      our
      Chief Executive Officer and Director, Robert Tarini, in his capacity as
      Markland’s Chief Executive Officer. Mr. Moulton was the largest single
      shareholder of EOIR prior to its acquisition by Markland, owning approximately
      67% of the EOIR capital stock. Mr. Moulton received approximately $5,863,000
      in
      cash and a promissory note of EOIR in the approximate principal amount of
      $6,967,000 for his shares of EOIR at the closing of the acquisition of EOIR
      by
      Markland.






47




In
      his
      complaint Mr. Moulton asserts, among other things, that Markland and EOIR
      breached their obligations under the Stock Purchase Agreement, dated June 30,
      2004, pursuant to which Markland acquired EOIR, by terminating Mr. Moulton's
      employment with EOIR and removing him from the EOIR board of
      directors.




Mr.
      Moulton is seeking damages allegedly suffered by his loss of employment, extreme
      emotional distress, and costs incurred to enforce his contractual rights. In
      addition, he is seeking some other equitable relief including, the appointment
      of a receiver to oversee the management of EOIR until these promissory notes
      issued to former EOIR shareholders at the closing of the acquisition are paid
      in
      full and a declaratory judgment that Markland and EOIR's actions constitute
      an
      event of default under these promissory notes allowing for the acceleration
      of
      all amounts due thereunder. As Mr. Moulton is suing in his personal capacity
      rather than as a representative of the former EOIR shareholders, he is asking
      the court to accelerate the payment of the outstanding principal amount of
      his
      note, which as of February 9, 2006, was $5,300,000. Markland is a guarantor
      of
      these notes.




Markland
      and EOIR believe that the allegations in this lawsuit are entirely without
      merit. Markland and EOIR have filed an answer denying Mr. Moulton's allegations
      and opposing vigorously all equitable relief sought. Markland and EOIR have
      also
      filed a counterclaim against Mr. Moulton seeking damages resulting from alleged
      misconduct and misrepresentations on the part of Mr. Moulton related to EOIR’s
      relationship with certain banks.




On
      December 16, 2005, the start of the trial of this matter was continued from
      January 17, 2006 to September 5, 2006. In addition on that day, Mr. Moulton
      was
      permitted by the Court to amend his complaint to add an additional cause of
      action.




On
      February 3, 2006, a hearing was held in the Spotsylvania County Circuit Court
      on
      Markland and EOIR’s demurrer to certain claims brought by Mr. Moulton. As a
      result of that hearing, Mr. Moulton’s cause of action that alleging breach of an
      employment contract by EOIR was dismissed with prejudice by the
      Court.




Markland
      and EOIR were notified on July 11, 2005 by counsel for Greg and Mary Williams,
      former shareholders and employees of EOIR and, in the case of Mr. Williams,
      a
      former director of Markland, that the Williamses filed a lawsuit in the
      Commonwealth of Virginia, naming EOIR and Markland as defendants, regarding
      a
      number of contractual disputes involving the registration of shares of Markland
      common stock underlying certain options issued to the Williamses in connection
      with the acquisition of EOIR by Markland and severance payments called for
      pursuant to severance agreements by and among the Williamses, EOIR and Markland.
      On August 3, 2005, EOIR and Markland filed an answer and a demurrer denying
      all
      liability.




48




**ITEM
      6. EXHIBITS**




Exhibit
                No.
            Description
            Filed
                with this Quarterly Report
            Incorporated
                by referenceForm
            Filing
                Date
            Exhibit
                No.10.1
            Lease
                Agreement between Branch Banking and Trust Company of Virginia and
              E-OIR
                Technologies, dated May 31, 2002
            X10.2
            First
                Amendment to Lease by and between Branch Banking and Trust Company
                of
                Virginia and E-OIR Technologies, Inc. dated October 1,
                2005
            X10.3
            Jackson
                Square Office Park Deed of Lease by and between LJ Holding, L.C.
                and E-OIR
                Technologies, Inc., dated September 22, 2004
            X10.4
            Deed
                of Commercial Office Lease Agreement between BDC Spotsylvania LLC
                and
                E-OIR Technologies, Inc., dated May 16, 2005
            X10.5
            First
                Amendment to Deed of Commercial Office Lease Agreement between BDC
                Spotsylvania LLC and E-OIR Technologies, Inc. dated September 29,
                2005
            X10.6
            Lease
                between Paul J Kingston, Trustee of M.P.A. Realty Trust, and Technest
                Holdings, Inc., dated December 31, 2005
            X10.7
            Office
                Lease Agreement between Motor City Drive, LLC and Genex Technologies,
                Inc., dated December 20, 2005
            X10.8
            Amendment
                No. 1 dated October 3, 2005, effective as of September 30, 2005,
                between
                Technest Holdings, Inc., Southridge Partners LP, Southshore Capital
                Fund
                Limited, ipPartners, Inc, and Verdi Consulting, Inc. amending the
                Registration Rights Agreement dated February 14, 2005 by and among
                Technest and certain holders of Technest’s Series C Preferred
                Stock
            
            8-K
            October
                7, 2005
            4.231.1
            Certification
                by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
                15d-14(a)
            X31.2
            Certification
                by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
                15d-14(a)
            X32.1
            Certification
                by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
                1350
            X







49




**SIGNATURES**




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




**TECHNEST
              HOLDINGS, INC.**Date: February
              21, 2006
            By:
            /s/ Gino
              M.
              PereiraGino
                M.
                Pereira
              Chief Financial
                Officer




50


Exhibit
      Index






Exhibit
                No.
            Description
            Filed
                with this Quarterly Report
            Incorporated
                by referenceForm
            Filing
                Date
            Exhibit
                No.10.1
            Lease
                Agreement between Branch Banking and Trust Company of Virginia and
              E-OIR
                Technologies, dated May 31, 2002
            X10.2
            First
                Amendment to Lease by and between Branch Banking and Trust Company
                of
                Virginia and E-OIR Technologies, Inc. dated October 1,
                2005
            X10.3
            Jackson
                Square Office Park Deed of Lease by and between LJ Holding, L.C.
                and E-OIR
                Technologies, Inc., dated September 22, 2004
            X10.4
            Deed
                of Commercial Office Lease Agreement between BDC Spotsylvania LLC
                and
                E-OIR Technologies, Inc., dated May 16, 2005
            X10.5
            First
                Amendment to Deed of Commercial Office Lease Agreement between BDC
                Spotsylvania LLC and E-OIR Technologies, Inc. dated September 29,
                2005
            X10.6
            Lease
                between Paul J Kingston, Trustee of M.P.A. Realty Trust, and Technest
                Holdings, Inc., dated December 31, 2005
            X10.7
            Office
                Lease Agreement between Motor City Drive, LLC and Genex Technologies,
                Inc., dated December 20, 2005
            X10.8
            Amendment
                No. 1 dated October 3, 2005, effective as of September 30, 2005,
                between
                Technest Holdings, Inc., Southridge Partners LP, Southshore Capital
                Fund
                Limited, ipPartners, Inc, and Verdi Consulting, Inc. amending the
                Registration Rights Agreement dated February 14, 2005 by and among
                Technest and certain holders of Technest’s Series C Preferred
                Stock.
            
            8-K
            October
                7, 2005
            4.231.1
            Certification
                by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
                15d-14(a)
            X31.2
            Certification
                by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule
                15d-14(a)
            X32.1
            Certification
                by CEO and CFO of Periodic Report Pursuant to 18 U.S.C. Section
                1350
            X






51