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


**Washington,
      D.C. 20549**






**FORM
        10-QSB**/A****




(Mark
      One)




x
            QUARTERLY
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934




For
                the quarterly period ended: March 31,
                2006




**OR**




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




For
                the transition period from ______________ to
                ______________






**Commission
      File Number 000-27023**










**TECHNEST
      HOLDINGS, INC.**


(Exact
      name of registrant as specified in its charter)






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




**One
      McKinley Square, Fifth Floor, Boston, MA 02109**


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




**(617)
      722-9800**


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




Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to filed such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days.


Yes x  No o




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes o  No
x




As
      of May
      19, 2006, there were 15,819,552 shares of common stock, $0.001 par value, of
      the
      registrant issued and outstanding.




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







**EXPLANATORY
          NOTE**
 
 Technest
          has restated its financial statements for the quarter ended March 31, 2006
          to
          correct its accounting for derivative financial instruments to conform
          to the
          requirements of Statements of Financial Accounting Standards ("SFAS") No.
          133,
          as amended, and Emerging Issues Task Force No. ("EITF") 00-19. For certain
          warrants issued by Technest in February 2005, Technest could not conclude
          that
          the warrants were able to be settled in unregistered shares of common stock
          due
          to liquidated damage provisions in registration rights agreements Therefore,
          the
          warrants did not meet the requirements for classification as equity instruments.
          Instead, the warrants were recorded as liabilities and carried at fair
          value.
          Fair value adjustments to these derivative liabilities are charged (credited)
          to
          the statement of operations.
 
 On
          September 30, 2005, Technest amended the terms of the registration rights
          agreement such that any liquidated damages would only be payable in common
          stock. As a result of this amendment, Technest was able to conclude that
          the
          settlement of the warrants in unregistered shares was no longer uneconomic.
          Therefore, on September 30, 2005, the then fair value of the warrants was
          reclassified from derivative liabilities to additional paid-in capital.
 
 Generally,
          no attempt has been made in this Quarterly Report on Form 10-QSB/A to modify
          or
          update other disclosures presented in the original report on Form 10-QSB
          except
          as required to effectuate the changes above. This Quarterly Report on Form
          10-QSB/A does not reflect events occurring after the filing of the original
          Form
          10-QSB or modify or update those disclosures. Information not affected
          by the
          amendment is unchanged and reflects the disclosure made at the time of
          the
          original filing of the Form 10-QSB with the Securities and Exchange Commission
          on May 22, 2006. Accordingly, this amended Quarterly Report on Form 10-QSB/A
          should be read in conjunction with our periodic filings made with the SEC
          subsequent to the date of the original filing, as well as any Current Reports
          filed on Form 8-K subsequent to the date of the original filing.
 
 In
          addition, this Amendment includes updated certifications from our Chief
          Executive Officer and Chief Financial Officer as Exhibits 31.1, 31.2 and
          32.1.









**TECHNEST
      HOLDINGS, INC.**




**FORM
          10-QSB** **/A**


**TABLE
      OF CONTENTS**


**MARCH
      31, 2006**




PagePART
                I.      FINANCIAL INFORMATION:Item
                  1.       Financial
                  Statements (Unaudited)Condensed
                  Consolidated Balance Sheet at March 31,
                  2006
              
              1Condensed
                  Consolidated Statements of Operations for the
                  Nine Months Ended March 31, 2006 and 2005
              
              2Condensed
                  Consolidated Statements of Operations for the
                  Three Months Ended March 31, 2006 and 2005
              
              3Condensed
                  Consolidated Statement of Stockholders’ Equity
                  for the Nine Months Ended March 31, 2006
              
              4Condensed
                  Consolidated Statements of Cash Flows for the
                  Nine Months Ended March 31, 2006 and 2005
              
              6Notes
                  to Condensed Consolidated Financial
                  Statements
              
              8Item
                  2.       Management’s Discussion and
                  Analysis or Plan of Operation
              
              27Item
                  3.       Controls and
                  Procedures
              
              48PART
                  II.      OTHER INFORMATIONItem
                  1.       Legal
                  Proceedings
              
              49Item
                  6.      
                  Exhibits
              
              51Signatures
              
              52






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."




i


**PART
      I. FINANCIAL INFORMATION**




**Item
      1.  Financial Statements**




**TECHNEST
                HOLDINGS, INC. AND SUBSIDIARIES****CONDENSED
                CONSOLIDATED BALANCE
                SHEET****MARCH
                31, 2006**(Unaudited)**ASSETS****Current
                Assets**
            
            (Restated)Cash
                and cash equivalents
            
            $
            1,911,575Accounts
                receivable
            
            
            7,608,188Work-in-process
            
            
            27,330Restricted
                cash
            
            
            250,000Prepaid
                expenses and other current assets
            
            
            124,692**Total
                Current Assets**
            
            
            9,921,785**Property
                and Equipment**-
                Net of accumulated depreciation of $561,418
            
            
            838,541**Other
                Assets**Deposits
            
            
            86,220Definite-lived
                intangible assets - Net of accumulated amortization of $3,039,013
            
            
            11,999,041Goodwill
            
            
            14,035,551**Total
                Other Assets**
            
            
            26,120,812**Total
                Assets**
            
            $
            36,881,138**LIABILITIES
                AND STOCKHOLDERS’ EQUITY****Current
                Liabilities**Accounts
                Payable
            
            $
            8,480,678Accrued
                expenses and other current liabilities
            
            
            2,090,470Due
                to related parties, net
            
            
            629,723Current
                portion of long-term debt
            
            
            2,244,580**Total
                Current Liabilities**
            
            
            13,445,451**Non-Current
                Liabilities**Long-term
                debt, less current portion and discount of $954,171
            
            
            5,663,278**Total
                Liabilities**
            
            
            19,108,729**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 March 31, 2006)
            
            
            --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; 632,178 shares issued and outstanding(preference
                in liquidation of $1,374,987 at March 31, 2006)
            
            
            632Common
                stock - par value $.001 per share;495,000,000
                shares authorized; 15,741,288 shares issued and
                outstanding
            
            
            15,741Additional
                paid-in capital
            
            
            31,520,411Accumulated
                deficit, from February 15, 2005
            
            
            (13,764,375
            )**Total
                Stockholders’ Equity**
            
            
            17,772,409**Total
                Liabilities and Stockholders’ Equity**
            
            $
            36,881,138See
                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****OPERATIONS**
 **Nine
        months ended March 31, 2006 and 2005** (unaudited)
 
 **2006**
              
              
              **2005**(Restated)
              
              
              (Restated)**Revenues**
              
              $
              55,141,077
              
              
              $
              7,448,800**Cost
                  of Revenues**
              
              
              44,845,200
              
              
              
              5,879,471**Gross
                  Profit**
              
              
              10,295,877
              
              
              
              1,569,329**Operating
                  Expenses**Selling,
                  general and administrative (including $750,000 and
                  $187,500
                to
                  related parties in 2006 and 2005 respectively)
              
              
              9,897,578
              
              
              
              1,673,405Research
                  and development
              
              
              138,448
              
              
              
              2,095,000Amortization
                  of intangible assets
              
              
              1,339,634
              
              
              
              163,264**Total
                  Operating Expenses**
              
              
              11,375,660
              
              
              
              3,931,669**Operating
                  Loss**
              
              
              (1,079,783
              )
              
              
              (2,362,340
              )**Other
                  Expenses (Income), Net**Interest
                  expense
              
              
              2,359,289
              
              
              
              212,794Derivative
                  (income) expense
              
              
              (25,046,489
              )
              
              
              12,938,263Other
                  income
              
              
              (118,811
              )
              
              
              (11,344
              )**Total
                  Other Expenses (Income), Net**
              
              
              (22,806,011
              )
              
              
              13,139,713**Net
                  Income (Loss)**
              
              
              21,726,228
              
              
              
              (15,502,053
              )Deemed
                  dividend on Series A preferred stock
              
              
              --
              
              
              
              124,858Deemed
                  dividend on Series C preferred stock
              
              
              --
              
              
              
              2,473,000**Net
                  Income (Loss) Attributable to Common Stockholders**
              
              $
              21,726,228
              
              
              $
              (18,099,911
              )**Basic
                  Income (Loss) Per Common Share**
              
              $
              1.45
              
              
              $
              (2.60
              )**Diluted
                  Income (Loss) Per Common Share**
              
              $
              1.36
              
              
              $
              (2.60
              )**Weighted
                  Average Number of Common Shares Outstanding -
                  Basic**
              
              
              15,034,540
              
              
              
              6,961,227- **Diluted**
              
              
              15,997,985
              
              
              
              6,961,227
  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.  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 **OPERATION******Three
                months ended March 31, 2006 and 2005**(unaudited)




**2006**
            
            
            **2005**(Restated)**Revenues**
            
            $17,855,160
            
            
            $7,448,800**Cost
                of Revenues**
            
            14,618,076
            
            
            5,879,471**Gross
                Profit**
            
            3,237,084
            
            
            1,569,329**Operating
                Expenses**Selling,
                general and administrative (including $250,000 and $187,500 to
                related
              parties
                in 2006 and 2005 respectively)
            
            3,586,344
            
            
            1,574,374Research
                and development
            
            --
            
            
            2,095,000Amortization
                of intangible assets
            
            446,512
            
            
            163,264**Total
                Operating Expenses**
            
            4,032,856
            
            
            3,832,638**Operating
                Loss**
            
            (795,772)
            
            
            (2,263,309)**Other
                Expenses (Income), Net**Interest
                expense
            
            763,469
            
            
            205,104Derivative
                expense
            
            --
            
            
            12,938,263Other
                income
            
            (35,633)
            
            
            (11,344)**Total
                Other Expenses, net**
            
            
            727,836
            
            
            
            13,132,023**Net
                Loss**
            
            
            (1,523,608
            )
            
            
            (15,395,332
            )Deemed
                Dividend on Series A Preferred Stock
            
            
            --
            
            
            
            124,858Deemed
                Dividend on Series C Preferred Stock
            
            
            --
            
            
            
            2,473,000**Net
                Loss Applicable to Common Stockholders**
            
            $
            (1,523,608
            )
            
            $
            (17,993,190
            )**Basic
                and Diluted Loss Per Common Share**
            
            $
            (0.10
            )
            
            $
            (7.55
            )**Weighted
                Average Number of Common Shares Outstanding**
            
            
            15,677,163
            
            
            
            2,384,747See
                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.  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 NINE MONTHS ENDED MARCH 31, 2006**


**(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, 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
            
            
            517,240
            
            
            517
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (517,247
            )
            
            (517
            )Common
                stock issued in connection with
              warrant
                exercises
            
            
            354,921
            
            
            355
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Common
                stock issued in connection with
              penalties
                for failure to effect registration rights
            
            
            284,265
            
            
            284
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Amortization
                and forfeiture of stock-based
              compensation
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Reclassification
                of derivative liability to equity
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Exchange
                of Series B Convertible Preferred
              Stock
                for Markland Series D preferred stock
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (517,243
            )
            
            (517
            )
            
            -
            
            
            -Net
                loss (restated)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Balance
                - March 31, 2006,
                restated
            
            
            15,741,288
            
            $
            15,741
            
            
            64
            
            $
            -
            
            
            -
            
            $
            -
            
            
            632,178
            
            $
            632




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 NINE MONTHS ENDED MARCH 31, 2006**


(Unaudited)






Additional
            
            
            
            TotalUnearned
            
            Paid-in
            
            Accumulated
            
            Stockholders'Compensation
            
            Capital
            
            Deficit
            
            EquityAmount
            
            Amount
            
            Amount
            
            AmountBalance
                - July 1, 2005, restated
            
            $
            (1,541,490
            )
            $
            29,548,840
            
            $
            (35,490,603
            )
            $
            (7,467,285
            )Conversion
                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
            
            
            -
            
            
            (355
            )
            
            -
            
            
            -Common
                stock issued in connection with penalties for
              failure
                to effect registration rights
            
            
            -
            
            
            1,499,716
            
            
            -
            
            
            1,500,000Amortization
                and forfeiture of stock-based compensation
            
            
            1,541,490
            
            
            (1,445,151
            )
            
            -
            
            
            96,339Reclassification
                of derivative liability to equity
            
            
            -
            
            
            1,917,127
            
            
            -
            
            
            1,917,127Exchange
                of Series B Convertible Preferred Stock for
              Markland
                Series D preferred stock
            
            
            -
            
            
            517
            
            
            -
            
            
            -Net
                income(restated)
            
            
            -
            
            
            -
            
            
            21,726,228
            
            
            21,726,228Balance
                - March 31, 2006,
                restated
            
            $
            -
            
            $
            31,520,411
            
            $
            (13,764,375
            )
            $
            17,772,409




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****Nine
                months ended March 31, 2006 and 2005**(unaudited)




**2006**
            
            
            **2005**(restated)
            
            
            (restated)**Cash
                Flows From Operating Activities:**Net
                income
                (loss)
            
            $
            21,726,228
            
            
            $
            (15,502,053
            )Adjustment
                  to reconcile net income
                  (loss)
                  to
                  net cash provided
                  by (used
                  in)
                  operating activities:Derivative
                  (income) expense
            
            
            (25,046,489
            )
            
            
            12,938,263Depreciation
                of property and equipment
            
            
            280,455
            
            
            
            52,233Amortization
                of intangible assets
            
            
            1,339,634
            
            
            
            163,264Common
                stock issued in settlement of liquidated damages
            
            
            1,500,000
            
            
            
            --Non-cash
                interest expense
            
            
            220,195
            
            
            
            36,698Stock-based
                compensation
            
            
            96,339
            
            
            
            152,155Acquired
                in-process research and development
            
            
            --
            
            
            
            2,095,000Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (11,325
            )
            
            
            2,265,329Inventory
                and work-in-process
            
            
            379,331
            
            
            
            (99,665
            )Prepaid
                expenses and other current assets
            
            
            393,023
            
            
            
            (54,944
            )Restricted
                cash
            
            
            (250,000
            )
            
            
            --Deposits
            
            
            (618
            )
            
            
            --Accounts
                payable
            
            
            (2,228,969
            )
            
            
            262,725Accrued
                expenses and other current liabilities
            
            
            425,380
            
            
            
            277,177Due
                to related parties
            
            
            (1,861,838
            )
            
            
            (208,899
            )**Net
                Cash (Used In) Provided by Operating Activities**
            
            
            (3,038,654
            )
            
            
            2,377,283**Cash
                Flows From Investing Activities:**Proceeds
                from the sale of property and equipment
            
            
            29,956
            
            
            
            --Purchase
                of property and equipment
            
            
            (286,178
            )
            
            
            --Cash
                acquired in acquisition of E-OIR Technologies, Inc.
            
            
            --
            
            
            
            1,916,079Cash
                used for acquisition of Genex Technologies, Inc., net of cash
                acquired
            
            
            --
            
            
            
            (2,515,516
            )**Net
                Cash Used In Investing Activities**
            
            
            (256,222
            )
            
            
            (599,437
            )**Cash
                Flows From Financing Activities:**Repayment
                of long-term debt
            
            
            (656,157
            )
            
            
            (41,961
            )Proceeds
                from sale of Series A convertible preferred stock
            
            
            --
            
            
            
            50,000Proceeds
                from sale of Series B and C convertible preferred stock,
                net
            
            
            --
            
            
            
            3,512,273**Net
                Cash Provided By (Used In) Financing Activities**
            
            
            (656,157
            )
            
            
            3,520,312**Net
                Increase (Decrease) In Cash**
            
            
            (3,951,033
            )
            
            
            5,298,158**Cash
                and Cash Equivalents - Beginning of Period**
            
            
            5,862,608
            
            
            
            1,334**Cash
                and Cash Equivalents - End of Period**
            
            $
            1,911,575
            
            
            $
            5,299,492





6








**Supplemental
                Disclosures Of Cash Flow Information:**Cash
                paid during the periods for:Interest
            
            $
            370,702
            
            
            $
            1,371Taxes
            
            $
            -
            
            
            $
            500Non-cash
                investing and financing activities:Conversion
                of notes payable and accrued interest into Series A
              preferred
                stock
            
            $
            --
            
            
            $
            74,848Common
                stock issued in conjunction with acquisition of
              Genex
                Technologies, Inc.
            
            $
            --
            
            
            $
            6,101,258Deemed
                dividend preferred stock - beneficial conversion
              feature
                - Series A
            
            $
            --
            
            
            $
            124,858Deemed
                dividend preferred stock - beneficial conversion
              feature
                - Series C
            
            $
            --
            
            
            $
            2,050,000Transfer
                of inventory to Markland
            
            $
            105,218
            
            
            $
            -







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.  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 Nine Months Ended March 31, 2006 and 2005**


(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. 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). 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.




Effective
      June 29, 2004, Markland acquired 100% of the outstanding common stock of E-OIR
      Technologies, Inc. (“EOIR”), a company incorporated under the laws of the
      Commonwealth of Virginia, in conjunction with a Stock Purchase Agreement dated
      June 29, 2004 ("the Acquisition"). Markland agreed to pay the stockholders
      of
      EOIR $19,000,000, consisting of $8,000,000 in cash and promissory notes of
      $11,000,000. Additionally, Markland issued certain members of EOIR's management
      team options to purchase approximately $4,000,000 of Markland common stock.
      As a
      result of this transaction, EOIR became a wholly-owned subsidiary of Markland
      effective June 29, 2004.





On
      August
      17, 2005, pursuant to a Stock Purchase Agreement with Markland, Technest
      purchased all of the outstanding stock of EOIR. As consideration for this
      purchase, Technest issued 12 million shares of its common stock to Markland.
      As
      a result of this transaction, EOIR became a wholly-owned subsidiary of Technest
      effective August 17, 2005. Since this was a transaction between entities under
      common control, in accordance with Statement of Financial Accounting Standards
      (“SFAS”) No. 141, “Business Combinations”, Appendix D, Technest recognized the
      net assets of EOIR at their carrying amounts in the accounts of Markland on
      the
      date Technest came into Markland’s control group, February 14, 2005 and restated
      the financial statements to include the activity of EOIR from that date forward
      (see Note 3).




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).




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.




Reorganization
      and Restatement




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 Technest came into Markland’s control group, February 14, 2005 and
      the Company has restated its financial statements to include EOIR from this
      date
      (see Note 3). Markland acquired EOIR on June 29, 2004.




8





Technest
          also corrected its accounting for derivative financial instruments to conform
          to
          the requirements of Statements of Financial Accounting Standards ("SFAS")
          No.
          133, as amended, and Emerging Issues Task Force No. ("EITF") 00-19 (See
          Notes 2
          and 5). For certain warrants issued by Technest in February 2005, Technest
          could
          not conclude that the warrants were able to be settled in unregistered
          shares of
          common stock due to liquidated damage provisions in registration rights
          agreements. Therefore the warrants did not meet the requirements for
          classification as equity instruments. Instead, the warrants were recorded
          as
          liabilities and carried at fair value. Fair value adjustments to these
          derivative liabilities are charged (credited) to the statement of operations.
 
 The
          Company also reclassified $251,628 from Due to Related Parties to Additional
          Paid-in Capital to correct the presentation of certain stock compensation
          issued
          by Markland to Technest employees.
  The
            impact of the restatement on the financial statements for the nine months
            ended
            March 31, 2006 to correct the accounting for the warrants is as
            follows:
  As
                      originally stated
                  
                  Impact
                      of restatement
                  
                  As
                      restatedNet
                      income (loss)
                  
                  $
                  (3,320,261
                  )
                  $
                  25,046,489
                  
                  $
                  21,726,228Net
                      income (loss) applicable to common stockholders
                  
                  $
                  (3,320,261
                  )
                  $
                  25,046,489
                  
                  $
                  21,726,228Net
                      income (loss) applicable to common stockholders per common
                      share
                  
                  $
                  (0.22
                  )
                  $
                  1.67
                  
                  $
                  1.45
 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 nine months ended March 31, 2006 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).






**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.




Fiscal
      Year-end




On
      June
      30, 2005, the Board of Directors of Technest unanimously voted to change the
      fiscal year-end from December 31 to June 30.




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.




9





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 mutual
      funds as of March 31, 2006.  The Company has cash balances in banks in
      excess of the maximum amount insured by the FDIC as of March 31, 2006.




Restricted
      Cash




Restricted
      cash represents a one-year certificate of deposit, originally maturing in
      February 2006 and extended until April 2007, 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 March 31, 2006. If management
      determines amounts to be uncollectible, they will be charged to operations
      when
      that determination is made.




Inventory
      and Work-in-Process




Inventories
      were stated at the lower of cost or market.  Cost was 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.




In
      the
      quarter ended March 31, 2006, the Company transferred all inventory related
      to
      Genex’s commercial products to Markland, at its cost of $105,218, in connection
      with a license agreement with Markland (see Note 9).




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 March 31, 2006:




Software
            
            $
            169,077Computer
                equipment
            
            
            643,944Furniture
                and fixtures
            
            
            330,930Leasehold
                improvements
            
            
            222,338Vehicles
            
            
            33,6701,399,959Less
                accumulated depreciation
            
            
            (561,418
            )$
            838,541




10





Depreciation
      expense for the nine months ended March 31, 2006 and 2005 was $265,738 and
      $2,935, 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 primarily to 3D imaging, intelligent
      surveillance and 3D facial recognition technologies.  As of March 31, 2006,
      certain of these technologies have been licensed to Markland (see Note
      9).




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.




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.




Fair
      Value of Financial Instruments




The
      financial statements include various estimated fair value information at March
      31, 2006, as required by SFAS 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.




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 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.




11




Revenue
      Recognition





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




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 No. 81-1 “Accounting for Performance of Construction-Type
      and Certain Production-Type Contracts”.  Revenues
      under teaming arrangements amounted to $3,597,800 and $978,487 for the nine
      months and three months ended March 31, 2006.





Shipping
      Costs




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




Research
      and Development





The
      Company charges unfunded research and development costs to expense as incurred.
      Funded research and development is part of the Company's revenue base and the
      associated costs are included in cost of revenues. The Company capitalizes
      costs
      related to acquired technologies that have achieved technological feasibility
      and have alternative uses. 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. For the period ended March 31, 2005,
      the Company expensed $2,095,000 of acquired in-process research and development
      related to the acquisition of Genex (see Note 3), as determined by management
      based on a number of factors including an independent purchase price allocation
      analysis.





Income
      Taxes





In
      accordance with SFAS No. 109, “Accounting for Income Taxes,” the Company
      allocates current and deferred taxes as if it were a separate tax payer. Since
      its acquisition by Markland, the Company files consolidated income tax returns
      with Markland and, for financial statement purposes, computes its provision
      or
      benefit for income taxes based on the income and expenses reported in the
      Company’s statements of operations. The allocation is not subject to a tax
      sharing arrangement with Markland and it is based on the tax effect of the
      Company’s operations as if it had not been included in a consolidated return,
      based on the preacquisition book and tax basis of the Company’s assets and
      liabilities. Therefore, the impact of applying push down accounting (see Note
      3)
      to the Company is not considered in determining the Company’s provision for
      income taxes. Amounts included in the Company’s statement of operations related
      to the impact of push down accounting, including the amortization of
      definite-lived intangible assets and stock-based compensation, have been
      considered permanent differences for purposes of the intercompany tax
      allocation.




12





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.


Income
          (Loss)Per
          Share
 
 Basic
          and
          diluted net income
          ( loss ) per
          common share has been computed based on the weighted average number of
          shares of
          common stock outstanding during the periods presented. Basic
          net
          income (loss) per share is computed by dividing net income (loss) by
          weighted-average common shares outstanding during the year. Diluted net
          income
          (loss) per share is computed by dividing net income (loss) by the
          weighted-average number of common and dilutive option and warrant shares
          outstanding based on the average market price of Technest’s common stock (under
          the treasury stock method).
 
 The
          following table sets forth the computation of the weighted-average number
          of
          shares used in calculating basic and diluted net income (loss) per share
          in the
          nine months ended March 31, 2006:
  Weighted-average
                    shares outstanding for basic net income per share
                
                
                15,034,540Series
                    A Convertible Preferred Stock
                
                
                306,028Series
                    C Convertible Preferred Stock
                
                
                632,178Warrants
                    to purchase common stock
                
                
                25,239Total
                    shares for diluted net income per share
                
                
                15,997,985
 
 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 for
          the
          three months ended March 31, 2006 and 2005 and the nine months ended March
          31,
          2005 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 acquisition of EOIR (see Note 3) were issued
      on
      February 14, 2005.





Loss
      per
      share for all prior periods have been retroactively restated to reflect a 1
      for
      211.18 reverse stock split effective
      at the close of business on July 19, 2005.




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 nine months ended
      March
      31, 2006.





Impairment
      of Long-Lived Assets





Pursuant
      to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived
      Assets", Technest continually monitors events and changes in circumstances
      that
      could indicate carrying amounts of long-lived assets may not be recoverable.
      An
      impairment loss is recognized when expected cash flows are less than the asset's
      carrying value. Accordingly, when indicators of impairment are present, Technest
      evaluates the carrying value of such assets in relation to the operating
      performance and future undiscounted cash flows of the underlying assets.
      Technest’s policy is to record an impairment loss when it is determined that the
      carrying amount of the asset may not be recoverable. No impairment charges
      were
      recorded in the nine months ended March 31, 2006.




Derivative
          Instruments
 
 Technest
          generally does not use derivative instruments to hedge exposures to cash-flow
          or
          market risks. However, certain warrants to purchase common stock that are
          indexed to the Company's common stock were classified as liabilities when
          the
          Company was not permitted to settle the instruments in unregistered shares.
          In
          such instances, net-cash settlement is assumed for financial reporting
          purposes,
          even when the terms of the underlying contracts do not provide for net-cash
          settlement. Such financial instruments were initially recorded at relative
          fair
          value with subsequent changes in fair value charged (credited) to operations
          in
          each reporting period. If the Company subsequently achieves the ability
          to
          settle the instruments in unregistered shares, the instruments are reclassified
          to equity at their fair value.







13


Stock-Based
        Compensation
 
 At
        March
        31, 2006, 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 nine months ended March 31, 2006 and 2005. There was no effect for the
        three
        months ended March 31, 2006.


Three
                    MonthsEnded
                
                Nine
                    months endedMarch
                    31,
                
                March
                    31,2005
                
                2006
                
                2005Netincome
                    (loss)as
                    reported
                
                $
                (17,993,190
                )
                $
                (21,726,228
                )
                $
                (18,099,911
                )Add:
                    stock-based employee compensation under intrinsic value
                    method
                  Includedin
                    net loss
                
                
                62,155
                
                
                96,339
                
                
                62,155Deduct:
                    stock-based employee compensation under fair value method
                
                
                (217,894
                )
                
                (118,232
                )
                
                (118,232
                )Pro
                    forma netincome
                    (loss)to
                    applicable to common stockholders
                
                $
                (18,148,929
                )
                $
                (21,704,335
                )
                $
                (18,155,988
                )Basicincome
                    (loss)per share - as reported
                
                $
                (7.55
                )
                $
                (1.45
                )
                $
                (2.60
                )Basicincome
                    (loss)per share - pro forma
                
                $
                (7.61
                )
                $
                (1.44
                )
                $
                (2.61
                )Diluted
                    income (loss) per share - as reported
                
                $
                (7.55
                )
                $
                1.36
                
                $
                (2.60
                )Diluted
                    income (loss) per share - pro forma
                
                $
                (7.61
                )
                $
                1.36
                
                $
                (2.61
                )





There
      were no options issued in the three and nine months ended March 31,
      2006.





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.




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 recognizes 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.




14





**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. and Restatement





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.





A
      summary
      of the allocation, as determined by management in consideration of a number
      of
      factors including an independent valuation, of the aggregate consideration
      for
      the merger to the fair value of the assets acquired and liabilities assumed
      is
      as follows:




Cash
                
                $
                3,300,000Shares
                    of Markland Technologies, Inc. common stock
                
                
                6,101,258Total
                    Purchase Price
                
                $
                9,401,258Fair
                    value allocation to net assets acquired:Fair
                    value of assets acquired -Current
                    assets, including cash of $784,484
                
                $
                1,199,402Property
                    and equipment
                
                
                44,000Fair
                    value of liabilities assumed -Accounts
                    payable & accrued expenses
                
                
                (544,292
                )Fair
                    value of identifiable net tangible assets acquired
                
                
                699,110Intangible
                    assets - intellectual property
                
                
                161,110In-process
                    research and development
                
                
                2,095,000Commercialized
                    patents
                
                
                440,000Contracts
                    and customer relationships
                
                
                1,130,000Goodwill
                
                
                4,876,038Total
                
                $
                9,401,258




15





As
      a
      result of the transaction being structured as a stock acquisition, Technest
      does
      not expect any goodwill or other identifiable intangible assets resulting from
      the transaction to be deductible for income tax reporting purposes.
      Consequently, no deferred tax assets were recorded in connection with the
      merger.





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).





At
      March
      31, 2005, the Company had not finalized the purchase price allocation for the
      acquisition of Genex. Therefore, the 10-QSB filed as of and for the periods
      ended March 31, 2005 did not reflect the final purchase price allocation,
      including the $2,095,000 of in-process research and development. Therefore,
      for
      comparative purposes, the financial statements for the three and nine months
      ended March 31, 2005 have been restated to reflect the impact of the Company’s
      final purchase price allocation for the acquisition of Genex (see Impact of
      Restatement below).





Acquisition
      of EOIR and Restatement




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.




Impact
      of Restatements





The
      impact of the restatement for the final Genex purchase price allocation and
      to
      include EOIR from February 14, 2005 on the financial statements for the three
      months ended March 31, 2005 is as follows:





Three
                months ended March 31, 2005As
                originally
              stated
            
            Impact
                of
              restatementLoss
                from operations
            
            $
            (2,744
            )
            $
            (2,454,325
            )Net
                loss applicable to common stockholders
            
            $
            (2,177,602
            )
            $
            (2,454,325
            )Net
                loss applicable to common stockholders percommon
                share
            
            $
            (1.95
            )
            $
            0.01





The
      impact of the restatement on the nine months ended March 31, 2005 has not been
      presented as Technest has not previously presented the nine months then ended
      since, prior to June 30, 2005, Technest’s fiscal year end was December
      31.





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.




16





Pro
      Forma Information





Unaudited
      pro forma financial information for the nine months ended March 31, 2005, had
      the acquisition of Genex and EOIR been completed as of July 1, 2004, the
      beginning of the period presented, is as follows:


Condensed
                  Pro Forma Statement of Net LossNine
                  Months
                Ended
                March
                  31, 2005Revenues
              $
              47,899,312Operating
                  loss
              $
              (2,770,717
              )Net
                  loss attributable to common shareholders
              $
              (5,958,210
              )Net
                  loss per common share
              $
              (0.42
              )






**4. 
      DEFINITE-LIVED INTANGIBLE ASSETS**





Definite-lived
      intangible assets consist of the following at March 31, 2006:


Amount
                  
                  Useful
                      life
                    (years)Patents
                      - Genex - commercialized technology
                  
                  $
                  440,000
                  
                  
                  5Patents
                      - Genex - other
                  
                  
                  161,110
                  
                  
                  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
                  
                  
                  1,551,944
                  
                  
                  10Accumulated
                      amortization
                  
                  
                  (3,039,013
                  )Net
                      definite-lived intangible asset
                  
                  $
                  11,999,041
  Patents
        are amortized over their estimated useful life but not to exceed the legal
        life
        of the patent. Customer relationships and contracts are amortized over the
        contractual term of the existing contracts plus anticipated contract renewals
        in
        accordance with EITF 02-17.





Amortization
      expense was $ 1,339,634 and $-0-
      for the nine months ended March 31, 2006 and 2005, respectively.




**5.** **DERIVATIVE
          LIABILITY**
  On
          February 14, 2005, in conjunction with the issuance of Technest’s Series B and C
          Convertible Preferred Stock, the Company issued warrants to purchase 1,149,425
          shares of common stock at $6.50 per share. The shares issuable upon exercise
          of
          these warrants are covered by a Registration Rights Agreement which requires
          the
          Company to pay certain liquidated damages in the event that the Company
          does not
          have an effective registration statement. Due to the significance of the
          liquidated damages potentially due under the Registration Rights Agreement,
          the
          Company must conclude that settling the warrants in unregistered shares
          was
“uneconomic”. Since it is not within the Company’s control to settle the
          warrants in registered shares, the Company is required to assume that the
          warrants will be net-cash settled. As a result, under EITF 00-19, the warrants
          did not meet the definition of equity instruments.
  On
          September 30, 2005, the Company amended the terms of the Registration Rights
          Agreement such that any liquidated damages would only be payable in common
          stock. As a result of this amendment, the Company was able to conclude
          that the
          settlement of the warrants in unregistered shares was no longer uneconomic.
          Therefore, on September 30, 2005, the then fair value of the warrants,
          $1,917,127, was reclassified from derivative liabilities to additional
          paid-in
          capital.







17


In
          the
          three months and nine months ended March 31, 2006 changes in the fair value
          of
          the warrants recorded as derivative income in the statements of operations
          were
          $-0- and $25,046,489, respectively. In the three months and nine months
          ended
          March 31, 2005 changes in the fair value of the warrants recorded as derivative
          expense in the statements of operations were
          $12,938,263.




**6. 
          LONG-TERM DEBT**
 
 Notes
        Payable - EOIR Acquisition
  On
        June
        29, 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 nine months ended March 31,
        2006,
        $220,195 was amortized to interest expense. The face value of the note and
        the
        unamortized discount at March 31, 2006 was $8,800,000 and $954,171,
        respectively.




Other
      Long-Term Bank Debt




EOIR's
      other long-term bank debt consists of the following as of March 31,
      2006:




First
                Market Bank, secured by research equipment, dated October, 2002
              with
                monthly payments of $2,075 including interest at LIBOR plus
              2.75%
                (7.75% at March 31, 2006)
            $
            37,352First
                Market Bank, dated July, 2002 with monthly payments of $1,640
              plus
                interest at LIBOR plus 2.75%, (7.75% at March 31, 2006)
            
            24,678$
            62,030





**7. 
        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 nine months ended March 31, 2006, 59.694 shares of Series
      A
      Preferred Stock were converted into 282,669 shares of the Company’s common
      stock.





At
      March
      31, 2006, 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 was convertible into Markland common stock upon the
      earlier to occur of February 14, 2006 or the trading day immediately following
      the first period of five trading days during which Markland common stock 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 was 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 had a liquidation preference of $2.175 per share, could only
      vote on changes to the rights, privileges and priority of the Series B Preferred
      Stock, did not accrue dividends and were not redeemable. Upon conversion, the
      Series B Preferred Stock would be cancelled and not reissuable. The
      Series B Preferred Stock ranked pari passu with the Company's Series A and
      C
      Preferred Stock.




18





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. Effective
      October 25, 2005, there no longer any units outstanding and the Company was
      not
      obligated to issue any additional common stock.




In
      the
      nine months ended March 31, 2006, Markland entered into a definitive exchange
      agreement with the Deer Creek Fund LLC, pursuant to which Markland exchanged
      2,250 shares of Markland Series D Preferred Stock for 517,243 shares of Technest
      Series B Convertible Preferred Stock. Subsequently, the Technest Series B
      Convertible Preferred shares held by Markland were cancelled.





In
      the
      nine months ended March 31, 2006, 517,247 shares of shares of Technest Series
      C
      preferred stock were converted to 517,240 shares of common stock.





On
      March
      31, 2006, the Company had -0- shares of Series B Preferred Stock and
      632,178 shares of Series C Preferred Stock issued and outstanding.





In
      the
      nine months ended March 31, 2006, the Company incurred liquidated damages of
      $1,725,000 which was charged to interest expense related to the Company's
      failure to file a registration statement and settled by the issuance of 284,265
      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 nine months ended March 31, 2006, the company issued the following amounts
      of common stock:


-
            282,669
                shares on conversion of Series A Preferred Stock-
            517,240
                shares on conversion of Series C Preferred Stock-
            354,921
                shares in connection with the net share exercise of
                warrants-
            284,265
                shares with a fair value of $1,500,000 in connection with liquidated
                damages, included in non-cash interest expense.





In
      the
      nine months ended March 31, 2005, Technest issued 21,308 shares of common stock
      to certain non-employees for consulting services. The Company valued these
      services at fair value, based on the quoted market price of the stock issued
      on
      the date of issuance which was determined to be more reliably measurable than
      the fair value of the services, and recorded consulting expense of
      $90,000.




19





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





Reverse
      stock split





On
      June
      2, 2005, the Board of Directors and the holder of a majority of our outstanding
      shares of common stock approved 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”). 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 remains at 495,000,000 shares. All share and per share
      information has been retroactively restated to reflect the Reverse Stock Split.





**8. 
      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 nine months ended March
      31,
      2006 and 2005.





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
              
              
              (517,236
              )
              $
              6.50Expired
              
              
              (3,138
              )
              $
              3,259.17Balance,
                  March 31, 2006
              
              
              374,286
              
              $
              6.50




20


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





Options
      and warrants outstanding and exercisable





Exercise
                price
            
            Number
            
            Expiration
                Date$   
                6.50
            
            374,286
            
            02/14/2010Weighted
                average remaining life
            4.00
                years





As
      of
      March 31, 2006 all 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.





Stock
      Award Plan





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





Technest
      has broad discretion in making grants under the Plan and may make grants subject
      to such terms and conditions as determined by the board of directors or the
      committee appointed by the board of directors to administer the Plan. Stock
      awards under the Plan will be subject to the terms and conditions, including
      any
      applicable purchase price and any provisions pursuant to which the stock may
      be
      forfeited, set forth in the document making the award. Pursuant to the
      Stockholder Agreement with Markland (see Note 8), (i) awards relating to no
      more
      than 500,000 shares may be granted in calendar year 2006 (the “2006 Awards”),
      (ii) the 2006 Awards shall vest no earlier than twelve (12) months following
      the
      date of grant of such awards, and (iii) awards granted on or after January
      1,
      2007 shall vest no more frequently than in four equal quarterly installments.




21





**9. 
      COMMITMENTS AND CONTINGENCIES**





Facility
      Rental





The
      Company leases approximately 2,000 square feet for its executive office in
      Boston, Massachusetts under a 4 year non-cancelable lease starting January
      2006.  The lease requires the Company to reimburse the landlord for its
      proportionate share of the landlord’s operating expenses, property taxes and
      condominium fees and charges in addition to the monthly lease amount of
      approximately $4,500.




EOIR
      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.




Genex
      currently leases offices with approximately 6,848 square feet in Bethesda,
      Maryland, pursuant to a five-year lease which expires March 31, 2011. Monthly
      lease amounts for this facility total approximately $14,263. Genex moved into
      this space on April 1, 2006. Genex had leased offices with approximately 6,831
      square feet in Kensington, Maryland, pursuant to a five-year lease which expired
      on January 31, 2006, which we had been extending on a monthly basis. Monthly
      lease amounts for this facility totaled approximately $10,100.




Rent
      expense for the nine months ended March 31, 2006 was $508,508.





Letter
      of Credit





Technest
      has issued a letter of credit in the amount of $250,000 in favor of a bank
      in
      conjunction with its corporate credit cards.





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 (prior to EOIR’s
      acquisition by Technest), 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.




22





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 2002 overpayments 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 March 31, 2006.




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





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





On
      March
      13, 2006, Technest entered into employment agreements with its President and
      Chief Executive Officer, Dr. Joseph Mackin, and its Chief Financial Officer,
      Gino M. Pereira. The employment agreements provide for:




·
            a
                term of five years beginning on March 13,
                2006;




·
            a
                base salary of $350,000 per year; in Mr. Pereira’s case, his base salary
                is subject to pro rata adjustment based on the time he spends working
                on
                Technest. Mr. Pereira is required to devote not less than sixty percent
                of
                his working time to Technest;




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




·
            $5,000
                per month for auto expense, business office expense and other personal
                expenses;




·
            eligibility
                to participate in bonus or incentive compensation plans that may
                be
                established by the board of directors from time to time applicable
                to the
                executive's services;




·
            eligibility
                to receive a bonus if Technest achieves revenue and profit milestones
                set
                by the board of directors; and




·
            eligibility
                to receive equity awards as determined by the board of directors
                or a
                committee of the board of directors composed in compliance with the
                corporate governance standards of any applicable listing exchange,
                with an
                initial award of 120,000 shares for Dr. Mackin and 72,000 shares
                for Mr.
                Pereira, which shall be issued on the first business day after Technest
                has filed a registration statement on Form S-8 registering the 2006
                Stock
                Award Plan and shall vest in three equal installments on April 1,
                2007,
                July 1, 2007 and October 1, 2007. At March 31, 2006, no shares had
                been
                issued to either Dr. Mackin or Mr.
                Pereira.




Both
      Dr.
      Mackin and Mr. Pereira will be eligible to receive a bonus of up to 300% of
      his
      annual base salary. If Technest meets the goals of the board of directors in
      annual gross profit, the executive shall be entitled to a bonus equal to fifty
      percent of his annual salary.  In the event that Technest exceeds the goals
      of the board of directors in annual gross profit, the executive shall be
      entitled to an additional amount equal to five
      percent of the gross profit in excess of the goals of the board of directors
      up
      to the maximum allowable cash bonus.




The
      employment agreements provide that in the event that the executive's engagement
      with Technest is terminated by Technest without cause (as that term is defined
      in Section 8(b) of the agreement), or by the executive for "Good Reason" (as
      that term is defined in Section 8(c) of the agreement), Technest will continue
      to pay the executive’s cash salary and provide health insurance through the
      expiration of his agreement, and in Dr. Mackin’s case, Technest will cause its
      wholly owned subsidiary, EOIR Technologies, Inc., to prepay the outstanding
      principal on the promissory note issued to Dr. Mackin in connection with the
      acquisition of EOIR by Markland on June 30, 2004. Currently, the outstanding
      principal amount on Dr. Mackin’s note is $635,417. In the event that the
      executive’s employment with Technest is terminated for any other reason, there
      will be no continuation of cash salary payments or health insurance or
      acceleration of debt payment.




23





Stockholder
      Agreement with Markland Technologies, Inc.





On
      March
      13, 2006, Technest entered into a stockholder agreement (the “Stockholder
      Agreement”) with Markland in order to clarify and define terms relating to (i)
      the issuance of Technest’s securities, (ii) Technest’s corporate governance,
      (iii) the listing of Technest’s securities on The NASDAQ Capital Market, (iv)
      registration of shares of Technest’s common stock currently held by the
      Stockholder, (v) intellectual property rights and (v) the provision by the
      Stockholder of certain corporate services to Technest.





Pursuant
      to the terms of the Stockholder Agreement, Technest is required to:





·
            refrain
                from issuing any shares of our common stock or securities convertible
                into
                our common stock without the consent of Markland for a period of
                twenty-six months, other than 1,000,000 shares to be issued under
                our 2006
                Stock Award Plan and certain permissible
                offerings;


·
            Maintain
                a board of directors consisting of five directors, not less than
                three of
                whom shall be “independent” directors as defined by the National
                Association of Securities Dealers;


·
            Comply
                with the corporate governance requirement set forth in the National
                Association of Securities Dealers’ Marketplace
                Rules;


·
            Submit
                an application for inclusion on The NASDAQ Capital Market and take
                all
                such actions as may be necessary to cause the application to be accepted;
                and


·
            Make
                twelve monthly payments, beginning in April 2006, in the amount of
                $83,333
                to Markland for certain services and other
                considerations.





Technest
      also granted Markland certain registration rights pursuant to which Technest
      is
      obligated to use its best efforts to register all or a portion of those shares
      of its common stock held by Markland, or any parties to whom Markland may
      transfer those shares, with the Securities and Exchange Commission for public
      resale. Such registrations are to be carried out from time to time, at our
      expense, upon the written request of Markland, with certain limitations. There
      are no liquidated damages provisions associated with these registration
      rights.





Pursuant
      to the terms of the Stockholder Agreement, Markland has agreed:





·
            For
                a period of twelve months from the date of the agreement, not to
                vote the
                shares held by it to increase the size of Technest’s board of directors or
                to remove any of the directors currently in
                office;


·
            To
                consent to Technest’s participation in up to two offerings of common stock
                in the next twelve months, provided that we do not offer shares of
                common
                stock in such an offering at a price of less than $5.85, and that
                Markland, and its assigns, be permitted to participate as a selling
                shareholder in any such offering.





License
      Agreement with Markland Technologies, Inc.





On
      March
      13, 2006, Technest entered into a license agreement with Markland (the “License
      Agreement”). Pursuant to the License Agreement, Technest granted Markland an
      exclusive, world-wide license to make, use and sell products and services based
      on its intellectual property, to parties other than federal, state or local
      government agencies involved in intelligence, military, law enforcement or
      homeland defense functions. The license granted by the License Agreement shall
      be in effect until all of its current patents or patent applications have
      expired or until such time as the License Agreement is terminated pursuant
      to
      its terms.





Pursuant
      to the terms of the License Agreement, Markland is required to pay us a royalty
      of twenty-five percent of the net gross profits, as defined in the License
      Agreement, they realize on any sale of any product or service utilizing the
      licensed intellectual property.





Additionally,
      if at the end of three years from the date of execution of the License
      Agreement, Markland has not realized enough net gross profits to generate an
      aggregate $300,000 of royalties, or $150,000 in royalties on an annual basis
      thereafter, the license shall become non-exclusive.





As
      a
      condition of the License Agreement, we are required to take all steps reasonably
      necessary to maintain our current patents and prosecute our current
      patent applications.





The
      License Agreement provides that Markland may cancel the agreement at any time
      upon 180 days notice. Technest may cancel the License Agreement if Markland
      fails to make a required royalty payment and does not cure such failure within
      thirty days of receiving notice of the failure or Markland violates the
      licensing terms of the License Agreement.





In
      conjunction with the License Agreement, Technest transferred inventory with
      a
      cost of $105,218 from Genex to Markland related to Genex’s commercial
      products.




24





**10. 
      INCOME TAXES**





There
      was
      no provision for federal or state income taxes for the three and nine months
      ended March 31, 2006 and 2005, due to the Company's operating losses and a
      full
      valuation reserve on deferred tax assets.





Since
      its
      acquisition by Markland, the Company files consolidated income tax returns
      with
      Markland and, for financial statement purposes, compute its provision or benefit
      for income taxes based on the income and expenses reporting in the Company’s
      statements of operations. The allocation is not subject to a tax sharing
      arrangement with Markland and it is based on the tax effect of the Company’s
      operations as if it had not been included in a consolidated return, based on
      the
      pre-acquisition book and tax basis of the Company’s assets and
      liabilities.




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





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





At
      March
      31, 2006, the Company had net operating loss carryforwards for federal income
      tax purposes of approximately $10,000,000, which will expire in various amounts
      through 2023.





**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 and former Technest director. 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 nine months ended March 31, 2006, Technest accrued an expense to Markland
      $750,000 for administrative support services, engineering services and services
      rendered by executive officers of Markland who, until March 13, 2006, also
      functioned as executive officers of Technest. During the nine months ended
      March
      31, 2006, EOIR paid Markland $1,800,000 in cash for amounts accrued at June
      30,
      2005 and subsequently.




The
        net
        amount due to Markland is $629,723 at March 31, 2006. These charges are
        related to cash advances, stock awards, shared expenses and transfer of
        inventory between Markland and Technest.





As
      of
      March 31, 2006, the Company is obligated under certain executive employment
      contracts and has agreed to pay Markland a total of $1,000,000 of cash over
      the
      next year (see Note 9).





**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.




25





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 nine months ended March 31, 2006 were
      $613,929.





**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
      May 17, 2006, the Company 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, Technest’s
      subsidiary 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.




26





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 On April
      10, 2006, a Second Amended Bill of Complaint seeking to join Technest as a
      defendant has been filed with the Court but no date has been requested for
      a
      hearing to determine if such an amendment would be allowed.





Greg
      & Mary Williams




Markland
      and Technest’s subsidiary 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.  On
      November 4, 2005, the Court heard the demurrer filed by EOIR Technologies,
      Inc.
      and Markland Technologies, Inc. and denied it. On April 6, 2006, a hearing
      was
      held in the Circuit Court for the City of Fredericksburg, Virginia on the
      William’s motion for summary judgment on certain claims brought by Mr. and Mrs.
      Williams relating to their severance payment. On May 4, 2006, the Court granted
      the Williams’ motion for summary judgment. The case is set for trial on November
      14, 15 and 16, 2006.




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





Since
      March 31, 2006, we have issued 78,264 shares of common stock valued at
      approximately $357,363 in satisfaction of liquidated damages arising under
      our
      Registration Rights Agreement dated February 14, 2005, as amended on October
      3,
      2005 and February 27, 2006.








**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.




27





**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”). 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.





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 intelligent surveillance, chemical and explosives detection, advanced
      technologies research and development and remote sensor systems and
      technologies. Our sources of operating revenue are from our wholly-owned
      subsidiaries, EOIR and Genex.




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.




28





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
      in Development*




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.·
            ACADA
                M22 Simulator - Training system that is a replica of the actual M22
                system
                and performs in the exact same way when simulated. Through a networked
                PDA
                that allows instructors to control random scenarios, permits remote
                control over multiple simulator units. The ACADA M22 Simulator reproduces
                all light sequence behaviors of the M22 system and uses actual unit’s
                alarm when agents are detected.




·
            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.




29




·
            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 remain 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.





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.




30





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.






**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 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.  Accordingly, the financial statements of Technest Holdings, 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.




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
      Technest because part of Markland’s control group, which occurred on February
      14, 2005. Additionally, Technest has included EOIR in its financial statements
      as though the transfer of EOIR occurred on that date.





As
      a
      result of these transactions, the results of operations for the three months
      and
      nine months ended March 31, 2005 are not comparable to the same periods in
      2006.




**Revenues**





Technest
      had $55,141,077 in revenue during the nine months ended March 31, 2006 compared
      with $7,448,800 for the same period in 2005. The prior period is not comparable
      as Technest acquired Genex and EOIR effectively on February 14, 2005. Technest
      had $17,855,160 in revenue during the three months ended March 31, 2006 compared
      with $7,448,800 for the comparable quarter in 2005.





Revenues
      from EOIR’s omnibus contract were $47,011,517 and $15,478,325 for the nine and
      three months ended March 31, 2006, respectively.





The
      increase in revenue was due to the acquisitions of EOIR and Genex, effectively
      February 14, 2005.





**Gross
      profit**





The
      gross
      profit for the nine months ended March 31, 2006 was $10,295,877, or 19% of
      revenue. The gross profit for the nine months and three months ended March
      31,
      2005 was $1,569,329 or 21% of revenue, reflecting the Genex and EOIR
      acquisitions from February 14, 2005. The gross profit for the three months
      ended
      March 31, 2006 was $3,237,084 or 18% of revenue.




31





**Selling,
      general and administrative expenses**





Selling,
      general and administrative expenses for the nine months ended March 31, 2006
      was
      $9,897,578 and consisted primarily of payroll. The same period in 2005 is not
      comparable but resulted in expenses of $1,673,405. Selling, general and
      administrative expenses for the three months ended March 31, 2006 and 2005
      were
      $3,586,344 and $1,574,374 respectively. Included in selling, general and
      administrative expenses, the amortization of compensatory element of stock
      issuances for the nine months ended March 31, 2006 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. Stock-based compensation
      for
      the nine months ending March 31, 2005 amounted to $152,155. Also included in
      selling, general and administrative expenses are management fees accrued to
      Markland. These amounted to $750,000 and $250,000 for the nine and three months
      ended March 31, 2006, respectively. Management fees to Markland accrued in
      the
      three and nine months ended March 31, 2005 were $187,500. 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 nine months and three months ended March 31,
      2006 were $138,448 and $-0-, respectively. These expenditures 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. Research and development expenses for the nine
      months and three months ended March 31, 2005 were $2,095,000. This charge was
      attributable to non-cash in process research and development written off on
      the
      acquisition of Genex. This amount was determined by management in consideration
      of a number of factors, including an independent purchase price allocation
      for
      Genex obtained as of the acquisition date and related to research and
      development projects in-process as of the acquisition date which have not
      reached technological feasibility and for which no alternative use exists.
      The
      projects in process were in the areas of intelligent surveillance,
      three-dimensional imaging, and medical imaging.





**Amortization
      of intangible assets**





Amortization
      of intangible assets for the nine and three months ended March 31, 2006 were
      $1,339,634 and $446,512, respectively. Amortization expense increased in 2006
      because of the amortization of definite-lived intangible assets acquired in
      conjunction with Genex and EOIR effectively in February 2005. Amortization
      of
      intangible assets for the nine and three months ended March 31, 2005 was
      $163,264.





**Operating
      loss**





The
      operating loss for the nine and three months ended March 31, 2006 were
      $1,079,783 and $795,772, respectively. The operating loss for the nine and
      three
      months ended March 31, 2005 were $2,362,340 and $2,263,309,
      respectively.





**Interest
      expense and other income**





Interest
      expense for the nine months and three months ended March 31, 2006 were
      $2,359,289 and $763,469, 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 $220,195 and $73,398 in the nine and three months ended March 31, 2006,
      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
          nine and three months ended March 31, 2006, Technest charged to interest
          expense
          $1,600,000 and $545,000, respectively, (including $1,500,000 and $350,000,
          respectively, paid in common stock) related to liquidated damages paid
          for
          failure to have an effective registration statement .
          On
          September 30, 2005, the Company amended the terms of its Registration Rights
          Agreement such that any liquidated damages would only be payable in common
          stock. As a result of this amendment, the Company was able to conclude
          that the
          warrants could be settled in unregistered shares. Therefore, the warrants
          were
          no longer required to be recorded as derivative liabilities and there have
          been
          no additional derivative income (loss) recorded related to these warrants
          since
          that datederivative
          income represents the change in the fair value of certain warrants issued
          by
          Technest on February 14, 2005. These warrants did not meet the requirements
          for
          classification as equity instruments since the Company could not conclude
          that
          the warrants were settleable in unregistered shares of its common stock.
          As a
          result, the Company was required to reflect these warrants as derivative
          liabilities on the balance sheet. Each period, the change in the fair value
          of
          the warrants was charged (credited) to the statement of operations. In
          the nine
          months ended March 31, 2006, the change in the fair value of the warrants
          recorded as derivative income in the statements of operations was $25,046,489.
          Derivative income had no impact of the Company’s cash flows and none of the
          warrants have been settled in cash. The Company determined the fair value
          of the
          warrants using the Black-Scholes option pricing model. Excluding derivative
          income would have resulted in pro forma net loss applicable to common
          shareholders of ($3,320,261) for the nine months ended March 31, 2006.
          Pro forma
          basic and diluted loss per common share would have been ($0.22) for the
          same
          period.




32


Interest
        expense for the nine months and three months ended March 31, 2005 were $212,794
        and $205,104, respectively, including non-cash interest expense related to
        the
        amortization of the EOIR notes discount of $36,698.
  Other
        income for the nine and three months ended March 31, 2006 were $118,811 and
        $35,633, respectively, and represents interest received on cash balances.
        Other
        income for the nine and three months ended March 31, 2005 was
        $11,344.





**LIQUIDITY
      AND CAPITAL RESOURCES**





**Cash
      and Working Capital**




On
          March
          31, 2006, Technest had a negative working capital balance of $3,523,666.
          Technest’s current liabilities include $629,723 due to Markland, Technest’s
          parent company. Net cash used in operating activities was $3,038,654 for
          the
          nine months ended March 31, 2006. Non-cash expenses included in the net
          income
          totaled $3,436,623 and non-cash income was $25,046,489, while changes in
          the
          components of working capital used cash of $3,155,016. Most of the change
          in
          working capital was related to a reduction of amounts due to related parties
          and
          trade payables by $4,090,807.




**Cash
      Used in Investing Activities**





In
      the
      nine months ended March 31, 2006, Technest used cash of $286,178 for the
      acquisition of property and equipment and received cash of $29,956 upon the
      sale
      of certain equipment.





**Cash
      Used in Financing Activities**





In
      the
      nine months ended March 31, 2006, $656,157 was used for loan
      repayments.




**Sources
      of Liquidity**





During
      the nine months ended March 31, 2006, we 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.





**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 374,286 shares of common
      stock. However, due to the net share settlement provisions of these warrants,
      Technest does not expect any material cash proceeds upon exercise.




**Effect
      of inflation and changes in prices**




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




**CRITICAL
      ACCOUNTING POLICIES**




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




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




33





**PRINCIPLES
      OF CONSOLIDATION**




Our
      consolidated financial statements as of March 31, 2006 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
      March 31, 2006, 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.




**RESEARCH
      AND DEVELOPMENT**




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





No
      new
      technologies were acquired during the nine months ended March 31, 2006 and
      as
      such there are no capitalized or expensed in-process research and development
      costs during this period relating thereto. During the nine months ended March
      31, 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 nine months ended March 31, 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 purchase price allocation analysis 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.




34





**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.




**IMPAIRMENT
      OF LONG-LIVED ASSETS**




Pursuant
      to SFAS No. 144, we continually monitor events and changes in circumstances
      that
      could indicate carrying amounts of long-lived assets may not be recoverable.
      We
      recognize an impairment loss when the carrying value of an asset exceeds
      expected cash flows. Accordingly, when indicators or impairment of assets are
      present, we evaluate the carrying value of such assets in relation to the
      operating performance and future undiscounted cash flows of the underlying
      business. Our policy is to record an impairment loss when we determine that
      the
      carrying amount of the asset may not be recoverable. No impairment charges
      were
      recorded in the nine months ended March 31, 2006 and 2005.




**REVENUE
      RECOGNITION**




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





Revenues
      from time and materials contracts are recognized as costs are incurred. Revenues
      from firm fixed price contracts are recognized on the percentage-of-completion
      method, either measured based on the proportion of costs recorded to date on
      the
      contract to total estimated contract costs or measured based on the proportion
      of labor hours expended to date on the contract to total estimated contract
      labor hours, as specified in the contract. However, during the nine months
      ended March 31, 2006 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. Revenues under teaming arrangements amounted to $3,597,800
      and
      $978,487 for the nine months and three months ended March 31, 2006.




35





**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.





36




**RISK
      FACTORS**





*Any
      investment in our common stock involves a high degree of risk. You should
      consider carefully the risks described below and elsewhere in this report before
      you decide to buy our common stock. If any of the following risks, or other
      risks not presently know to us or that we currently believe are not material,
      develop into an actual event, then our business, financial condition and results
      of operations could be adversely affected. In that case, the value of the
      securities could fall and you may lose all or part of the money you paid to
      buy
      the securities. 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 a limited operating history. As a result, it may be difficult to evaluate
      our prospects for profitable operations and our ability to produce a positive
      return on Genex or EOIR.**




Technest
      has a limited operating history on which a potential investor may base an
      evaluation of us, our prospects and our 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 March 31,
        2006, our accumulated deficit was $13,764,375.
        If Technest continues to suffer losses as it has in the past, investors may
        not
        receive any return on their investment and may lose their entire
        investment.




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




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




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




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




We
      have
      rapidly and significantly expanded our 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:




37




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




·
            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 result
      in
      additional expenses, which could harm our business.**




We
      have
      made significant acquisitions in the past, and we plan to continue to review
      potential acquisition candidates, and our business plan includes building our
      business through strategic 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 the assimilation 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 acquisitions
      of EOIR and Genex, 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 and Genex, 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.




38





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




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




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




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




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




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




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




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




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




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




·
            timing
                of orders from our largest customers - the DOD, Homeland Security,
                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.




39





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 derive 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 (including revenue already recognized) depending
      upon
      the U.S. Army's needs of which our subsidiary, EOIR, recognized in excess of
      approximately $23.9 million in revenues for the six months ended June 30, 2005
      or 85% of our total consolidated revenues during that period. For the year
      ended December 31, 2004, we recognized $52.8 million in revenues under this
      contract and 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 or be increased
      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.




40





**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.





**Our
      Government contracts contain numerous provisions that are unfavorable to us.**




Government
      contracts, including ours, contain provisions and are subject to laws and
      regulations that give the government rights and remedies, some of which are
      not
      typically found in commercial contracts, including allowing the Government
      to:




•
            
            cancel
                multi-year contracts and related orders if funds for contract performance
                for any subsequent year become unavailable;




•
            
            claim
                rights in systems and software developed by us;




•
            
            suspend
                or debar us from doing business with the Government or with a Government
                agency, impose fines and penalties and subject us to criminal prosecution;
                and




•
            
            control
                or prohibit the export of our data and technology.




If
      the
      Government terminates any of our contracts for convenience, we may recover
      only
      our incurred or committed costs, settlement expenses and profit on work
      completed prior to the termination. If the Government terminates any of our
      contracts for default, we may be unable to recover even those amounts, and
      instead may be liable for excess costs incurred by the Government in procuring
      undelivered items and services from another source. Depending on the value
      of
      the particular contract, that type of termination could cause our actual results
      to differ materially from those anticipated. Our Government contracts also
      contain organizational conflict of interest clauses that limit our ability
      to
      compete for certain related follow-on contracts. For example, when we work
      on
      the design of a particular system, we may be precluded from competing for the
      contract to install that system. As we grow our business, we expect to
      experience organizational conflicts of interest more frequently. Depending
      upon
      the value of the matters affected by an organizational conflict of interest
      issue that precludes our participation in a program or contract could cause
      our
      actual results to differ materially from those anticipated.




41





**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 unable to provide 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.




**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.




42





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




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





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




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




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





**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.




43





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 May
      17, 2006, Markland controlled approximately 85% 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.
      Further, pursuant to the Stockholder Agreement entered into between Markland
      and
      Technest on March 13, 2006, Markland agreed for a period of twelve months from
      the date of the agreement, not to vote the shares held by it to increase the
      size of our board of directors or to remove any of the directors currently
      in
      office.




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




While Mr. Pereira’s employment agreement provides that he shall spend no less
      than 60% of his time working for Technest, there can be no assurance competing
      demands on Mr. Pereira at a given time will not result in an allocation of
      time
      and resources unfavorable to us. Neither our organizational documents nor our
      policies specify a minimum standard of time and attention that our officers
      and
      directors are required to devote to us, and there can be no assurance that
      conflicts of interest will not arise.





**Risks
      Related To Capital Structure**




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




Pursuant
      to the terms of the Merger Agreement and the Registration Rights Agreements
      executed on February 14, 2005, as amended, in connection with our acquisition
      of
      Genex, Technest was obligated to file one or more registration statements with
      the Securities and Exchange Commission covering the shares that are being
      registered pursuant to a registration statement, which has not yet been declared
      effective by the Securities and Exchange Commission. In addition, we are
      obligated to registered shares held by Markland or any of its transferees.
      Our
      common stock is thinly traded. The registration of these shares for public
      resale may result in a greater number of shares being available for trading
      than
      the market can absorb. This may cause the market price of our common stock
      to
      decrease.




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




The
      significant downward pressure on our stock price caused by the sale of a
      significant number of 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.




44





**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.




**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.




45





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




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




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




Our
      stock
      price has been volatile. From January 2003 to May 17, 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.




46





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




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





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




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




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




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




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




**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.





47





**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 nine months ended March
      31,
      2006 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.




48





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




**ITEM
      1.  Legal Proceedings**




*Technest
      Holdings, Inc.*





On
      or
      about July 23, 1998, H & H Acquisition Corporation, individually and
      purportedly on behalf of Technest Holdings, commenced an action in United States
      District Court, Southern District of New York entitled H & H Acquisition
      Corp., individually and on behalf of Technest Holdings, Inc. v. Financial
      Intranet Holdings, Inc. Technest Holdings, Inc., F/K /A Financial Intranet,
      Inc., Ben Stein, Interwest Transfer Co., Steven A. Sanders, Michael Sheppard,
      Maura Marx, Henry A. Schwartz, Leonard Gotshalk, Gotshalk Enterprises, Law
      Office of Steven A. Sanders, P.C. and Beckman, Millman & Sanders, LLP, 98
      Civ. 5269 The 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 plaintiff. The plaintiff asserts sixteen
      causes of action. Only some make allegations against Technest Holdings, Inc.,
      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.




In
      September 2002, Technest was served with a Summary Judgment Motion regarding
      H
& H Acquisition Corp. and we answered the motion in November 2002. On
      January 3, 2005, the court denied the motion for summary judgment. On November
      23, 2005, Technest was notified that the trial of this matter, which was
      scheduled to begin on January 4, 2006, was postponed by the trial judge. As
      of
      May 17, 2006, Technest has not been notified of a new trial date.





*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, Technest’s
      subsidiary EOIR, and our former Chief Executive Officer and former 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.




49





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 there under. 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 May 17, 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 alleging breach of an
      employment contract by EOIR was dismissed with prejudice by the Court On April
      10, 2006, a Second Amended Bill of Complaint seeking to join Technest as a
      defendant has been filed with the Court but no date has been requested for
      a
      hearing to determine if such an amendment would be allowed.




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, seeking
      damages in the amount of $3,000,000 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. On November 4, 2005,
      the
      Court heard the demurrer filed by EOIR Technologies, Inc. and Markland
      Technologies, Inc. and denied it. On April 6, 2006, a hearing was held in the
      Circuit Court for the City of Fredericksburg, Virginia on the William’s motion
      for summary judgment on certain claims brought by Mr. and Mrs. Williams relating
      to their severance payment. On May 4, 2006, the court granted the Williams’
motion for summary judgment. The case is set for trial on November 14, 15 and
      16, 2006.




50





**ITEM
      6.  EXHIBITS**




Exhibit
                  No.
              Description
              Filed
                  with this Quarterly Report
              Incorporated
                  by referenceForm
              Filing
                  Date
              Exhibit
                  No.4.1
              Amendment
                  No. 2 to Registration Rights Agreement dated February 27, 2006
                  among
                  Technest Holdings, Inc., Verdi Consulting, Inc., ipPartners, Inc.,
                  Southridge Partners LP and Southshore Capital Fund, Ltd., amending
                  the
                  Registration Rights Agreement dated February 14, 2005 among these
                  parties.
              
              8-K
              March
                  2, 2006
              4.210.1
              Stockholders’
                  Agreement between Markland Technologies, Inc. and Technest Holdings,
                  Inc.
                  dated March 13, 2006.
              
              8-K
              March
                  16, 2006
              10.110.2
              License
                  Agreement between Markland Technologies, Inc. and Technest Holdings,
                  Inc.
                  dated March 13, 2006.
              
              8-K
              March
                  16, 2006
              10.210.3
              Employment
                  Agreement between Joseph P. Mackin and Technest Holdings, Inc.
                  dated March
                  13, 2006.
              
              8-K
              March
                  16, 2006
              10.310.4
              Employment
                  Agreement between Gino M. Pereira and Technest Holdings, Inc. dated
                  March
                  13, 2006.
              
              8-K
              March
                  16, 2006
              10.410.5
              Form
                  of Restricted Stock Agreement between Joseph P. Mackin and Technest
                  Holdings, Inc.
              
              8-K
              March
                  16, 2006
              10.510.6
              Form
                  of Restricted Stock Agreement between Gino M. Pereira and Technest
                  Holdings, Inc.
              
              8-K
              March
                  16, 2006
              10.610.7
              Release
                  and Indemnification Agreement between Robert Tarini and Technest
                  Holdings,
                  Inc. dated March 13, 2006.
              
              8-K
              March
                  16, 2006
              10.710.8
              Technest
                  Holdings, Inc. 2006 Stock Award Plan.
              
              8-K
              March
                  16, 2006
              10.831.1
              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





**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:
                    January 24, 2007
                By:
                /s/
                    Joseph P.
                    Mackin
                  Joseph
                    P. Mackin
                  Chief
                    Executive Officer and PresidentDate:January
                    24, 2007
                By:
                /s/
                    Gino M.
                    PereiraGino
                    M. Pereira
                  Chief
                    Financial Officer


52





**Exhibit
      Index**


Exhibit
                      No.
                  Description
                  Filed
                      with this Quarterly Report
                  Incorporated
                      by referenceForm
                  Filing
                      Date
                  Exhibit
                      No.4.1
                  Amendment
                      No. 2 to Registration Rights Agreement dated February 27, 2006
                      among
                      Technest Holdings, Inc., Verdi Consulting, Inc., ipPartners,
                      Inc.,
                      Southridge Partners LP and Southshore Capital Fund, Ltd., amending
                      the
                      Registration Rights Agreement dated February 14, 2005 among
                      these
                      parties.
                  
                  8-K
                  March
                      2, 2006
                  4.210.1
                  Stockholders’
                      Agreement between Markland Technologies, Inc. and Technest
                      Holdings, Inc.
                      dated March 13, 2006.
                  
                  8-K
                  March
                      16, 2006
                  10.110.2
                  License
                      Agreement between Markland Technologies, Inc. and Technest
                      Holdings, Inc.
                      dated March 13, 2006.
                  
                  8-K
                  March
                      16, 2006
                  10.210.3
                  Employment
                      Agreement between Joseph P. Mackin and Technest Holdings, Inc.
                      dated March
                      13, 2006.
                  
                  8-K
                  March
                      16, 2006
                  10.310.4
                  Employment
                      Agreement between Gino M. Pereira and Technest Holdings, Inc.
                      dated March
                      13, 2006.
                  
                  8-K
                  March
                      16, 2006
                  10.410.5
                  Form
                      of Restricted Stock Agreement between Joseph P. Mackin and
                      Technest
                      Holdings, Inc.
                  
                  8-K
                  March
                      16, 2006
                  10.510.6
                  Form
                      of Restricted Stock Agreement between Gino M. Pereira and Technest
                      Holdings, Inc.
                  
                  8-K
                  March
                      16, 2006
                  10.610.7
                  Release
                      and Indemnification Agreement between Robert Tarini and Technest
                      Holdings,
                      Inc. dated March 13, 2006.
                  
                  8-K
                  March
                      16, 2006
                  10.710.8
                  Technest
                      Holdings, Inc. 2006 Stock Award Plan.
                  
                  8-K
                  March
                      16, 2006
                  10.831.1
                  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
   53