**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**






**FORM
      10-KSB**






x
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**For
                the Fiscal Year Ended June 30, 2006.o
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**


**Commission
      File Number 000-27023**








**Technest
      Holdings, Inc.**





( *Exact
      name of Registrant as specified in its Charter* )








**Nevada**
              (*State
                or other jurisdiction*
              *of
                incorporation or organization*)
              
              **One
                McKinley Square, Fifth Floor, Boston, MA**
              (*Address
                of principal executive offices*)
              
              **276
                Washington Street, No. 367, Boston, MA 02108**
              *(Mailing
                Address)*
            **88-0357272**
              (*I.R.S.
                Employer Identification No.*)
              
              
              **02109**
              *(Zip
                Code)*







**Issuer’s
      Telephone Number: (617) 722-9800**






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




**Title
                of Class**
            
            **Name
                of each exchange on which registered**None
            
            Not
                Applicable







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




**Common
      Stock, par value $0.001 per share**


(Title
      or
      Class)






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




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




The
      issuer’s revenues for the year ended June 30, 2006 were
      $81,092,049.





The
      number of shares outstanding of the issuer’s class of Common Stock, as of
      October 9, 2006 is 16,241,663, $.001 par value. Of this number, a total of
      2,764,256 shares, having an aggregate market value of $5,528,512 based on the
      closing price of the issuer’s common stock of $2.00 on October 9, 2006 as quoted
      on the Electronic Over-the-Counter Bulletin Board (“OTCBB”), were held by
      non-affiliates* of the issuer.







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







**APPLICABLE
      ONLY TO CORPORATE REGISTRANTS**




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




16,241,663
      shares as of October 9, 2006, all of one class of common stock, $0.001 par
      value.









**DOCUMENTS
      INCORPORATED BY REFERENCE**




Documents
      Incorporated by reference: None




Transitional
      Small Business Disclosure Format (check one): Yes [   ]  No [X]







**TECHNEST
      HOLDINGS, INC.**


**FORM
      10-KSB**


**TABLE
      OF CONTENTS**


**June
      30, 2006**







**Part
                I**Item
                1.
            Description
                of Business
            1Item
                2.
            Description
                of Property
            10Item
                3.
            Legal
                Proceedings
            11Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            12**Part
                II**Item
                5.
            Market
                for Common Equity and Related Stockholder
                Matters
            13Item
                6.
            Management’s
                Discussion and Analysis
            14Item
                7.
            Financial
                Statements
            F-1Item
                8.
            Changes
                in and Disagreements With Accountants on Accounting
                and Financial Disclosures
            37Item
                8A.
            Controls
                and Procedures
            37Item
                8B
            Other
                Information
            37**Part
                III**Item
                9.
            Directors
                and Executive Officers of the Registrant;
                Compliance with Section 16(a) of the Exchange Act
            38Item
                10.
            Executive
                Compensation
            38Item
                11.
            Security
                Ownership of Certain Beneficial Owners and
                Management
            38Item
                12.
            Certain
                Relationships and Related
                Transactions
            38Item
                13.
            Exhibits
            39Item
                14.
            Principal
                Accountant Fees and Services
            46




-i-




*NOTE
      REGARDING FORWARD-LOOKING STATEMENTS*




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




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




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




The
      information contained in this report has been retroactively adjusted to reflect
      a 1-for-211.18 reverse stock split of our common stock effective July 19, 2005,
      where we exchanged 211.18 shares of common stock for one new share of common
      stock, thereby reducing the number of shares outstanding.






-ii-




**PART
      I**





**Item
      1. Description of Business**





**General**





Technest
      Holdings, Inc. provides advanced technology, products, and services to the
      defense and homeland security marketplaces. We work closely with the U.S.
      military, major defense prime contractors, and government intelligence agencies
      to develop advanced electronic systems, devices, and equipment. We remain
      aligned with the needs of the U.S. Government and the U.S. Department of Defense
      by focusing on intelligence, surveillance, reconnaissance, communication and
      network systems, and systems integration. Through our operating subsidiaries,
      we
      have been serving the military and government sectors for over 25 years.





**Company
      Organization**





We
      operate in five principal technical areas: Advanced Sensor Systems, Imaging
      and
      Intelligence Solutions, Operational Management, Intelligent Surveillance, and
      Chemical and Explosive Detection.





**Advanced
      Sensor Systems**





Advanced
      Sensor Systems is engaged in design, research and development, systems
      integration, sustainment, support, and upgrade of advanced sensor systems for
      the U.S. military; this includes high performance targeting and surveillance
      sensors, driving enhancements, rifle sights, fusion and automatic target
      recognition, mine and minefield detection, mine neutralization, minefield
      breaching, sensor system performance modeling and analysis, virtual prototyping,
      simulation-based analyses, high-performance multi-color Focal Plane Arrays
      (FPA), multi-function lasers, distributed sensor networks, Long Wavelength
      Infrared (LWIR) and Short Wavelength Infrared (SWIR) arrays, unattended ground
      sensors, and rapid prototyping.





The
      majority of the work performed by Advanced Sensor Systems is carried out through
      an Omnibus Contract with the United States Army Night Vision and Electronic
      Sensors Directorate. We retain non exclusive rights to sell the technologies
      that we develop under this contract. Our main products include Interchangeable
      Wide Area Search Surveillance System (IWAS 3 ),
      Safety
      Evaluation Range Training System (SERTS TM ),
      Universal Sensor Remoting Device (USRD), Pelco Camera Translators,
      WinProc TM ,
      IProc TM ,
      GPS
      GroundTruther, TTAASP TM ,
      and
      EOIRTA TM .





IWAS 3 is a
      passive multi-spectrum mast-mounted surveillance system that delivers complete
      360-degree long-range surveillance, reconnaissance, and protection. It is
      currently in design based on a request from the Army’s Night Vision and
      Electronic Sensors Directorate.





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





IProcTM
is
      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.


-1-


GPS
      GroundTruther is a software based tool that can be used to keep accurate
      positioning information for multiple vehicles during field tests.





TTAASPTM
      and EOIRTATM are software based tools that assist in predictive modeling of
      thermal targets and are used to calculate detection probabilities of targets
      at
      arbitrary angles and ranges.





**Imaging
      and Intelligence Solutions**





Imaging
      and Intelligence Solutions is engaged in the design, research and development,
      integration, analysis, modeling, and training of classified solutions in support
      of the United States’ intelligence community and homeland security.





We
      provide support to the National Geospatial-Intelligence Agency (NGA) College,
      including program management support, curriculum development and instruction
      in
      Geospatial and Imaging Analysis, Advanced Geospatial Intelligence, and
      Measurements and Signal Intelligence. We develop core curriculum: platform,
      web-
      and computer-based training; and maintain the Soft Copy Keys Program. We develop
      specialized tools and algorithms for atmospheric computation and full-spectrum
      signal processing, promote imaging standards, evaluate new technology, assist
      users with Advanced Geospatial Intelligence technologies, and maintain spectral
      libraries used throughout the Intelligence Community. For the National Ground
      Intelligence Center, we provide systems modeling, intelligence analysis for
      military operations and disaster relief, and we develop and integrate remote
      triggering devices and monitoring stations used in field testing and air-and
      ground-based sensor analysis. We support maritime advanced geospatial imagery
      exploitation and counter drug operations, as well as all-source analysis for
      Army operational forces.





**Operational
      Management**





Operational
      Management is engaged in the program management, integration, training,
      logistics, analysis, and field support of numerous projects for the U.S.
      military.





We
      provide program management support for the Marine Corps Systems Command (MCSC),
      which includes providing logistical support of current projects and integration
      with legacy systems. We also are assisting in the development of the
      Electro-Optical Test Facility (EOTF) for the Program Manager Optics and
      Non-Lethal Systems (PM ONLS). This encompasses the full life-cycle of the test
      facility; as we will design the facility, oversee the procurement of equipment,
      develop standard operating procedures, and manage the thermal testing portion
      of
      the lab. We provide systems integration, board design, training, and field
      support for products, such as DoubleShot, which is currently actively deployed
      in Operation Iraqi Freedom (OIF) in support of the Marine Corps Warfighting
      Lab
      (MCWL). In addition, we represent the Marine Corps in the joint development
      of
      Joint Chemical Agent Detector (JCAD), Joint Service Light Standoff Chemical
      Agent Detector (JSLSCAD), Joint Service Light Nuclear, Biological, Chemical,
      Reconnaissance System (JSLNBCRS), as well as other engineering technology in
      support of the MCSC Chemical, Biological, Radiological, Nuclear Defense (CBRND)
      team. This support consists of testing emerging technology, providing logistical
      support and management of legacy systems. We also provide systems integration
      support for the Directed Energy Technology Office (DETO) at Naval Surface
      Warface Center Dahlgren Division (NSWCDD) integrating various sensors, such
      as
      Driver Viewer Enhancer and Blue Force Tracker, into a prototype directed energy
      system in support of OIF.





**Intelligent
      Surveillance**





Intelligent
      Surveillance is engaged in the design, research and development, integration,
      analysis, modeling, system networking, and support of advanced surveillance
      and
      three-dimensional imaging devices and systems.





We
      provide full life-cycle support, technology, and very specialized expertise
      in
      the areas of real-time embedded image processing, software and systems
      engineering, as well as three-dimensional facial recognition. We also develop
      re-configurable, multi-sensor systems with unique, nonstandard architectures.
      In
      addition, we develop sensors for detection of concealment of intent using
      thermal and three-dimensional imaging, devices for early detection of cancer
      using non-invasive and non-radiological diffuse optical tomography, and more
      effective and less risky radiation treatments for cancer by using
      three-dimensional imaging for patient re-positioning. Our major products include
      our OmniEyeTM Wellcam, OmniEyeTM Cerberus, Smart Optical Sensor (SOS), Smart
      SuiteTM, Omnivision, Small Tactical Ubiquitous Detection System (STUDS), and 3D
      SketchArtist.





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





-2-


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





OmniVision
      is a software platform for a 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.





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





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





**Chemical
      and Explosive Detection**





Chemical
      and Explosive Detection is engaged in the design, research and development,
      software and hardware engineering, integration, training, and networking of
      advanced Chemical/Biological and Improvised Explosive Devices (IED) detection
      sensors.





We
      provide technologies that reliably detect the presence of chemical, biological,
      and explosive devices or components from stand-off distances utilizing
      multi-spectral electro-optical sensing methods. We also provide
      Chemical/Biological and IED simulators and real-time training devices with
      product specific specifications. Our major products include our Shipboard
      Automatic Chemical Agent Detection and Alarm (ACADA), Automated, Adaptive
      Chemical Examination System (AACES), and M22 Simulator.





The
      Shipboard ACADA is a man-portable point detection system used to detect all
      classic nerve and blister agents as well as other chemical warfare agent vapors.
      The system is easily upgradeable for new agents. Designed for and patented
      by
      the U.S. Navy, it can operate in a shipboard environment and detect agents
      at
      low concentrations in real time. It also has visible and audible alarms.





AACES
      is
      a Fourier Transform Infrared (FTIR) spectrometer-based chemical detector that
      not only detects but also identifies chemicals at standoff ranges of several
      kilometers and can do so passively, at a distance safe from danger to the user.
      The system can also transmit data wirelessly to a PDA, allowing the user to
      be
      at even greater standoff ranges.





The
      M22
      Simulator is a training system that is a replica of the actual M22 system and
      simulates the operation of the M22 ACADA when activated. Through a networked
      PDA
      that allows instructors to control random scenarios, the system permits remote
      control over multiple simulator units. The M22 Simulator reproduces all light
      sequence behaviors of the M22 system and uses a recording of the actual unit’s
      alarm when stimulants are detected.





**Business
      Strategy**





Moving
      forward it is our goal to continue to strengthen our position as a niche
      supplier of very advanced electronic devices and systems. The strategies that
      we
      have in place to achieve this goal are outlined below:





·
            Leverage
                existing relationships with government agencies to help fund product
                development;





·
            Utilize
                relationships with current industry partners to bring technology
                to
                market;





·
            Develop
                and expand upon our existing technologies and
                services;





·
            Offer
                more fully integrated services and
                products;





·
            Continue
                to develop a robust intellectual property portfolio for licensing
                and
                partnership purposes; and





·
            Seek
                strategic acquisitions.


-3-


**Technest
      History**





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




On
      March
      25, 2003, we sold all outstanding shares of Technest.com, Inc. (a subsidiary
      of
      Technest Holdings, Inc.) to Aberdeen Avenue LLC for the purchase price of $1.00.
      As a result of this sale, we reversed $2,234,428 of the subsidiary’s liabilities
      which was recorded as other income during the second quarter 2003.




On
      April
      1, 2003, we exchanged all of our shares in Corpfin.com, Inc. with six
      shareholders in return for 16,261,822 shares of our common stock. Thereafter
      we
      retired these shares. On October 10, 2003, we filed a Form N-54C withdrawing
      our
      election to be treated as a business development company.




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





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





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





In
      connection with the financings of the acquisition of Genex, Technest entered
      into a Registration Rights Agreement dated February 14, 2005 with the investors
      in the financing. Pursuant to this agreement, Technest agreed to file a
      registration statement covering the resale of all of the common stock issuable
      upon conversion of the Series C preferred stock, (b) all of the common stock
      issuable upon exercise of the common stock purchase warrants, and (c) common
      stock which may become issuable to selling stockholders as liquidated damages
      for breach of covenants contained in or as a result of adjustments contemplated
      by the securities purchase agreement and the registration rights agreement.
      Failure to comply with the terms of this agreement triggers liquidated damages
      that accrue at a rate of 4% of the initial subscription amount for any month,
      or
      pro-rata portion thereof, during which a condition giving rise to liquidated
      damages shall continue, and such damages shall be paid in Technest common stock.


-4-


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





*Acquisition
      of EOIR* . On
      August
      17, 2005, pursuant to a Stock Purchase Agreement with Markland, our majority
      stockholder, we purchased all of the outstanding stock of EOIR, formerly one
      of
      Markland’s wholly-owned subsidiaries. As consideration for the stock of EOIR, we
      issued 12 million shares of our common stock to Markland, and, as a result,
      Markland’s ownership of Technest increased at the time of the transaction from
      85% to approximately 98% on a primary basis and from 39% to approximately 82%
      on
      a fully diluted basis (assuming the conversion of all of our convertible
      securities and the exercise of all warrants to purchase Technest common stock).
      This reorganization did not result in a change of control of EOIR. We did not
      need stockholder consent in order to complete this reorganization.
 Markland acquired EOIR on June 29, 2004.  EOIR generated
      approximately 97% of Markland’s revenue for fiscal 2005.





Because
      Markland continues to own a majority interest in Technest, Markland will
      continue to include Technest results in its consolidated financial
      statements.





**Competition**





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





We
      have
      particular proprietary technologies, some that have been developed and others
      that are in development. We will focus on our proprietary technologies, or
      leverage our management experience, in order to differentiate ourselves from
      these organizations. There are many other technologies being presented to the
      Department of Homeland Security that directly compete with our technologies.
      The
      Department of Homeland Security may pursue solutions different from
      ours.





**Intellectual
      Property**





Our
      ability to compete effectively depends to a significant extent on our ability
      to
      protect our proprietary information. We rely primarily on patents and trade
      secret laws and confidentiality procedures to protect our intellectual property
      rights. We own 12 U.S. patents. We enter into confidentiality agreements with
      our consultants and key employees, and maintain controls over access to and
      distribution of our technology, software and other proprietary information.
      The
      steps we have taken to protect our technology may be inadequate to prevent
      others from using what we regard as our technology to compete with
      us.





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





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





-5-


**Dependence
      On U.S. Government Contracts**





Almost
      all of our range of services and products are sold to agencies of the U.S.
      Government. Although we are continuously working to diversify our client base,
      we will continue to aggressively seek additional work from the U.S. Government.
      As with other government contractors, our business is subject to government
      client funding decisions and actions that are beyond our control.





Much
      of
      our business is won through submission of formal competitive bids. Commercial
      bids are frequently negotiated as to terms and conditions for schedule,
      specifications, delivery and payment. With respect to bids for government work,
      however, in most cases the client specifies the terms and conditions and the
      form of contract.





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





**Government
      Regulation**





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





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





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





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





**Sales
      and Marketing**





We
      currently divide the marketing efforts of our products and services into three
      areas: (1) directly to federal or local government agencies; (2) to large
      partners who may represent an opportunity for us as subcontractors; and (3)
      to
      commercial entities. These marketing duties are divided among senior
      management.





**Manufacturing**





Our
      primary manufacturing facilities are located in Spotsylvania, Virginia.





**Employees**





As
      of
      October 9, 2006, Technest Holdings had a total of 193 employees, 161 of which
      are full-time employees of our wholly-owned subsidiary, EOIR, 12 of which are
      part-time employees of EOIR and 20 of which are full-time employees of our
      wholly-owned subsidiary, Genex Technologies. We believe our future success
      will
      depend upon the continued service of our key technical and senior management
      personnel and upon our continued ability to attract and retain highly qualified
      technical and managerial personnel. None of our employees is represented by
      a
      labor union. We have never experienced a work stoppage and consider our
      relationship with our employees to be good.


-6-


**Recent
      Transactions**





**Bank
      Financing**





On
      August
      10, 2006, Technest and its wholly-owned subsidiaries, E-OIR and Genex, closed
      on
      a financing (the “Financing”) under two Loan and Security Agreements with
      Silicon Valley Bank (the “Bank”) executed on August 4, 2006 (the “Credit
      Agreements”). One Credit Agreement provides for a term loan facility under which
      the Company may borrow term loans with an initial minimum loan of $3,000,000
      (the “Term Loan Facility”). Subject to the Bank’s receipt of additional
      documentation for the period through the month ending December 31, 2006 and
      if
      no event of default under the Credit Agreement has occurred or is continuing,
      we
      may borrow up to an additional $1,000,000 under the Term Loan Facility on or
      before February 15, 2007. The other Credit Agreement provides for a one year
      revolving line of credit for up to $8,750,000 (the “Revolver”), provided that
      our borrowing under the Revolver is limited to 80% of our eligible accounts
      receivable. In addition, the maximum amount outstanding under both Credit
      Agreements at any time may not exceed $10,000,000. Both the Term Loan Facility
      and the Revolver are secured by all of our assets and the assets of our
      subsidiaries, including all of our intellectual property and of our
      subsidiaries





Upon
      the
      date of closing under the Credit Agreements, we borrowed the entire $3,000,000
      available under the Term Loan Facility and borrowed approximately $4,445,000
      under the Revolver.





Interest
      on all outstanding amounts under the Term Loan is payable monthly at a rate
      equal to the Bank’s prime rate plus 2.75%. This interest rate will be reduced to
      (i) the Bank’s prime rate plus 2.00% if we achieve a Fixed Charge Coverage Ratio
      (as defined in the Credit Agreement with respect to the Term Loan Facility)
      of
      at least 1.75 to 1.0 for three consecutive fiscal quarters after August 4,
      2006
      or (ii) the Bank’s prime rate plus 1.50% if we achieve a Fixed Charge Coverage
      Ratio of at least 2.0 to 1.0 for three consecutive fiscal quarters after August
      4, 2006. Each loan under the Term Loan Facility is repayable in 36 equal monthly
      principal installments plus accrued interest.





The
      Revolver will bear interest at a rate equal to the Bank’s prime rate plus 0.50%
      per annum, but we must pay a minimum quarterly amount equal to the interest
      on
      an outstanding balance of $1,400,000. In addition, we will pay a monthly
      collateral handling fee of 0.10% per month on financed receivables. Interest
      and
      handling fees are paid as invoices are collected.





The
      financial covenants under the Term Loan require that we maintain, on a monthly
      basis tested as of the last day of each month, a minimum quick ratio
      (representing the ratio of quick assets (or cash and accounts receivable) plus
      total marketable securities to current liabilities, plus all short-term
      indebtedness to the Bank but excluding subordinated debt and debt from
      affiliates) of 0.70 to 1.0 through November 30, 2006, 0.85 to 1.0 from December
      31, 2006 through May 31, 2007, 1.0 to 1.0 from June 30, 2007 through August
      31,
      2007 and 1.20 to 1.0 from September 30, 2007 and all monthly reporting periods
      thereafter. If we do not maintain these ratios, then the sum of our cash plus
      80% of our eligible accounts receivable minus our borrowings under the Revolver
      must exceed $2,000,000. We must maintain a Fixed Charge Coverage Ratio measured
      on the last day of every month for the three month period ending on the last
      day
      of such month, of at least 1:0 to 1:0 through periods ending November 30, 2006;
      at least 1.25:1.0 for periods ending on December 31, 2006 through May 31, 2007;
      and at least 1.50:1.0 for all periods thereafter. In addition, the Credit
      Agreements contain affirmative and negative covenants concerning our operations
      including restrictions on our ability to dispose of our assets, change our
      business, ownership or management, incur other indebtedness, create or permit
      liens on our property, make investments, pay dividends, redeem stock or engage
      in transactions with affiliates.





Markland
      Technologies, Inc. (“Markland”), the holder of the majority of Technest’s common
      stock, has entered into an Unconditional Guaranty pursuant to which Markland
      agreed to guaranty up to $6,000,000 of the principal obligations plus interest
      thereon and related expenses under the Credit Agreements and a Stock Pledge
      Agreement pursuant to which Markland pledged to the Bank 1,739,130 shares of
      Technest common stock currently owned by Markland, which had a market value
      of
      $6,000,000 as of August 4, 2006. The Guaranty and the Stock Pledge Agreement
      terminate August 3, 2008 if no event of default has occurred.





The
      Credit Agreements, the Unconditional Guaranty by Markland and the Stock Pledge
      Agreement are filed as Exhibits 10.1, 10.2, 10.4 and 10.5, respectively to
      Technest’s Current Report on Form 8-K filed August 14, 2006.





**Pre-Payment
      of Promissory Notes**





We
      used a
      portion of the proceeds of the Financing to pre-pay the outstanding principal
      of
      $4,952,526 of certain EOIR promissory notes issued in June 2004. After these
      payments, there remains outstanding EOIR notes issued in June 2004 having a
      total outstanding principal balance of $1,655,893, of which $608,957 is
      outstanding principal owed to Technest’s current Chief Executive Officer and one
      of our directors, Joseph P. Mackin. The security interest securing these
      remaining notes was subordinated to the Bank’s first priority security interest.





-7-


**Transaction
      with Markland Technologies, Inc.**





*The
      following summary highlights the material terms of a Stockholder Agreement
      and
      License Agreement with Markland Technologies, Inc., each dated March 13, 2006.
      A
      detailed description of these agreements is also set forth in our current report
      on Form 8-K (SEC File # 000-27023) filed with the SEC on March 17, 2006 and
      the
      agreements themselves are filed as exhibits thereto. The Form 8-K and exhibits
      thereto are publicly available on the SEC’s web site at www.sec.gov. We urge you
      to obtain and read carefully copies of this report and documents before making
      an investment decision.*





*Stockholder
      Agreement with Markland Technologies, Inc.*





On
      March
      13, 2006, we entered into a stockholder agreement (the “Stockholder Agreement”)
      with Markland Technologies, Inc., the holder of a majority of our outstanding
      common stock in order to clarify and define terms relating to (i) the issuance
      of Technest’s securities, (ii) our 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, we are 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 administrative, manufacturing and engineering services
                for
                product development to Technest.





We
      have
      also granted Markland certain registration rights pursuant to which we are
      obligated to register all or a portion of those shares of our 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.





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 our board of directors
                or to
                remove any of the directors currently in
                office;


·
            To
                consent to our 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, we entered into a license agreement with Markland (the “License
      Agreement”). Pursuant to the License Agreement, we granted Markland an
      exclusive, world-wide license to make, use and sell products and services based
      on our 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 our 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
      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.





-8-


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. We 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.





**Markland’s
      Ownership of Technest Common Stock**





Markland
      Technologies, Inc., our majority stockholder, filed current reports on Form
      8-K
      (SEC File # 000- 28863 )
      on
      March 28, 2006 and April 19, 2006, to announce the entry into definitive
      agreements involving Markland’s ownership of certain shares of our common stock.
      Among other things, the Form 8-Ks reported that Markland issued a new series
      of
      preferred stock, referred to as the Markland Series E preferred stock. Each
      share of Markland’s Series E preferred stock is convertible, at the option of
      the holder, into either (i) 3,000 shares of Technest common stock, currently
      outstanding and held by Markland, or (ii) 697,500 shares of Markland’s common
      stock.




*Registration
      Rights*





In
      connection with the issuance of shares of the newly designated Series E
      preferred stock, Markland agreed to cause us to file a registration statement
      with the SEC to register the resale of our common stock underlying the
      conversion of the Markland Series E preferred stock. Pursuant to our Stockholder
      Agreement with Markland, dated March 13, 2006, we are contractually required
      to
      prepare and file certain types of resale registration statements at Markland’s
      request. Based solely
      on
      the disclosures in Markland’s Form 8-Ks, we understand that Markland has issued
      approximately 1,232.2 shares of Series E preferred stock to four institutional
      investors (the “Series E Investors”), which is potentially convertible into
      3,696,600 shares of our common stock. The
      availability of these shares for sale in the public markets pursuant to an
      effective registration statement may cause a significant drop in the market
      price of our common stock.





*Important
      Aspects of Markland Agreements*





It
      is
      important to note that Technest is not a party to any of the agreements
      involving the Markland Series E preferred stock and the issuance of the Markland
      Series E preferred stock does not require Technest to issue any additional
      securities. Conversions of the Markland Series E preferred stock will be
      satisfied entirely by shares of our common stock that are currently outstanding
      and held by Markland.





In
      addition to the registration rights mentioned above, some important aspects
      of the March 24, 2006 agreements, as amended, between Markland and the Series
      E
      Investors include:





·
            the
                escrow of an aggregate of 4,640,192shares of our common stock held by Markland to secure the conversion
                of
                the Markland Series E preferred
                stock;


·
            an
                agreement by two of the Series E Investors to purchase up to an additional
                267.2 shares of Markland Series E preferred stock, convertible into
                801,600 shares of our common stock, in five separate closings between
                April 17, 2006 and June 15, 2006, of which 92 shares of Markland
                Series E
                was purchased on April 17, 2006;


·
            the
                transfer of 500,000 shares of our common stock held by Markland to
                Verdi
                Consulting, Inc. as compensation for services rendered in connection
                with
                arranging and negotiating the above mentioned
                transactions;


·
            an
                agreement that Markland, subject to certain specified exceptions,
                for up
                to two (2) years will not sell or transfer any shares of our common
                stock
                without the consent of a majority of the Series E Investors and thereafter
                will not sell more than 10% of its shares of our common stock into
                the
                open market during any calendar month;
                and


·
            an
                agreement from each of the Series E Investors that they will not
                convert
                more that 10% of their shares of Series E preferred stock during
                any
                calendar month and will not sell more than 10% of their shares of
                our
                common stock into the open market during any calendar
                month.





A
      description of the March 24, 2006 agreements, as amended, between Markland
      and
      the Series E Investors is set forth in Markland’s current reports on Form 8-K
      filed with the SEC on March 28, 2006 and April 19, 2006. The Form 8-Ks and
      exhibits thereto are publicly available on the SEC’s web site at www.sec.gov.
      Although we did not participate in the preparation of these current reports
      and
      can therefore provide no assurances as to the accuracy of the information they
      contain, we urge you to obtain and read carefully copies of these reports and,
      in particular, the agreements included as exhibits to these reports, before
      making a decision to invest in our common stock.





-9-


**Item
      2. Description of Property**





EOIR,
      our
      wholly owned subsidiary, holds a three-year lease for its executive and
      administrative offices of approximately 5,420 square feet in Woodbridge,
      Virginia. The lease expires on September 30, 2008. EOIR leases approximately
      10,000 square feet in Spotsylvania, Virginia, where it houses its software
      development unit. The lease expires on October 31, 2009. EOIR also holds a
      five-year lease for 6,951 square feet in Spotsylvania, Virginia. The lease
      expires on October 15, 2010. EOIR also has several offices located in
      Fredericksburg, Virginia - one office with 1,200 square feet, with a two-year
      lease that expires on October 31, 2006, and one with 4,200 square feet, with
      a
      three-year lease that expires on June 30, 2007. Monthly lease amounts for these
      facilities total approximately $36,600. In addition, we have a three-year lease
      for executive offices of approximately 2,000 square feet in Boston,
      Massachusetts, which expires December 1, 2009. The monthly rental amount for
      this facility is approximately $4,500.





Genex
      Technologies, Inc., our wholly-owned subsidiary, 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. Genex has entered into a five-year lease for approximately 6,800 square
      feet in Bethesda, Maryland with a monthly lease amount of approximately $14,250.
      Genex moved into this space on April 1, 2006.





We
      believe that our present facilities are adequate to meet our current needs.
      If
      new or additional space is required, we believe that adequate facilities are
      available at competitive prices. However, we may not be able to relocate to
      a
      new facility without severely disrupting the production of our
      goods.





-10-


**Item
      3. Legal Proceedings**





*Technest
      Holdings, Inc.*





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




Technest,
      Mr. Sheppard and Ms. Marx believe that the claims against Technest, Mr. Sheppard
      and Ms. Marx are without merit and are vigorously defending the action.
      Technest, Mr. Sheppard and Ms. Marx have filed responses to the claims against
      them. The responses deny all material allegations of the complaint and the
      claim
      asserted by the transfer agent, and asserts a variety of defenses. We cannot
      make any assurances about the litigation’s outcome.





In
      June
      2006, the court directed the parties to address the court’s continuing subject
      matter jurisdiction over Technest in the H&H matter. Technest has responded
      to the court’s direction and believes that as a result of intervening corporate
      actions, the injunctive relief sought by the plaintiff which gives rise the
      court’s subject matter jurisdiction in this case has been rendered moot, thereby
      depriving the court of continuing subject matter jurisdiction. Technest believes
      that the case as currently styled is fundamentally a dispute between H&H
      Acquisition Corp. and Ben Stein.





As
      of
      October 9, 2006, Technest has not been notified of a trial date for this
      matter.





On
      or
      about May 30, 2006, Deer Creek Fund LLC filed a claim for Interference with
      Contract and Breach of the Implied Covenant of Good Faith and Fair Dealing
      against Technest, seeking unspecified monetary damages.  Deer Creek alleges
      misconduct on the part of Technest related to a proposed sale by Deer Creek
      of
      157,163 shares of Technest common stock at $7.00 per share and the applicability
      of certain selling restrictions under a registration rights agreement entered
      into between the parties. Technest believes that the allegations in this
      lawsuit are entirely without merit. Technest has been aggressively defending
      this action, and has filed an answer denying Deer Creek’s allegations and
      vigorously opposes all relief sought.





*EOIR
      Technologies, Inc.*





On
      or
      about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the
      Circuit Court of Spotsylvania County, Virginia, against Markland, EOIR, and
      our
      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.




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.




On
      August
      3, 2006, Mr. Moulton, Technest, Markland, EOIR and Robert Tarini reached a
      settlement agreement pursuant to which upon payment of $120,000 and the
      pre-payment of certain EOIR outstanding promissory notes, the parties each
      dismissed their claims against one another. The payments required by the
      settlement agreement were made on August 10, 2006.




-11-


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 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 Williams’ motion for summary
      judgment. On May 4, 2006, the court granted the Williams’ motion for summary
      judgment with regard to liability on Count I of the Williams’ claim regarding
      severance payment and Count III of their claim regarding Markland’s failure to
      register shares of Markland’s common stock underlying their options. We have,
      and continue to assert that Count III of the Williams’ complaint does not allege
      wrongdoing by EOIR and thus, we believe that we have no liability on that claim.
      Count II of the claim, which seeks a declaration that the promissory notes
      issued to Mr. and Mrs. Williams in connection with the acquisition of EOIR
      by
      Markland on June 29, 2004 are in default and an acceleration of the payments
      due
      under those notes, was not addressed by the court’s order.





On
      July
      27, 2006, we entered into an agreement with the Williams pursuant to which
      we
      paid them $246,525 in satisfaction of their claims for severance under Count
      I
      and agreed to pay the outstanding balance of their promissory notes, along
      with
      all accrued but unpaid interest, in satisfaction of Count II which was paid
      on
      August 10, 2006. The Williams continue to assert claims against us for
      attorney’s fees and costs on all three counts of their complaint. Count III was
      not addressed by this agreement.





On
      September 1, 2006, we entered into an agreement with Markland pursuant to which
      we agreed to indemnify Markland against any judgment for damages or attorney’s
      fees ordered by the Court pursuant to Counts I or II and Markland agreed to
      indemnify us against any judgment for damages or attorney’s fees ordered by the
      Court pursuant to Count III.





The
      case
      is currently set for trial on November 14, 15 and 16, 2006, at which time the
      damages, if any, for Count III will be determined as well as costs and
      attorney’s fees, if applicable, for Counts I, II and III.





In
      the
      event that Mr. and Mrs. Williams prevail in any of their claims against
      Markland, Technest shares owned by Markland would be among the assets available
      to satisfy a resulting judgment.







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




We
      did
      not submit any matter to a vote of security holders during the three months
      ended June 30, 2006, which is the fourth quarter of our fiscal
      year.





-12-


**PART
      II**





**Item
      5. Market for Common Equity and Related Stockholder
      Matters**





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





**Calendar
                Year**
            **High**
            
            **Low****2004**First
                Quarter
            $27.43
            
            $4.22Second
                Quarter
            $4.22
            
            $4.22Third
                Quarter
            $12.66
            
            $2.11Fourth
                Quarter
            $21.10
            
            $2.11**2005**First
                Quarter
            $63.29
            
            $10.55Second
                Quarter
            $40.08
            
            $12.66Third
                Quarter
            $52.74
            
            $5.15Fourth
                Quarter
            $5.50
            
            $4.50**2006**First
                Quarter
            $11.35
            
            $4.40Second
                Quarter
            $4.80
            
            $2.20Third
                Quarter
            $3.52
            
            $1.60




The
      above
      quotations reflect inter-dealer prices, without retail mark-up, markdown or
      commission. These quotes are not necessarily representative of actual
      transactions or of the value of our common stock, and are in all likelihood
      not
      based upon any recognized criteria of securities valuation as used in the
      investment banking community. As of October 9, 2006, there were approximately
      128 record holders of our common stock.





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





We
      incorporate information regarding the securities authorized for issuance under
      our equity compensation plans into this section by reference from the Proxy
      Statement for our 2006 annual meeting of stockholders.




**Issuer
      Purchases of Equity Securities**





We
      did
      not make any purchases of our common stock during the three months ended June
      30, 2006, which is the fourth quarter of our fiscal year.





-13-


**Issuance
      of Unregistered Securities**





As
      consideration for an agreement with Crystal Research Associates, LLC for the
      assistance in the creation of marketing information entered into on July 17,
      2006, we issued Crystal a Warrant to purchase 200,000 shares of Technest common
      stock at an exercise price of $1.89 per share, 110% premium to the closing
      price
      of Technest common stock on July 17, 2006. The Warrant expires on July 17,
      2011.
      We also entered into a Registration Rights Agreement with Crystal pursuant
      to
      which we granted “piggy-back” and S-3 registration rights for the shares of
      Technest common stock underlying the Warrant. This transaction was not
      registered under the Securities Act, but was made in reliance upon the
      exemptions from the registration requirements of the Securities Act set forth
      in
      Section 4(2) thereof. The Warrant and Registration Rights Agreement are filed
      hereto as Exhibits 4.15 and 4.16, respectively.








**Item
      6. Management’s Discussion and Analysis**





*The
      following discussion and analysis of our financial condition and results of
      operations for the transition period beginning January 1, 2005 and ending June
      30, 2005 and for the year ended June 30, 2006 should be read together with
      our
      financial statements and related notes included elsewhere in this annual report
      on Form 10-KSB.*




*When
      reviewing the discussion below, you should keep in mind the substantial risks
      and uncertainties that characterize our business. In particular, we encourage
      you to review the risks and uncertainties described in the section entitled
      "Risk Factors” beginning on page 24 of this annual report on Form 10-KSB. These
      risks and uncertainties could cause actual results to differ materially from
      those forecasted in forward-looking statements or implied by past results and
      trends. Forward-looking statements are statements that attempt to project or
      anticipate future developments in our business; we encourage you to review
      the
      examples of forward-looking statements under "Note Regarding Forward-Looking
      Statements." These statements, like all statements in this annual report on
      Form
      10-KSB, speak only as of June 30, 2006 and we undertake no obligation to update
      or revise the statements in light of future developments.*




***Recent
      Developments***




*Change
      in Fiscal Year.* In June
      2005, we changed our fiscal year end from December 31 to June 30.




*Reverse
      Stock Split.* On June
      2, 2005, our Board of Directors and the holders of a majority of our outstanding
      shares of common stock approved a recapitalization in the form of a one (1)
      for
      two hundred eleven and eighteen one hundredths (211.18) reverse stock split
      of
      our shares of common stock, par value $.001 per share, outstanding after
      considering and concluding that the Reverse Stock Split was in our best
      interests and the best interests of our stockholders, with all fractional shares
      rounded up to the nearest whole number. The Reverse Stock Split was effective
      as
      of the close of business on July 19, 2005. The Reverse Stock Split did not
      reduce our authorized shares of common stock, which remains at 495,000,000
      shares. Based on the number of shares outstanding as of July 19, 2005, after
      giving effect to the Reverse Stock Split, we had approximately 2,302,193 shares
      of Technest common stock outstanding. Technest began trading under the symbol
      "TCNH" on July 20, 2005.




*Acquisition
      of EOIR.* 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., formerly one of Markland’s
      wholly-owned subsidiaries. As consideration for the stock of EOIR, we issued
      12
      million shares of our common stock to Markland, and, as a result, Markland’s
      ownership of Technest increased from 85% immediately prior to the transaction
      to
      approximately 98% on a primary basis and from 39% to approximately 82% on a
      fully diluted basis (assuming the conversion of all of our convertible
      securities and the exercise of all warrants to purchase Technest common
      stock).




EOIR
      offers: (i) design and fabrication of customized remote sensor systems and
      platforms for U.S. Department of Defense, United States intelligence agencies
      and U.S. Department of Homeland Security applications; (ii) remote sensor data
      collection, data signal processing and data exploitation; and (iii) training
      in
      the use of remote sensor systems and data. Markland acquired EOIR on June 29,
      2004. EOIR generated approximately 97% of Markland’s revenue for fiscal
      2005.


-14-


*Bank
      Financing and Certain Loan Repayments.* On
      August 10, 2006, Technest, EOIR and Genex, closed on a financing under two
      Loan
      and Security Agreements with Silicon Valley Bank executed on August 4, 2006.
      One
      Credit Agreement provides for a term loan facility under which the Company
      may
      borrow term loans with an initial minimum loan of $3,000,000 (the “Term Loan
      Facility”). The other Credit Agreement provides for a one year revolving line of
      credit for up to $8,750,000 (the “Revolver”), provided that the Company’s
      borrowing under the Revolver is limited to 80% of eligible accounts receivable.
      In addition, the maximum amount outstanding under both Credit Agreements at
      any
      time may not exceed $10,000,000. Both the Term Loan Facility and the Revolver
      are secured by all of the Company’s assets and the assets of its subsidiaries,
      including all intellectual property.





Upon
      the
      date of closing under the Credit Agreements, the Company borrowed the entire
      $3,000,000 available under the Term Loan Facility and borrowed approximately
      $4,445,000 under the Revolver.





The
      Company used a portion of the proceeds of the Financing to pre-pay the
      outstanding principal of $4,952,526 of certain EOIR promissory notes issued
      in
      June 2004. After these payments, there remains outstanding EOIR notes issued
      in
      June 2004 having a total outstanding principal balance of $1,655,893, of which
      $608,957 is outstanding principal owed to Technest’s current Chief Executive
      Officer and one of the Company’s directors, Joseph P. Mackin. The security
      interest securing these remaining notes was subordinated to the Bank’s first
      priority security interest.








**Year
      ended June 30, 2006 compared with the six months ended June 30, 2005**




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 became part of Markland’s control group, which occurred on February 14,
      2005. 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.





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. 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.





As
      a
      result of these transactions, and the change in fiscal year end previously
      described, the results of operations for the year ended June 30, 2006 are not
      comparable to the June 30, 2005.





**Revenues**




Technest
      had $81,092,049 in revenue during the year ended June 30, 2006 compared with
      $27,890,072 in revenue during the six months ended June 30, 2005. The prior
      period is not comparable as Technest acquired Genex and EOIR effectively on
      February 14, 2005 and revenue was included only from that date forward. The
      increase in revenue was due to a full year of revenue included in 2006 versus
      a
      partial year in 2005 and only since the acquisitions of EOIR and Genex,
      effective February 14, 2005. For the year ended June 30, 2006, our acquisition
      of EOIR contributed revenues of $77,547,584 and Genex contributed $3,544,465.
      For the six months ended June 30, 2005, our acquisition of EOIR contributed
      revenues of $26,732,019 and Genex contributed $1,158,053.





-15-


Revenues
      from EOIR’s omnibus contract were approximately $70.3 million and $31.5 for the
      year ended June 30, 2006, and the full six months ended June 30, 2005
      respectively. EOIR has had a history of providing services under NVESD
      contracts.  In 1993, EOIR won the first NVESD Omnibus contract.  When
      this contract was re-competed in 1996, EOIR won the follow-on contract known
      as
      the Low-Tech contract, a five-year contract with a $248 million ceiling. 
In July 2001 EOIR won the Low-Tech re-compete, a five year contract with a
      $406
      million ceiling. In August 2006, the Government granted EOIR an additional
“award term” for one year from July 2006 to July 2007. The performance periods
      for these contracts extend for 12 months beyond the end of the contract award
      period.





The
      overall value for the current five year contract is $406 million.  The
      cumulative value of individual awarded orders was approximately $360 million
      on
      June 30, 2006.





As
      the
      Company has been awarded this contract three consecutive times, we remain
      confident that we are in a strong position for the upcoming re-compete, however
      there can be no assurances that this will happen. The near term prospects for
      the Company will be dependent on the Company’s ability to be awarded the new
      contract.




**Gross
      profit**




The
      gross
      profit for the year ended June 30, 2006 was $14,549,810 or 18% of revenues.
      The
      gross profit for the six months ended June 30, 2005 was $5,408,939 or 19% of
      revenues. Technest expects to expand its commercial product revenues and,
      accordingly, gross profit on future revenues may differ. The gross profit
      margins allowed by our Government customers vary depending on the type of
      services performed depending on the degree of complexity and involvement in
      performing the service.




**Selling,
      general and administrative expenses**




Selling,
      general and administrative expenses for the year ended June 30, 2006 were
      $14,380,208 and consisted primarily of payroll costs plus a management fee
      of
      $1,000,000 to Markland, a related party, for administrative support services,
      engineering services and services rendered by executive officers of Markland.
      These management fees are expected to terminate by March 31, 2007 in accordance
      with our stockholder agreement with Markland. Also included in the selling,
      general and administrative expenses is $375,767 for stock-based compensation.
      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. It also
      includes the issuance by Technest of certain restricted stock grants to
      employees.





Selling,
      general and administrative expenses for the six months ended June 30, 2005
      reflecting the Genex and EOIR acquisitions from February 14, 2005, were
      $5,809,945, and consisted primarily of payroll costs plus a management fees
      and
      other expenses of $893,219 to Markland, a related party, for administrative
      support services, engineering services and services rendered by executive
      officers of Markland. Also included in the selling, general and administrative
      expenses in 2005 is $1,044,512 for 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.




**Research
      and development**




Research
      and development expenses for the year ended June 30, 2006 were $159,209. 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 six months ended June 30, 2005 were $2,395,950.
      Of
      this amount, $2,095,000 was attributable to non-cash in-process research and
      development written off as a result of 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 year ended June 30, 2006 was $1,786,146.
      Amortization of intangible assets for the six months ended June 30, 2005 was
      $611,471. Amortization expense relates to the definite-lived intangible assets
      acquired in conjunction with Genex and EOIR effective as of February
      2005.


-16-


**Operating
      loss**





The
      operating loss for the year ended June 30, 2006 was $1,775,753. The operating
      loss for the six months ended June 30, 2005 was $3,408,427.




Interest
        expense for the year ended June 30, 2006 was $3,179,672. Interest expense
        for
        the six months ended June 30, 2005 was $446,027.




**Other
      (expenses) income**




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 $293,592 for the year ended June 30, 2006 and $110,097 for the six months
      ended June 30, 2005. These notes bear interest at the rate of six percent (6%)
      per annum and must be repaid within the next three years. Subsequent to June
      30,
      2006, Technest pre-paid outstanding principal of $4,952,526 of certain of the
      EOIR promissory notes. After these payments, there remain outstanding EOIR
      notes
      having a total principal balance of $1,655,893. Interest expense related to
      these notes was approximately $533,200 for the year ended June 30, 2006 and
      $324,000 in the six months ended June 30, 2005.





In
      the
      year ended June 30, 2006, Technest charged to interest expense $2,204,461
      (including $2,104,461 paid in common stock) related to liquidated damages
      incurred for failure to have an effective registration statement.





Derivative
      income (loss) represents the changes 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
      year ended June 30, 2006 and the six months ended June 30, 2005, changes in
      the
      fair value of the warrants recorded as derivative income (loss) in the
      statements of operations was $25,046,489 and ($30,212,400), respectively.
      Derivative income (loss) 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 (loss) would have resulted in pro
      forma net loss applicable to common shareholders would have been ($4,793,825)
      and ($6,403,735) for the year ended June 30, 2006 and six months ended June
      30,
      2005, respectively. Pro forma basic and diluted loss per common share would
      have
      been ($0.31) and ($0.60) for the year ended June 30, 2006 and six months ended
      June 30, 2005, respectively.





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 date.





Other
      income for the year ended June 30, 2006 and the six months ended June 30, 2005
      was $161,600 and $40,567, respectively, and was primarily related to interest
      income on cash balances.







**Net
      income (loss) applicable to common shareholders**





The
      net
      income applicable to common stockholders for the year ended June 30, 2006 was
      $20,252,664. As previously described, the net income was entirely due to
      derivative income of $25,046,489.





The
      net
      (loss) applicable to common stockholders for the six months ended June 30,
      2005
      was ($36,616,135). This reflects the non-cash deemed dividends related to the
      beneficial conversion features of $124,848 for Series A convertible preferred
      stock and $2,465,000 for Series C convertible preferred stock. It also includes
      a derivative loss of ($30,212,400).


-17-


**Liquidity
      and Capital Resources**




**Cash
      and Working Capital**





On
      June
      30, 2006, Technest had a negative working capital balance of $3,525,242.
      Technest’s current liabilities include $595,782 due to Markland, Technest’s
      parent company. Net cash provided by operating activities was $903,036 for
      the
      year ended June 30, 2006. Net non-cash income included in the net income of
      $20,252,664 totaled $20,140,290 while changes in the components of working
      capital provided cash of $790,662. Most of the change in working capital was
      related to a reduction of amounts due to related parties of $1,553,960 plus
      an
      increase in accounts receivable of $3,832,138 which was offset by an increase
      in
      payables and accrued liabilities of $5,979,373. Derivative income (loss) had
      no
      impact on cash or net cash provided by operations.





**Cash
      Used in Investing Activities**





In
      the year
      ended June 30 ,
      2006,
      Technest used cash of $324,499 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 year
      ended June 30 ,
      2006,
      $2,858,891 was used for loan repayments, primarily related to the EOIR seller
      notes.




**Sources
      of Liquidity**





During
      the year ended June 30, 2006, we satisfied our cash requirements primarily
      by
      generating positive operating cash flows and using our cash reserves. Although
      the Company had a negative working capital balance of $3,525,242 at June 30,
      2006 and net cash decreased $2,250,398 for the year ended June 30, 2006, the
      Company had $3.4 million in cash and cash equivalents at the end of June 2006
      and the Company’s funded contract backlog from the Government was $41.4 million.
      In addition, subsequent to year-end, the Company obtained a revolving line
      of
      credit with a commercial bank in the maximum amount of $10 million. Although
      $4.9 million of this line was used to pre-pay existing indebtedness, the
      balance, under certain conditions, is available to fund the Company’s working
      capital needs. As a result of the forgoing, management believes that Technest
      has sufficient sources of liquidity to satisfy its obligations for at least
      the
      next 12 months.




**Commitments
        And Contingencies**
 **Facilities**




Technest has a three-year lease for executive offices of approximately 2,000
        square feet in Boston, Massachusetts, which expires December 31, 2009. The
        monthly rental amount for this facility is approximately $4,500.
  Genex
        Technologies, Inc., a wholly-owned subsidiary of Technest, 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, increasing annually by 3%. 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.
  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.
   -18-




**Legal**
  *Technest
        Holdings, Inc.*
 
 On
        or
        about July 23, 1998, H & H Acquisition Corporation, individually and
        purportedly on behalf of Technest Holdings, commenced an action in United
        States
        District Court, Southern District of New York entitled “H & H Acquisition
        Corp., individually and on behalf of Technest Holdings, Inc. v. Financial
        Intranet Holdings, Inc. Technest Holdings, Inc., F/K /A Financial Intranet,
        Inc., Ben Stein, Interwest Transfer Co., Steven A. Sanders, Michael Sheppard,
        Maura Marx, Henry A. Schwartz, Leonard Gotshalk, Gotshalk Enterprises, Law
        Office of Steven A. Sanders, P.C. and Beckman, Millman & Sanders, LLP, 98
        Civ. 5269”. The plaintiffs are purporting to act on behalf of Technest in the
        context of a shareholder’s derivative suit. The action’s principal basis appears
        to be a claim that Ben Stein, a former director and Secretary of Technest,
        wrongfully claims ownership of shares of common stock that Stein agreed to
        purchase from H&H. According to H&H, these shares belong to them.
        H&H asserts sixteen causes of action. Only some make allegations against
        Technest Holdings, Inc., Michael Sheppard and Maura Marx, former officers
        of
        Technest.
  Technest,
        Mr. Sheppard and Ms. Marx believe that the claims against Technest, Mr. Sheppard
        and Ms. Marx are without merit and are vigorously defending the action.
        Technest, Mr. Sheppard and Ms. Marx have filed responses to the claims against
        them. The responses deny all material allegations of the complaint and the
        claim
        asserted by the transfer agent, and asserts a variety of defenses. We cannot
        make any assurances about the litigation’s outcome.
 
 In
        June
        2006, the court directed the parties to address the court’s continuing subject
        matter jurisdiction over Technest in the H&H matter. Technest has responded
        to the court’s direction and believes that as a result of intervening corporate
        actions, the injunctive relief sought by the plaintiff which gives rise the
        court’s subject matter jurisdiction in this case has been rendered moot, thereby
        depriving the court of continuing subject matter jurisdiction. Technest believes
        that the case as currently styled is fundamentally a dispute between H&H
        Acquisition Corp. and Ben Stein.
 
 As
        of
        October 9, 2006, Technest has not been notified of a trial date for this
        matter.
 
 On
        or
        about May 30, 2006, Deer Creek Fund LLC filed a claim for Interference with
        Contract and Breach of the Implied Covenant of Good Faith and Fair Dealing
        against Technest, seeking unspecified monetary damages.  Deer Creek alleges
        misconduct on the part of Technest related to a proposed sale by Deer Creek
        of
        157,163 shares of Technest common stock at $7.00 per share and the applicability
        of certain selling restrictions under a registration rights agreement entered
        into between the parties. Technest believes that the allegations in this
        lawsuit are entirely without merit. Technest has been aggressively defending
        this action, and has filed an answer denying Deer Creek’s allegations and
        vigorously opposes all relief sought.
 
 *EOIR
        Technologies, Inc.*
 
 On
        or
        about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the
        Circuit Court of Spotsylvania County, Virginia, against Markland, EOIR, and
        our
        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.
  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.
  On
        August
        3, 2006, Mr. Moulton, Technest, Markland, EOIR and Robert Tarini reached
        a
        settlement agreement pursuant to which upon payment of $120,000 and the
        pre-payment of certain EOIR outstanding promissory notes, the parties each
        dismissed their claims against one another. The payments required by the
        settlement agreement were made on August 10, 2006.
   -19-
  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 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 Williams’ motion for summary
          judgment. On May 4, 2006, the court granted the Williams’ motion for summary
          judgment with regard to liability on Count I of the Williams’ claim regarding
          severance payment and Count III of their claim regarding Markland’s failure to
          register shares of Markland’s common stock underlying their options. We have,
          and continue to assert that Count III of the Williams’ complaint does not allege
          wrongdoing by EOIR and thus, we believe that we have no liability on that
          claim.
          Count II of the claim, which seeks a declaration that the promissory notes
          issued to Mr. and Mrs. Williams in connection with the acquisition of EOIR
          by
          Markland on June 29, 2004 are in default and an acceleration of the payments
          due
          under those notes, was not addressed by the court’s order.
 On
          July
          27, 2006, the Company entered into an agreement with the Williams pursuant
          to
          which the Company paid them $246,525 in satisfaction of their claims for
          severance under Count I and agreed to pay the outstanding balance of their
          promissory notes, along with all accrued but unpaid interest, in satisfaction
          of
          Count II which was paid on August 10, 2006. The Williams continue to assert
          claims against us for attorney’s fees and costs on all three counts of their
          complaint. Count III was not addressed by this agreement.
  On
          September 1, 2006, the Company entered into an agreement with Markland
          pursuant
          to which we agreed to indemnify Markland against any judgment for damages
          or
          attorney’s fees ordered by the Court pursuant to Counts I or II and Markland
          agreed to indemnify the Company against any judgment for damages or attorney’s
          fees ordered by the Court pursuant to Count III.
  The
          case
          is currently set for trial on November 14, 15 and 16, 2006, at which time
          the
          damages, if any, for Count III will be determined as well as costs and
          attorney’s fees, if applicable, for Counts I, II and III.
  **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.
          As
          of June 30, 2006, Technest had 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.
  **Principles
          Of Consolidation**
  Our
          consolidated financial statements for the periods presented include the
          accounts
          of Technest, and our wholly-owned subsidiaries- Genex and EOIR. We have
          eliminated all significant inter-company balances and transactions.
   -20-
  **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.
  For
            the
            periods presented, 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 year ended June 30, 2006 and as
            such there
            are no capitalized or expensed in-process research and development costs
            during
            this period relating thereto. During the six months ended June 30, 2005,
            we had,
            however, acquired in-process technology as a part of our acquisition
            of Genex.
            These technologies had neither achieved technological feasibility nor
            had
            alternative uses and as such the research and development costs of $2,095,000
            were expensed in the six months ended June 30, 2005.
 
 The
            amount recorded as expense for in-process research and development (IPR&D)
            was arrived at by management after considering a number of factors, including
            an
            independent 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.
 
 **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.
   -21-
  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 .any of the periods presented.
 
 **Derivative
              Instruments**
 
 Technest
              generally does not use derivative instruments to hedge exposures to
              cash-flow or
              market risks. However, certain warrants to purchase common stock that
              are
              indexed to the Company's common stock are classified as liabilities
              when the
              Company is not permitted to settle the instruments in unregistered
              shares. In
              such instances, net-cash settlement is assumed for financial reporting
              purposes,
              even when the terms of the underlying contracts do not provide for
              net-cash
              settlement. Such financial instruments are initially recorded at relative
              fair
              value with subsequent changes in fair value charged (credited) to operations
              in
              each reporting period. If the Company subsequently achieves the ability
              to
              settle the instruments in unregistered shares, the instruments are
              reclassified
              to equity at their fair value.
  **Revenue
              Recognition**
  Revenues
              from products are recognized when the following criteria are met: (1)
              there is
              persuasive evidence of an arrangement, such as contracts, purchase
              orders or
              written requests; (2) delivery has been completed and no significant
              obligations
              remain; (3) price to the customer is fixed or determinable; and (4)
              collection
              is probable.
  Revenues
              from time and materials contracts are recognized as costs are incurred
              and
              billed. Allowable costs incurred but not billed as of a period end
              are recorded
              as work in process.
  Revenues
              from firm fixed price contracts are recognized on the percentage-of-completion
              method, either measured based on the proportion of costs recorded to
              date on the
              contract to total estimated contract costs or measured based on the
              proportion
              of labor hours expended to date on the contract to total estimated
              contract
              labor hours, as specified in the contract.
  Provisions
              for estimated losses on all contracts are made in the period in which
              such
              losses become known. Changes in job performance, job conditions, and
              estimated
              profitability, including those arising from contract penalty provisions,
              and
              final contract settlements may result in revisions to costs and income
              and are
              recognized in the period in which the revisions are determined.
  -22-
 The
                Company participates in teaming agreements where it is the primary
                contractor
                and it also participates with other organizations to provide complex
                integrated
                remote sensor product and technology development services to the
                Federal
                government. EITF Issue No. 99-19, “Reporting Revenue Gross as a Principal versus
                Net as an Agent” discusses the factors or indicators which should be considered
                in evaluating whether a company should recognize revenue based on
                (a) the gross
                amount billed to a customer because it has earned revenue from the
                sale of the
                goods or services or (b) the net amount retained (that is, the amount
                billed to
                the customer less the amount paid to a supplier) because it has earned
                a
                commission or fee. The Task Force reached a consensus that this is
                a matter of
                judgment that depends on the relevant facts and circumstances. The
                Company
                considered that it is the primary obligator in these arrangements
                and 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.
                The Company also considered that, as the prime contractor it accepts
                risks for
                these customer funded tasks. The Company also considered that in
                many cases part
                of the services ordered by the customer are performed by the Company
                itself.
                Further in some cases the Company has discretion in supplier selection
                and also
                a reasonable latitude to establish the price with the customer for
                the service.
                The Company believes that based on the aforesaid considerations it
                meets with
                the criteria for Gross Revenue Reporting as discussed in EITF Issue
                No. 99-19.
                The Company therefore 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 .
  Revenues
                from teaming agreements for the year ended June 30, 2006 and the
                six months
                ended June 30, 2005 were $4.4  million
                and $1.7 million respectively.
  **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. 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 made by Markland to its 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 Markland 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 by Markland or Technest to the Company’s employees in the
                future.
  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 currently receive 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.
 
 In
                May
                2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
                Corrections - A
                Replacement of APB Opinion No. 20 and FASB Statement No. 3 ("SFAS
                154")". SFAS
                154 requires retrospective application to prior periods' financial
                statements of
                changes in accounting principle, unless it is impracticable to determine
                either
                the period-specific effects or the cumulative effect of the change.
                SFAS 154
                does not change the guidance for reporting the correction of an error
                in
                previously issued financial statements or a change in accounting
                estimate. The
                provisions of SFAS 154 shall be effective for accounting changes
                and corrections
                of errors made in fiscal years beginning after December 15, 2005.
                The Company
                does not expect the adoption of SFAS 154 to have a material effect
                on the
                consolidated financial position or results of operations.
  -23-
  In
                  July 2006, the FASB issued Interpretation No. 48, “Accounting for
                  Uncertain Tax Positions”, an Interpretation of SFAS No. 109 (“FIN 48”),
                  which clarifies the criteria for recognition and measurement of
                  benefits from
                  uncertain tax positions. Under FIN 48, an entity should recognize
                  a tax benefit
                  when it is “more-likely-than-not”, based on the technical merits, that the
                  position would be sustained upon examination by a taxing authority.
                  The amount
                  to be recognized, given the “more likely than not” threshold was passed, should
                  be measured as the largest amount of tax benefit that is greater
                  than 50 percent
                  likely of being realized upon ultimate settlement with a taxing
                  authority that
                  has full knowledge of all relevant information. Furthermore, any
                  change in the
                  recognition, derecognition or measurement of a tax position should
                  be recognized
                  in the interim period in which the change occurs. The Company expects
                  to adopt
                  FIN 48 as of July 1, 2007, and any change in net assets as a result of
                  applying the Interpretation will be recognized as an adjustment
                  to retained
                  earnings on that date. The Company does not expect the adoption
                  of FIN 48 to
                  have a material effect on the consolidated financial position or
                  results of
                  operations.
  In
                  September 2006, the FASB issue SFAS No. 157, "Fair Value Measurement"
                  ("SFAS
                  157"). SFAS 157 defines fair value, establishes a framework for
                  measuring fair
                  value and expands disclosures about fair value measurements. SFAS
                  157 is
                  effective for financial statements issued for fiscal years beginning
                  after
                  November 17, 2007 and interim periods within those fiscal years.
                  The Company is
                  evaluating the impact of adopting SFAS 157 on our consolidated
                  financial
                  position, results of operations and cash
                  flows.








**RISK
      FACTORS**




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





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




**We
      have a limited operating history. As a result, it may be difficult to evaluate
      our prospects for profitable operations 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.


-24-


**We
      have a history of operating losses and cannot give assurance of future revenues
      or operating profits; investors may lose their entire
      investment.**




Technest
      has had net operating losses each year since its inception. As of June 30,
      2006,
      our accumulated deficit was $15,237,939. 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:




·
            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.


-25-


**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 acquisition
      of EOIR, our business will suffer.**




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




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




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





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




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




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.


-26-


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.





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
      contract with the United States Army Night Vision and Electronic Sensors
      Directorate expires in July 2007. We are in the “re-compete” process. If we are
      not awarded a new contract, our revenues would decrease significantly and our
      financial condition would be adversely affected.**





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 $70.31 million
      in revenues for the year ended June 30, 2006 or 86.6% of our total consolidated
      revenues during that period. This contract expires in July 2007 and we
      anticipate that the U.S. Army will competitively award a replacement contract. We
      will
      expend substantial cost and managerial time and effort to prepare for the bid
      and proposal for this new contract. Although
      we believe that it is likely that we will be awarded a new contract, if we
      are
      not awarded a new contract, our revenues would significantly decrease and our
      financial condition could be adversely affected.


-27-


Although
      the U.S. Army has not announced the evaluation criteria for the replacement
      contract, there are several factors that are likely to be considered during
      the
      re-compete process, such as our ability to do the work or find subcontractors
      that can do the work; our competitive pricing; our reputation, the Government’s
      prior experience with our work; our competition; changes in Government programs
      or requirements; budgetary priorities; changes in fiscal policies; curtailment
      of the Government’s use of technology solutions firms; new contract
      requirements; and the government’s need for a diverse contracting base. If we
      are not able to satisfy the Government’s requirements, we may not be awarded a
      new contract.




**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 $70.31 million in revenues for the year ended June 30, 2006 or
      86.6% of our total consolidated revenues during that period. Although we expect
      this contract to account for a substantial portion of our revenues going
      forward, this contract expires in July 2007 and we are in the process of
      competing for a new contract. If we are not awarded a new contract, our revenues
      would significantly decrease and our financial condition could be adversely
      affected.




In
      addition, 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.


-28-


**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.


-29-


**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.


-30-


**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.


-31-


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
      October 9, 2006, Markland controlled approximately 83% 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.  Pursuant to the Stockholder Agreement between
      Markland and Technest dated March 13, 2006, Markland agreed to elect Joseph
      Mackin, Gino Pereira, and our three independent directors, Robert Doto, Gen.
      David Gust (US Army Rtd.) and Darlene Deptula-Hicks.




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.





**If
      our majority stockholder, Markland Technologies, Inc., sells or transfers all
      or
      a significant portion of the shares of our common stock that it currently holds,
      a change of control could result, which could significant disrupt our
      operations.**





Currently,
      Markland owns approximately 83% of our outstanding common stock. Markland has
      declared a distribution to its stockholders of 2,500,000 shares that it owns
      of
      Technest and has placed in escrow an aggregate of 4,640,192 shares of our common
      stock held by Markland to secure the conversion of the Markland Series E
      preferred stock. Upon the distribution to its stockholders of 2,500,000 shares
      of Technest, Markland’s ownership of Technest will be 67.7%. If all of the
      shares held in escrow were transferred by Markland, Markland’s ownership of
      Technest would drop to 39%. These holdings represent a significant portion
      of
      Markland’s assets. If Markland disposes of a large number of shares of our
      common stock for any reason, a change of control may result.  In
      particular, Markland is subject to various legal actions, proceedings and claims
      and may become subject to additional actions, proceedings and claims in the
      future. Were any of these claims to result in an outcome adverse to Markland,
      the resulting damages or amounts paid in settlement could be satisfied partially
      or wholly with shares of our common stock. A change of control at the
      shareholder level could result in a change to the composition of our board
      and,
      ultimately, a change in our management and business plan.  Any such
      transition could lead to, among other things, a decline in service levels,
      disruption in our operations and departures of key personnel, which could in
      turn harm our business.





**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.


-32-


In
      light
      of Markland’s significant holdings of our common stock and the potential for
      conflict given Mr. Pereira’s current positions with Markland and Technest, in an
      effort to avoid even the mere appearance of a conflict, the board of directors
      of Technest on September 22, 2006 formed a special committee comprised of the
      three independent directors, Robert
      Doto, Gen. David Gust (US Army Rtd.) and Darlene Deptula-Hicks, to address
      issues arising from or related to, directly or indirectly, the ownership of
      our common stock by Markland and its assignees and to take any action the
      special committee deems appropriate.





**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 in connection with our acquisition of Genex,
      Technest was obligated to file one or more registration statements with the
      Securities and Exchange Commission covering shares that are being registered
      pursuant to a registration statement that was filed with the SEC. 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.




**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:


-33-





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




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




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




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




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




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





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




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





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





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





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





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




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 October 9, 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.




-34-


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.




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 thereunder. These
      regulations when we become subject to them will increase our legal and financial
      compliance and make some activities more difficult, time-consuming and
      costly.





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




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




-35-


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




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




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




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




Rules
      adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002
      require annual assessment of our internal control over financial reporting,
      and
      attestation of this assessment by our independent registered public accountant.
      We expect that these requirements will first apply to our annual report for
      the
      fiscal year ending June 30, 2008 and June 30, 2009, respectively. The standards
      that must be met for management to assess the effectiveness of the internal
      control over financial reporting are new and complex, and require significant
      documentation, testing and possible remediation to meet the detailed standards.
      We may encounter problems or delays in completing activities necessary to make
      an assessment of its internal control over financial reporting. In addition,
      we
      may encounter problems or delays in completing the implementation of any
      requested improvements and receiving an attestation of its assessment by our
      independent registered public accountants. If management cannot assess our
      internal control over financial reporting as effective, or our independent
      registered public accounting firm is unable to issue an unqualified attestation
      report on such assessment, investor confidence and share value may be negatively
      impacted.


-36-





**Item
      7. Financial Statements**




**TECHNEST
      HOLDINGS, INC.**


**CONSOLIDATED
      FINANCIAL STATEMENTS**





**INDEX**




**Page
                Number****Technest
                Holdings, Inc. and Subsidiaries****Periods
                ended June 30, 2006 and June 30, 2005**Report
                of Independent Registered Public Accounting Firm
            F-2Consolidated
                Balance Sheet
            F-3Consolidated
                Statements of Operations
            F-5Consolidated
                Statements of Changes in Stockholders’ Equity (Deficit)
            F-6Consolidated
                Statements of Cash Flows
            F-9Notes
                to Consolidated Financial Statements
            F-12






F-1





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors


Technest
      Holdings, Inc. and Subsidiaries


Boston,
      Massachusetts








We
      have
      audited the accompanying consolidated balance sheet of Technest Holdings, Inc.
      and subsidiaries as of June 30, 2006, and the related consolidated statements
      of
      operations, changes in stockholders' equity (deficit) and cash flows for the
      year ended June 30, 2006 and six months ended June 30, 2005. These financial
      statements are the responsibility of the Company's management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audits.





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





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects the financial position of Technest Holdings, Inc. and
      subsidiaries as of June 30, 2006, and the results of its operations and its
      cash
      flows for the year ended June 30, 2006 and six months ended June 30, 2005,
      in
      conformity with U.S. generally accepted accounting principles.





As
      described in Note 3 to the financial statements, the financial statements as
      of
      and for the six months ended June 30, 2005 have been retroactively restated
      to
      reflect certain warrants as derivative liabilities and to reflect the
      acquisition of an entity under common control as of the date the Company became
      a member of the controlled group.











/s/
      Wolf
& Company, P.C.




Wolf
      & Company, P.C.


Boston,
      Massachusetts


October
      6, 2006


F-2


**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**BALANCE
      SHEET**


**JUNE
      30, 2006**






**ASSETS****Current
                  Assets**Cash
                  and cash equivalents
              
              $
              3,362,210Accounts
                  receivables
              
              
              9,374,879Unbilled
                  receivables
              
              
              2,054,121Inventory
                  and work-in-process
              
              
              20,235Restricted
                  cash
              
              
              250,000Prepaid
                  expenses and other current assets
              
              
              154,352**Total
                  Current Assets**
              
              
              15,215,797**Property
                  and Equipment**-
                  Net of accumulated depreciation of $663,187
              
              
              772,284**Other
                  Assets**Deposits
              
              
              75,250Definite-lived
                  intangible assets - Net of accumulated amortization of
                  $3,485,525
              
              
              11,552,529Goodwill
              
              
              14,035,551**Total
                  Other Assets**
              
              
              25,663,330**Total
                  Assets**
              
              $
              41,651,411**LIABILITIES
                  AND STOCKHOLDERS’ EQUITY****Current
                  Liabilities**Accounts
                  payable
              
              $
              13,245,437Accrued
                  expenses and other current liabilities
              
              
              4,848,935Due
                  to related parties, net
              
              
              595,782Current
                  portion of long-term debt
              
              
              50,885**Total
                  Current Liabilities**
              
              
              18,741,039**Non-Current
                  Liabilities**Long-term
                  debt, less current portion and discount of $880,773
              
              
              5,727,638**Total
                  Liabilities**
              
              
              24,468,677**Commitments
                  and Contingencies**


F-3




**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**BALANCE
      SHEET (continued)**


**JUNE
      30, 2006**






**Stockholders’
                Equity**Series
                A Convertible Preferred Stock - $.001 par value;150
                shares authorized; 64.325 shares issued and outstanding(preference
                in liquidation of $124,325 at June 30, 2006)
            
            
            --Series
                B Convertible Preferred Stock - $.001 par value;No
                shares authorized, issued and outstanding
            
            
            --Series
                C Convertible Preferred Stock - $.001 par value;1,149,425
                shares authorized;632,185
                issued and outstanding(preference
                in liquidation of $1,374,987 at June 30, 2006)
            
            
            632Common
                Stock - par value $.001 per share;495,000,000
                shares authorized; 15,867,911 shares issued and
                outstanding
            
            
            15,867Additional
                paid-in capital
            
            
            32,404,174Accumulated
                deficit
            
            
            (15,237,939
            )**Total
                Stockholders’ Equity**
            
            
            17,182,734**Total
                Liabilities and Stockholders’ Equity**
            
            $
            41,651,411






See
                notes to consolidated financial statements.(Reflects
                reverse stock split of 1 for 211.18 on July 19, 2005)


F-4




**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**FOR
      THE YEAR ENDED JUNE 30, 2006 AND THE SIX MONTHS ENDED JUNE 30, 2005
      (RESTATED)**






**2006**
            
            **2005****(Restated)****Revenues**
            
            $
            81,092,049
            
            $
            27,890,072**Cost
                of Revenues**
            
            
            66,542,239
            
            
            22,481,133**Gross
                Profit**
            
            
            14,549,810
            
            
            5,408,939**Operating
                Expenses**Selling,
                general and administrative (including $1,000,000 and $893,219 to
                related
                parties in the year ended June 30, 2006 and six months ended June
                30,
                2005, respectively)
            
            
            14,380,208
            
            
            5,809,945Research
                and development
            
            
            159,209
            
            
            2,395,950Amortization
                of intangible assets
            
            
            1,786,146
            
            
            611,471**Total
                Operating Expenses**
            
            
            16,325,563
            
            
            8,817,366**Operating
                Loss**
            
            
            (1,775,753
            )
            
            (3,408,427
            )**Other
                (Expenses) Income, Net**Other
                income
            
            
            161,600
            
            
            40,567Interest
                expense
            
            
            (3,179,672
            )
            
            (446,027
            )Derivative
                income (loss)
            
            
            25,046,489
            
            
            (30,212,400
            )**Total
                other expenses (income), net**
            
            
            22,028,417
            
            
            (30,617,860
            )**Net
                Income (Loss)**
            
            
            20,252,664
            
            
            (34,026,287
            )Deemed
                dividend on Series A Convertible Preferred Stock
            
            
            --
            
            
            124,848Deemed
                dividend on Series C Convertible Preferred Stock
            
            
            --
            
            
            2,465,000**Net
                Income (Loss) Applicable to Common Shareholders**
            
            $
            20,252,664
            
            $
            (36,616,135
            )**Basic
                Income (Loss) Per Common Share**
            
            $
            1.33
            
            $
            (3.42
            )**Diluted
                Income (Loss) Per Common Share**
            
            $
            1.25
            
            $
            (3.42
            )**Weighted
                Average Number of Common Shares Outstanding**
              **-
                Basic**
            
            
            15,228,294
            
            
            10,691,584**-
                Diluted**
            
            
            16,266,487
            
            
            10,691,584







See
      notes
      to consolidated financial statements.


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


F-5




**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)**


**FOR
      THE YEAR ENDED JUNE 30, 2006 AND THE SIX MONTHS ENDED JUNE 30, 2005 (RESTATED)**





Series
                  A
              
              Series
                  BConvertible
              
              ConvertibleCommon
                  Stock
              
              Preferred
                  Stock
              
              Preferred
                  StockShares
              
              Amount
              
              Shares
              
              Amount
              
              Shares
              
              AmountBalance
                  - January 1, 2005
              
              
              139,260
              
              $
              139
              
              
              -
              
              $
              -
              
              
              -
              
              $
              -Issuance
                  of Series A Convertible Preferred
                Stock
              
              
              -
              
              
              -
              
              
              124
              
              
              -
              
              
              -
              
              
              -Net
                  loss through February 14, 2005
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Balance
                  - February 14, 2005
              
              
              139,260
              
              
              139
              
              
              124
              
              
              -
              
              
              -
              
              
              -Impact
                  of applying push down accounting
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Acquisition
                  of EOIR
              
              
              12,000,000
              
              
              12,000
              
              
              -
              
              
              -
              
              
              -
              
              
              -Amortization
                  and remeasurement of stock-based compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Issuance
                  of common stock to Markland in
                connection
                  with the Genex acquisition
              
              
              1,954,023
              
              
              1,954
              
              
              -
              
              
              -
              
              
              -
              
              
              -Issuance
                  of Series B and C Convertible
                Preferred
                  Stock and warrants
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,149,425
              
              
              1,149Exchange
                  of Series B Convertible Preferred
                Stock
                  for Markland Series D Preferred Stock
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (632,182
              )
              
              (632
              )Common
                  Stock issued in conjunction with
                warrant
                  exercises
              
              
              208,910
              
              
              209
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  loss from February 15, 2005 to June 30, 2005 (restated)
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Balance
                  - June 30, 2005 (restated)
              
              
              14,302,193
              
              
              14,302
              
              
              124
              
              
              -
              
              
              517,243
              
              
              517Conversion
                  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
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  Stock issued in conjunction with warrant exercises
              
              
              354,921
              
              
              355
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  Stock issued in connection with
                liquidated
                  damages associated with registration rights agreements
              
              
              410,888
              
              
              410
              
              
              -
              
              
              -
              
              
              -
              
              
              -Exchange
                  of Series B Convertible Preferred
                Stock
                  for Markland Series D Preferred Stock
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (517,243
              )
              
              (517
              )Amortization
                  and forfeiture of stock-based compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Stock-based
                  compensation related to restricted stock grants
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Reclassify
                  derivative liability to equity
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Balance
                  - June 30, 2006
              
              
              15,867,911
              
              $
              15,867
              
              
              64
              
              $
              -
              
              
              -
              
              $
              -





See
      notes
      to consolidated financial statements.


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


F-6


**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)**


**FOR
      THE YEAR ENDED JUNE 30, 2006 AND THE SIX MONTHS ENDED JUNE 30, 2005** **(RESTATED)**







Series
                  CConvertible
              
              Subscription
              
              UnearnedPreferred
                  Stock
              
              Receivable
              
              CompensationShares
              
              Amount
              
              Amount
              
              AmountBalance-
                  January 1, 2005
              
              
              -
              
              $
              -
              
              $
              (7,035
              )
              $
              -Issuance
                  of Series A Convertible Preferred Stock
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  loss through February 14, 2005
              
              
              -
              
              
              -
              
              
              -
              
              
              -Balance
                  - February 14, 2005
              
              
              -
              
              
              -
              
              
              (7,035
              )
              
              -Impact
                  of applying push down accounting
              
              
              -
              
              
              -
              
              
              7,035
              
              
              -Acquisition
                  of EOIR
              
              
              -
              
              
              -
              
              
              -
              
              
              (2,175,542
              )Amortization
                  and remeasurement of stock based
                compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              634,052Issuance
                  of common stock to Markland in connection with
                the
                  Genex acquisition
              
              
              -
              
              
              -
              
              
              -
              
              
              -Issuance
                  of Series B and C Convertible Preferred Stock
                and
                  warrants
              
              
              1,149,425
              
              
              1,149
              
              
              -
              
              
              -Exchange
                  of Series B Convertible Preferred Stock for
                Markland
                  Series D Preferred Stock
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued in conjunction with warrant exercises
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  loss from February 15, 2005 to June 30, 2005 (restated)
              
              
              -
              
              
              -
              
              
              -
              
              
              -Balance
                  - June 30, 2005 (restated)
              
              
              1,149,425
              
              
              1,149
              
              
              -
              
              
              (1,541,490
              )Conversion
                  of Series A Convertible Preferred Stock to
                Common
                  Stock
              
              
              -
              
              
              -
              
              
              -
              
              
              -Conversion
                  of Series C Convertible Preferred Stock to
                Common
                  Stock
              
              
              (517,240
              )
              
              (517
              )
              
              -
              
              
              -Common
                  Stock issued in conjunction with warrant exercises
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued in connection with liquidated
                damages
                  associated with registration rights agreements
              
              
              -
              
              
              -
              
              
              -
              
              
              -Exchange
                  of Series B Convertible Preferred Stock for
                Markland
                  Series D Preferred Stock
              
              
              -
              
              
              -
              
              
              -
              
              
              -Amortization
                  and forfeiture of stock based compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              1,541,490Stock
                  based compensation related to restricted stock grants
              
              
              -
              
              
              -
              
              
              -
              
              
              -Reclassification
                  of derivative liability to equity
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -Balance
                  - June 30, 2006
              
              
              632,185
              
              $
              632
              
              $
              -
              
              $
              -


See
      notes
      to consolidated financial statements.


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


F-7


**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)**


**FOR
      THE YEAR ENDED JUNE 30, 2006 AND THE SIX MONTHS ENDED JUNE 30, 2005** **(RESTATED)**





Additional
              
              
              
              TotalPaid-In
              
              Accumulated
              
              Stockholders'Capital
              
              Deficit
              
              Equity
                  (Deficit)Amount
              
              Amount
              
              AmountBalance
                  - January 1, 2005
              
              $
              15,229,318
              
              $
              (15,531,599
              )
              $
              (309,177
              )Issuance
                  of Series A Convertible Preferred Stock
              
              
              124,848
              
              
              -
              
              
              124,848Net
                  loss through February 14, 2005
              
              
              -
              
              
              (2,250
              )
              
              (2,250
              )Balance
                  February 14, 2005 -
              
              
              15,354,166
              
              
              (15,533,849
              )
              
              (186,579
              )Impact
                  of applying push down accounting
              
              
              (15,356,554
              )
              
              15,533,849
              
              
              184,330Acquisition
                  of EOIR
              
              
              16,533,761
              
              
              (1,466,566
              )
              
              12,903,653Amortization
                  and remeasurement of stock based compensation
              
              
              158,832
              
              
              -
              
              
              792,884Issuance
                  of common stock to Markland in connection with the Genex
                  acquisition
              
              
              6,099,304
              
              
              -
              
              
              6,101,258Issuance
                  of Series B and C Convertible Preferred Stock and warrants
              
              
              2,451,124
              
              
              -
              
              
              2,453,422Exchange
                  of Series B Convertible Preferred Stock for Markland Series D Preferred
                  Stock
              
              
              632
              
              
              -
              
              
              -Common
                  Stock issued in conjunction with warrant exercises
              
              
              4,307,575
              
              
              -
              
              
              4,307,784Net
                  loss from February 15, 2005 to June 30, 2005 (restated)
              
              
              -
              
              
              (34,024,037
              )
              
              (34,024,037
              )Balance
                  June 30, 2005 (restated)
              
              
              29,548,840
              
              
              (35,490,603
              )
              
              (7,467,285
              )Conversion
                  of Series A Convertible preferred stock to common stock
              
              
              (283
              )
              
              -
              
              
              -Conversion
                  of Series C convertible Preferred Stock to Common Stock
              
              
              -
              
              
              -
              
              
              -Common
                  Stock issued in conjunction with warrant exercises
              
              
              (355
              )
              
              -
              
              
              -Common
                  Stock issued in connection with liquidated damages associated with
                  registration rights agreements
              
              
              2,104,051
              
              
              -
              
              
              2,104,461Exchange
                  of Series B Convertible Preferred Stock for Markland Series D Preferred
                  Stock
              
              
              517
              
              
              -
              
              
              -Amortization
                  and forfeiture of stock based compensation
              
              
              (1,445,151
              )
              
              -
              
              
              96,339Stock
                  based compensation related to restricted stock grants
              
              
              279,428
              
              
              -
              
              
              279,428Reclassification
                  of derivative liability to equity
              
              
              1,917,127
              
              
              -
              
              
              1,917,127Net
                  income
              
              
              -
              
              
              20,252,664
              
              
              20,252,664Balance
                  June 30,2006
              
              $
              32,404,174
              
              $
              (15,237,939
              )
              $
              17,182,734


See
      notes
      to consolidated financial statements.


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


F-8




**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONSOLIDATED STATEMENTS OF CASH FLOWS**


**FOR
      THE YEAR ENDED JUNE 30, 2006 AND THE SIX MONTHS ENDED JUNE 30, 2005** **(RESTATED)**







**2006**
            
            **2005**
              **(Restated)**CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income (loss)
            
            $
            20,252,664
            
            $
            (34,026,287
            )Adjustment
                to reconcile net income (loss) to netcash
                provided by operating activities:Derivative
                (income) loss
            
            
            (25,046,489
            )
            
            30,212,400Common
                stock issued in settlement of liquidated damages
            
            
            2,104,461
            
            
            --Depreciation
                of property and equipment
            
            
            385,032
            
            
            120,524Accrued
                  interest on note payable paid inSeries A Convertible Preferred
                  Stock
            
            
            --
            
            
            7,690Amortization
                of intangible assets
            
            
            1,747,347
            
            
            611,471Acquired
                in-process research and development
            
            
            --
            
            
            2,095,000Stock-based
                compensation
            
            
            375,767
            
            
            1,044,512Non-cash
                interest expense
            
            
            293,592
            
            
            110,097Changes
                in operating assets and liabilities:Accounts
                receivable and unbilled receivables
            
            
            (3,832,138
            )
            
            (356,042
            )Inventory
                and work in process
            
            
            281,211
            
            
            (183,704
            )Deposits
                and prepaid expenses and other current assets
            
            
            (83,824
            )
            
            (46,969
            )Restricted
                cash
            
            
            --
            
            
            (250,000
            )Due
                to related parties
            
            
            (1,553,960
            )
            
            295,638Accounts
                payable
            
            
            2,795,528
            
            
            4,464,187Accrued
                expenses and other current liabilities
            
            
            3,183,845
            
            
            326,307NET
                CASH PROVIDED BY OPERATING ACTIVITIES
            
            
            903,036
            
            
            4,424,824CASH
                FLOWS FROM INVESTING ACTIVITIES:Cash
                  used for acquisition of Genex Technologies, Inc., net of cash
                  acquired
            
            
            --
            
            
            (2,515,516
            )Proceeds
                from the sale of property and equipment
            
            
            29,956
            
            
            --Cash
                acquired in acquisition of E-OIR Technologies, Inc.
            
            
            --
            
            
            1,916,079Purchase
                of property and equipment
            
            
            (324,499
            )
            
            (65,657
            )NET
                CASH USED IN INVESTING ACTIVITIES
            
            
            (294,543
            )
            
            (665,094
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Proceeds
                  from sale of Series A Convertible Preferred Stock
            
            
            --
            
            
            50,000Proceeds
                  from sale of Series B and C ConvertiblePreferred Stock and
                  warrants, net
            
            
            --
            
            
            3,512,422Payment
                of note payable and long-term debt
            
            
            (2,858,891
            )
            
            (1,709,683
            )NET
                CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
            
            
            (2,858,891
            )
            
            1,852,739NET
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            (2,250,398
            )
            
            5,612,469CASH
                AND CASH EQUIVALENTS - BEGINNING OF PERIOD
            
            
            5,612,608
            
            
            139CASH
                AND CASH EQUIVALENTS - END OF PERIOD
            
            $
            3,362,210
            
            $
            5,612,608







See
      notes
      to consolidated financial statements.


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


F-9




**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS (continued)**


**FOR
      THE YEAR ENDED JUNE 30, 2006 AND THE SIX MONTHS ENDED JUNE 30, 2005** **(RESTATED)**






**2006**
            
            **2005**
              **(Restated)**SUPPLEMENTAL
                DISCLOSURES OF CASH FLOW INFORMATION:Cash
                paid during the periods for:Interest
            
            $
            576,620
            
            $
            325,503Taxes
            
            $
            --
            
            $
            500Non-cash
                investing and financing activities:Conversion
                of notes payable and accrued interest into Series APreferred
                Stock
            
            $
            --
            
            $
            74,848Common
                Stock issued in exchange for shares of MarklandTechnologies,
                Inc. used in conjunction with the acquisition ofGenex
                Technologies, Inc.
            
            $
            --
            
            $
            6,101,258Common
                Stock issued in conjunction with the acquisitionof
                E-OIR Technologies, Inc.
            
            $
            --
            
            $
            12,903,653Deemed
                dividend Preferred Stock - beneficial conversionfeature
                - Series A
            
            $
            --
            
            $
            124,848Deemed
                dividend Preferred Stock - beneficial conversionfeature
                - Series C
            
            $
            --
            
            $
            2,465,000Reclassification
                of derivative liability to equity
            
            $
            1,917,127
            
            $
            4,307,784Inventory
                transferred to Markland
            
            $
            105,218
            
            
            --






See
      notes
      to consolidated financial statements.


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


F-10




**TECHNEST
      HOLDINGS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS (concluded)**


**FOR
      THE YEAR ENDED JUNE 30, 2006 AND THE SIX MONTHS ENDED JUNE 30, 2005** **(RESTATED)**







On
      February 14, 2005, the Company acquired 100% of the outstanding common stock
      of
      Genex Technologies, Inc. The
      transaction had
      the
      following non-cash impact on the balance sheet:




Accounts
                receivable
            
            $
            166,557Inventory
                and work in process
            
            
            222,957Prepaid
                expenses and other current assets
            
            
            25,403Property
                and equipment
            
            
            44,000Intangible
                assets, goodwill and in-process research and development
            
            
            8,702,149Accounts
                payable
            
            
            (314,718
            )Accrued
                expenses and other current liabilities
            
            
            (229,574
            )Equity
                issued
            
            
            (6,101,258
            )Net
                cash used for acquisition, net of cash acquired of $784,485
            
            $
            2,515,516







On
      the
      date of the acquisition of Genex Technologies, Inc. and the application of
      push-down accounting (see Note 3), Technest Holdings, Inc. had net accounts
      payable of $184,330.




On
      August
      17, 2005, the Company acquired 100% of the outstanding common stock of E-OIR
      Technologies, Inc. from Markland, Technest’s majority shareholder. As this was a
      transaction between entities under common control, Technest recognized the
      net
      assets of EOIR at their carrying amounts in the accounts of Markland at the
      date
      Technest came into Markland’s control group, February 14, 2005. The financial
      statements previously issued have been adjusted retroactively (restated) to
      reflect the transaction as of that date and to include the activity of EOIR
      from
      that date forward. The transaction had the following non-cash impact on the
      balance sheet:









Accounts
                receivable
            
            $
            7,044,264Prepaid
                expenses and other current assets
            
            
            73,406Property
                and equipment
            
            
            873,640Intangible
                assets and goodwill
            
            
            21,371,550Accounts
                payable
            
            
            (5,615,425
            )Accrued
                expenses and other current liabilities
            
            
            (1,109,208
            )Notes
                payable
            
            
            (9,943,408
            )Due
                to related parties
            
            
            (1,707,245
            )Equity
                issued
            
            
            (12,903,653
            )Cash
                acquired in acquisition
            
            $
            1,916,079







See
      notes
      to consolidated financial statements.


F-11


**TECHNEST
      HOLDINGS INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**FOR
      THE YEAR ENDED JUNE 30, 2006 AND THE SIX MONTHS ENDED JUNE 30, 2005** **(RESTATED)**







**1.
      NATURE OF OPERATIONS**





Business
      and Basis of Presentation





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





On
      February 14, 2005, Technest became a majority-owned subsidiary of Markland
      Technologies, Inc. (“Markland”), a homeland defense, armed services and
      intelligence contractor. Markland is a public company with a class of equity
      securities registered pursuant to Section 12(g) of the Exchange Act. Technest
      issued to Markland 1,954,023 shares of its common stock, representing a 93%
      ownership interest in Technest’s common stock, in exchange for 10,168,764 shares
      of Markland common stock valued at $6,101,258 which were used as partial
      consideration for the concurrent acquisition of Genex Technologies, Inc.
      (“Genex”) (see Note 3).





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 the Genex acquisition, the accounts of Technest 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).





We
      operate in five principal technical areas: Advanced Sensor Systems, Imaging
      and
      Intelligence Solutions, Operational Management, Intelligent Surveillance, and
      Chemical and Explosive Detection.





**Advanced
      Sensor Systems**





Advanced
      Sensor Systems is engaged in design, research and development, systems
      integration, sustainment, support, and upgrade of advanced sensor systems for
      the U.S. military; this includes high performance targeting and surveillance
      sensors, driving enhancements, rifle sights, fusion and automatic target
      recognition, mine and minefield detection, mine neutralization, minefield
      breaching, sensor system performance modeling and analysis, virtual prototyping,
      simulation-based analyses, high-performance multi-color Focal Plane Array (FPA),
      multi-function lasers, distributed sensor networks, Long Wavelength Infrared
      (LWIR) and Short Wavelength Infrared (SWIR) arrays, unattended ground sensors,
      and rapid prototyping.





The
      majority of the work performed by Advanced Sensor Systems is carried out through
      an Omnibus Contract with the United States Army Night Vision and Electronic
      Sensors Directorate. We retain non exclusive rights to sell the technologies
      that we develop under this contract. Our main products, developed or nearing
      development, include Interchangeable Wide Area Search Surveillance System
      (IWAS 3 ),
      Safety
      Evaluation Range Training System (SERTS TM ),
      Universal Sensor Remoting Device (USRD), Pelco Camera Translators,
      WinProc TM ,
      IProc TM ,
      GPS
      GroundTruther, TTAASP TM ,
      and
      EOIRTA TM .


F-12


**Imaging
      and Intelligence Solutions**





Imaging
      and Intelligence Solutions is engaged in the design, research and development,
      integration, analysis, modeling, and training of classified solutions in support
      of the United States’ intelligence community and homeland security.





We
      provide support to the NGA College, including program management support,
      curriculum development and instruction in Geospatial and Imaging Analysis,
      Advanced Geospatial Intelligence, and Measurements and Signal Intelligence.
      We
      develop core curriculum: platform, web- and computer-based training; and
      maintain the Soft Copy Keys Program. We develop specialized tools and algorithms
      for atmospheric computation and full-spectrum signal processing, promote imaging
      standards, evaluate new technology, assist users with Advanced Geospatial
      Intelligence technologies, and maintain spectral libraries used throughout
      the
      Intelligence Community. For the National Ground Intelligence Center, we provide
      systems modeling, intelligence analysis for military operations and disaster
      relief, and we develop and integrate remote triggering devices and monitoring
      stations used in field testing and air-and ground-based sensor analysis. We
      support maritime advanced geospatial imagery exploitation and counter drug
      operations, as well as all-source analysis for Army operational
      forces.





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 expect to 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.





**Operational
      Management**





Operational
      Management is engaged in the program management, integration, training,
      logistics, analysis, and field support of numerous projects for the U.S.
      military.





We
      provide program management support for the Marine Corps Systems Command (MCSC),
      which includes providing logistical support of current projects and integration
      with legacy systems. We also are assisting in the development of the
      Electro-Optical Test Facility (EOTF) for the Program Manager Optics and
      Non-Lethal Systems (PM ONLS). This encompasses the full life-cycle of the test
      facility; as we will design the facility, oversee the procurement of equipment,
      develop standard operating procedures, and manage the thermal testing portion
      of
      the lab. We provide systems integration, board design, training, and field
      support for products, such as DoubleShot, which is currently actively deployed
      in Operation Iraqi Freedom (OIF) in support of the Marine Corps Warfighting
      Lab
      (MCWL). In addition, we represent the Marine Corps in the joint development
      of
      Joint Chemical Agent Detector (JCAD), Joint Service Light Standoff Chemical
      Agent Detector (JSLSCAD), Joint Service Light Nuclear, Biological, Chemical,
      Reconnaissance System (JSLNBCRS), as well as other engineering technology in
      support of the MCSC Chemical, Biological, Radiological, Nuclear Defense (CBRND)
      team. This support consists of testing emerging technology, providing logistical
      support and management of legacy systems. We also provide systems integration
      support for the Directed Energy Technology Office (DETO) at Naval Surface
      Warface Center Dahlgren Division (NSWCDD) integrating various sensors, such
      as
      Driver Viewer Enhancer and Blue Force Tracker, into a prototype directed energy
      system in support of OIF.





**Intelligent
      Surveillance**





Intelligent
      Surveillance is engaged in the design, research and development, integration,
      analysis, modeling, system networking, and support of advanced surveillance
      and
      three-dimensional imaging devices and systems.





We
      provide full life-cycle support, technology, and very specialized expertise
      in
      the areas of real-time embedded image processing, software and systems
      engineering, as well as three-dimensional facial recognition. We also develop
      re-configurable, multi-sensor systems with unique, nonstandard architectures.
      In
      addition, we develop sensors for detection of concealment of intent using
      thermal and three-dimensional imaging, devices for early detection of cancer
      using non-invasive and non-radiological diffuse optical tomography, and more
      effective and less risky radiation treatments for cancer by using
      three-dimensional imaging for patient re-positioning. Our major products,
      developed or nearing development, include our OmniEyeTM Wellcam, OmniEyeTM
Cerberus, Smart Optical Sensor (SOS), Smart SuiteTM, Omnivision, Small Tactical
      Ubiquitous Detection System (STUDS), and 3D SketchArtist.


F-13


**Chemical
      and Explosive Detection**





Chemical
      and Explosive Detection is engaged in the design, research and development,
      software and hardware engineering, integration, training, and networking of
      advanced Chemical/Biological and Improvised Explosive Devices detection
      sensors.





We
      provide technologies that reliably detect the presence of chemical, biological,
      and explosive devices or components from stand-off distances utilizing
      multi-spectral electro-optical sensing methods. We also provide
      Chemical/Biological and Improvised Explosive Devices simulators and real-time
      training devices with product specific specifications. Our major
      products,developed or nearing development, include our Shipboard Automatic
      Chemical Agent Detection and Alarm (ACADA), Automated, Adaptive Chemical
      Examination System (AACES), and M22 Simulator.





Reorganization
      and Restatements




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.





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
      impact of the restatement on the financial statements for the six months ended
      June 30, 2005 to include EOIR from February 14, 2005 and to correct the
      accounting for the warrants is as follows:





As
                originallystated
            
            Impact
                ofEOIR
            
            Impact
                ofderivatives
            
            Total
                impact of restatementNet
                loss
            
            $
            (2,728,639
            )
            $
            (1,085,248
            )
            $
            (30,212,400
            )
            $
            (31,297,648
            )Net
                loss applicable to common stockholders
            
            $
            (4,903,487
            )
            $
            (1,085,248
            )
            $
            (30,627,400
            )
            $
            (31,712,648
            )Net
                loss applicable to common stockholders per common share
            
            $
            (3.02
            )
            $
            2.46
            
            $
            (2.86
            )
            $
            (0.40
            )








The
      net
      loss applicable to common stockholders per common share increased from ($3.02)
      to ($3.42) as a result of the acquisition of EOIR, the correction of the
      accounting for the warrants and the resulting restatement described above.
      Although the net loss applicable to common stockholders increased from
      ($4,903,487) to ($36,616,135), the additional 12,000,000 shares of common stock
      issued in the acquisition of EOIR increased the weighted average number of
      common shares outstanding from 1,624,918 to 10,691,584. The impact of the
      increased weighted average common shares outstanding significantly offset the
      additional net loss resulting in a small net increase in net loss applicable
      to
      common stockholders per common share.


F-14


**2.
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





Principles
      of Consolidation





The
      consolidated financial statements include the accounts of Technest and its
      wholly-owned subsidiaries, Genex Technologies, Inc. and E-OIR Technologies,
      Inc.
      Genex was acquired on February 14, 2005. On
      August
      17, 2005, Technest purchased all of the outstanding stock of EOIR, formerly
      one
      of Markland’s wholly-owned subsidiaries. As
      the
      transfer of EOIR was a transaction between entities under common control,
      t he
      Company has restated its financial statements as though the transfer of EOIR
      occurred on the date Technest became part of Markland’s control group, February
      14, 2005. All
      significant inter-company balances and transactions have been eliminated in
      consolidation.





The
      purchase method of accounting was used by Technest to record the assets acquired
      and liabilities assumed of Genex Technologies, Inc. on February 14, 2005.
      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 as of and for periods
      ended prior to the acquisition.




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





Concentrations
      and Risks





Technest
      has cash balances in banks in excess of the maximum amount insured by the FDIC
      as of June 30, 2006.





A
      significant portion of revenue is generated from contracts with Federal
      government agencies, including one contract with the U.S. Army expiring July
      2007 which represented approximately $70,310,000 of revenue in the year ended
      June 30, 2006. Consequently, a significant portion of accounts receivable are
      due from Federal government agencies either directly or through other government
      contractors.




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





Cash
      and Cash Equivalents





The
      Company considers all highly liquid investments with maturities of ninety days
      or less to be cash equivalents. Cash equivalents consist of money market funds
      as of June 30, 2006.





Accounts
      Receivable





Accounts
      receivable represent the amounts invoiced by the Company under contracts. An
      allowance for doubtful accounts is determined based on management's best
      estimate of probable losses inherent in the accounts receivable balance.
      Management assesses the allowance based on known trouble accounts, historical
      experience and other currently available evidence.




F-15




A
        significant portion of the Company's receivables are due from government
        contracts, either directly or as a subcontractor. The Company has not
        experienced any material losses in accounts receivable related to these
        contracts and has provided no allowance at June 30, 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
        are stated at the lower of cost or market.  Cost is determined by the
        first-in, first-out method and market represents the lower of replacement
        costs
        or estimated net realizable value. Work in process represents allowable costs
        incurred but not billed related to contracts.
  Property
        and Equipment
  Property
        and equipment are valued at cost and are being depreciated over their useful
        lives using the straight-line method for financial reporting  purposes.
        Routine maintenance and repairs are charged to expense as incurred. Expenditures
        which materially increase the value or extend useful lives are capitalized.
  Property
        and equipment are depreciated over the estimated useful lives of assets as
        follows:
  Software
              
              
              3
                  yearsComputer
                  equipment
              
              
              3
                  yearsFurniture
                  and fixtures
              
              
              5-7
                  yearsLeasehold
                  improvements
              
              
              Shorter
                  of useful life or lease termVehicles
              
              
              5
                  years
  Property
        and equipment consisted of the following at June 30, 2006:
  Software
                
                $
                169,077Computer
                    equipment
                
                
                665,111Furniture
                    and fixtures
                
                
                345,275Leasehold
                    improvements
                
                
                222,338Vehicles
                
                
                33,6701,435,471Less
                    accumulated depreciation
                
                
                (663,187
                )$
                772,284
 
  Depreciation
        expense for the year ended June 30, 2006 and the six months ended June 30,
        2005
        was $385,032 and $120,524, respectively.
  Definite-lived
        Intangible Assets
  Included
        in definite-lived intangible assets are the amounts assigned to customer
        relationships and contracts and patents acquired in connection with business
        combinations (see Note 3). Also included are certain costs of outside legal
        counsel related to obtaining new patents.
  Patent
        costs are amortized over the legal life of the patents, generally fifteen
        years,
        starting on the patent issue date.  The costs of unsuccessful and abandoned
        patent applications are expensed when abandoned.  The cost to maintain
        existing patents are expensed as incurred.  The nature of the technology
        underlying these patents relates to 3-D imaging, intelligent surveillance
        and
        3-D facial recognition technologies.
  F-16
  With
        the
        acquisition of Genex, Technest acquired Commercialized Technology (patents)
        relating to 3D facial recognition cameras and Contracts and Customer
        Relationships from the application of 3D imaging technologies to breast cancer
        research for the National Institute of Health and disposable sensors and
        3D face
        mapping for the Department of Defense. The amounts assigned to definite-lived
        intangible assets were determined by management based on a number of factors
        including an independent purchase price allocation analysis. These assets
        have
        an estimated useful life of five years.
  With
        the
        acquisition of EOIR, Technest acquired Contracts and Customer Relationships
        (see
        Note 3) related to sensor and chemical detection technologies with estimated
        useful lives of nine and ten years, respectively. The amounts assigned to
        definite-lived intangible assets were determined 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
        June
        30, 2006, as required by Statement of Financial Accounting Standards No.
        107,
        "Disclosures about Fair Value of Financial Instruments." Financial instruments
        are initially recorded at historical cost. If subsequent circumstances indicate
        that a decline in the fair value of a financial asset is other than temporary,
        the financial asset is written down to its fair value.
  Unless
        otherwise indicated, the fair values of financial instruments approximate
        their
        carrying amounts. By their nature, all financial instruments involve risk,
        including credit risk for non-performance by counterparties. The maximum
        potential loss may exceed any amounts recognized in the consolidated balance
        sheets.
  The
        fair
        value of cash, accounts receivable and accounts payable 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
        6) have
        been recorded at their fair value, as determined and valued by management
        considering various factors including an independent appraisal done by a
        valuation and financial advisory firm, which is less than the face value
        due to
        a below market interest rate.
  Operating
        Segments
  The
        Company operates in two Operating Segments as defined in paragraph 10 of
        SFAS
        No. 131, “Disclosures about Segments of an Enterprise and Related Information”.
        These are (1) the business of EOIR which primarily consists of products and
        services in the remote sensing technology and (2) the business of Genex which
        primarily consists of research and development, design and fabrication of
        3D
        imaging and of intelligent surveillance products. Further, since both these
        operating segments have similar economic characteristics, as well as similar
        products and services, production processes, customers, distribution methods
        and
        regulatory environment, the Company concluded that they meet the aggregation
        criteria outlined in paragraph 17 of SFAS No. 131. Therefore, the Company
        aggregates the two operating segments into a single reportable segment in
        accordance with paragraph 16 of SFAS No. 131.
  Revenue
        Recognition
  Revenues
        from products are recognized when the following criteria are met: (1) there
        is
        persuasive evidence of an arrangement, such as contracts, purchase orders
        or
        written requests; (2) delivery has been completed and no significant obligations
        remain; (3) price to the customer is fixed or determinable; and (4) collection
        is probable.
  Revenues
        from time and materials contracts are recognized as costs are incurred and
        billed. Allowable costs incurred but not billed as of a period end are recorded
        as work in process.
  Revenues
        from firm fixed price contracts are recognized on the percentage-of-completion
        method, either measured based on the proportion of costs recorded to date
        on the
        contract to total estimated contract costs or measured based on the proportion
        of labor hours expended to date on the contract to total estimated contract
        labor hours, as specified in the contract.
  F-17
  Provisions
        for estimated losses on all contracts are made in the period in which such
        losses become known. Changes in job performance, job conditions, and estimated
        profitability, including those arising from contract penalty provisions,
        and
        final contract settlements may result in revisions to costs and income and
        are
        recognized in the period in which the revisions are determined.
  The
        Company participates in teaming agreements where it is the primary contractor
        and it also participates with other organizations to provide complex integrated
        remote sensor product and technology development services to the Federal
        government. EITF Issue No. 99-19, “Reporting Revenue Gross as a Principal versus
        Net as an Agent” discusses the factors or indicators which should be considered
        in evaluating whether a company should recognize revenue based on (a) the
        gross
        amount billed to a customer because it has earned revenue from the sale of
        the
        goods or services or (b) the net amount retained (that is, the amount billed
        to
        the customer less the amount paid to a supplier) because it has earned a
        commission or fee. The Task Force reached a consensus that this is a matter
        of
        judgment that depends on the relevant facts and circumstances. The Company
        considered that it is the primary obligator in these arrangements and 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.
        The Company also considered that, as the prime contractor it accepts risks
        for
        these customer funded tasks. The Company also considered that in many cases
        part
        of the services ordered by the customer are performed by the Company itself.
        Further in some cases the Company has discretion in supplier selection and
        also
        a reasonable latitude to establish the price with the customer for the service.
        The Company believes that based on the aforesaid considerations it meets
        with
        the criteria for Gross Revenue Reporting as discussed in EITF Issue No. 99-19.
        The Company therefore 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 .
  Revenues
        from teaming agreements for the year ended June 30, 2006 and the six months
        ended June 30, 2005 were $4.4  million
        and $1.7 million respectively.
  Shipping
        Costs
 
 Delivery
        and shipping costs are included in contract revenue and direct costs in the
        accompanying statements of operations.
  Research
        and Development
  The
        Company charges unfunded research and development costs to expense as incurred.
        Funded research and development is part of the Company’s revenue base and the
        associated costs are included in cost of revenues. The Company capitalizes
        costs
        related to acquired technologies that have achieved technological feasibility
        and have alternative uses. Acquired technologies which do not meet these
        criteria are expensed as in-process research and development costs. For the
        period ended June 30, 2005, the Company expensed $2,095,000 of acquired
        in-process research and development related to the acquisition of Genex (see
        Note 3).
  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.
  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.
  F-18
  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
        year ended June 30, 2006:
 
 **2006**Weighted-average
                  shares outstanding for basic net income per share
              
              
              15,228,294Series
                  A Convertible Preferred Stock
              
              
              306,047Series
                  C Convertible Preferred Stock
              
              
              632,178Warrants
                  to
                  purchase common stock
              
              
              99,968Total
                  shares for diluted net income per share
              
              
              16,266,487
  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 six months ended June 30, 2005 because their inclusion
        would
        have had the effect of decreasing the loss per share otherwise computed.
        As
        described in Note 9, common stock equivalents totaling 2,624,016 shares have
        been excluded from the calculation of net loss per share because they were
        antidilutive.
  Net
        income (loss) per share for the period ended June 30, 2005 has 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 purchase price over the fair value
        of
        the identifiable net assets acquired. Goodwill is identified and recorded
        at the
        reporting unit level as required by paragraphs 30-31 of SFAS No. 142, "Goodwill
        and Other Intangible Assets". SFAS No. 142 prescribes a two-step process
        for
        impairment testing, at the reporting unit level, of goodwill, which is performed
        annually, as well as when an event triggering impairment may have occurred.
        The
        first step tests for impairment, while the second step, if necessary, measures
        the impairment. The Company has determined that its reporting 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 year
        ended June 30, 2006 and the six months ended June 30, 2005.
  Impairment
        of Long-Lived Assets
  Pursuant
        to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived
        Assets", Technest continually monitors events and changes in circumstances
        that
        could indicate carrying amounts of long-lived assets may not be recoverable.
        An
        impairment loss is recognized when expected cash flows are less than the
        asset's
        carrying value. Accordingly, when indicators of impairment are present, Technest
        evaluates the carrying value of such assets in relation to the operating
        performance and future undiscounted cash flows of the underlying assets.
        Technest’s policy is to record an impairment loss when it is determined that the
        carrying amount of the asset may not be recoverable. No impairment charges
        were
        recorded in year ended June 30, 2006 and the six months ended June 30, 2005.
  Derivative
        Instruments
 
 Technest
        generally does not use derivative instruments to hedge exposures to cash-flow
        or
        market risks. However, certain warrants to purchase common stock that are
        indexed to the Company's common stock are classified as liabilities when
        the
        Company is not permitted to settle the instruments in unregistered shares.
        In
        such instances, net-cash settlement is assumed for financial reporting purposes,
        even when the terms of the underlying contracts do not provide for net-cash
        settlement. Such financial instruments are initially recorded at relative
        fair
        value with subsequent changes in fair value charged (credited) to operations
        in
        each reporting period. If the Company subsequently achieves the ability to
        settle the instruments in unregistered shares, the instruments are reclassified
        to equity at their fair value.
  F-19
  Stock-Based
        Compensation
  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 interpretations
        including Financial Accounting Standards Board ("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 income (loss) for the year ended June 30, 2006
        and
        the six months ended June 30, 2005.
  Year
                  ended June 30, 2006
              
              Six
                  months ended June 30, 2005Net
                  income (loss), as reported
              
              $
              20,252,664
              
              $
              (34,026,287
              )Add:
                  stock-based employee compensation under intrinsic value method
                  included in
                  net loss
              
              
              96,339
              
              
              634,052Deduct:
                  stock-based employee compensation under fair value method
              
              
              (118,232
              )
              
              (1,097,587
              )Pro
                  forma net income (loss)
              
              
              20,230,771
              
              
              (34,489,822
              )Deemed
                  dividends on Series A and C Convertible Preferred Stock
              
              
              --
              
              
              (2,589,848
              )Pro
                  forma net income (loss) applicable to common stockholders
              
              $
              20,230,771
              
              $
              (37,079,670
              )Basic
                  income (loss) applicable to common stockholders per common
                  share
              
              $
              1.33
              
              $
              (3.42
              )Diluted
                  income (loss) applicable to common stockholders per common
                  share
              
              $
              1.25
              
              
              (3.42
              )Pro
                  forma basic income (loss) applicable to common stockholders per
                  common
                  share
              
              $
              1.33
              
              
              (3.47
              )Pro
                  forma diluted income (loss) applicable to common stockholders per
                  common
                  share
              
              $
              1.24
              
              $
              (3.47
              )
 
 The
        assumptions used and weighted average information for the year ended June
        30,
        2006 and six months ended June 30, 2005 is as follows:
  Fair
                  value of stock
              $0.12Exercise
                  price
              $0.06Expected
                  dividend yield
              0%Expected
                  lives (in years)
              9Volatility
              69%Risk-free
                  interest rate
              3.53%
  Stock-based
        employee compensation relates to Markland issuances of its shares of common
        stock and options to purchase its common stock to employees of the Company
        (see
        Note 7) as well as issuances of Technest restricted stock to
        employees.
  F-20
  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 made by Markland to its 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 Markland 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 by Markland or Technest to the Company’s employees in the
        future.
  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 currently receive 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.
  In
        May
        2005, the FASB issued SFAS No. 154 "Accounting Changes and Error Corrections
        - A
        Replacement of APB Opinion No. 20 and FASB Statement No. 3 ("SFAS 154")".
        SFAS
        154 requires retrospective application to prior periods' financial statements
        of
        changes in accounting principle, unless it is impracticable to determine
        either
        the period-specific effects or the cumulative effect of the change. SFAS
        154
        does not change the guidance for reporting the correction of an error in
        previously issued financial statements or a change in accounting estimate.
        The
        provisions of SFAS 154 shall be effective for accounting changes and corrections
        of errors made in fiscal years beginning after December 15, 2005. The Company
        does not expect the adoption of SFAS 154 to have a material effect on the
        consolidated financial position or results of operations.
  In
        July 2006, the FASB issued Interpretation No. 48, “Accounting for
        Uncertain Tax Positions”, an Interpretation of SFAS No. 109 (“FIN 48”),
        which clarifies the criteria for recognition and measurement of benefits
        from
        uncertain tax positions. Under FIN 48, an entity should recognize a tax benefit
        when it is “more-likely-than-not”, based on the technical merits, that the
        position would be sustained upon examination by a taxing authority. The amount
        to be recognized, given the “more likely than not” threshold was passed, should
        be measured as the largest amount of tax benefit that is greater than 50
        percent
        likely of being realized upon ultimate settlement with a taxing authority
        that
        has full knowledge of all relevant information. Furthermore, any change in
        the
        recognition, derecognition or measurement of a tax position should be recognized
        in the interim period in which the change occurs. The Company expects to
        adopt
        FIN 48 as of July 1, 2007, and any change in net assets as a result of
        applying the Interpretation will be recognized as an adjustment to retained
        earnings on that date. The Company does not expect the adoption of FIN 48
        to
        have a material effect on the consolidated financial position or results
        of
        operations.
  In
        September 2006, the FASB issue SFAS No. 157, "Fair Value Measurement" ("SFAS
        157"). SFAS 157 defines fair value, establishes a framework for measuring
        fair
        value and expands disclosures about fair value measurements. SFAS 157 is
        effective for financial statements issued for fiscal years beginning after
        November 17, 2007 and interim periods within those fiscal years. The Company
        is
        evaluating the impact of adopting SFAS 157 on our consolidated financial
        position, results of operations and cash flows.
  F-21
  **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 valued at $6,101,258 (“the Markland Investment”). The common stock
        issued to Markland represented 93% of Technest’s outstanding common stock.
        Consequently, Technest became a majority owned subsidiary of Markland on
        that
        date. The Securities Purchase Agreement contains provisions that may require
        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
        7).
  Purchase
        of Genex Technologies, Inc.
  The
        acquisition of Genex was effected pursuant to an Agreement and Plan of Merger
        dated February 14, 2005 (the "Merger Agreement"), by and among Markland,
        Technest, MTECH Acquisition, Inc. ("MTECH") (a wholly-owned subsidiary of
        Technest), Genex and Jason Geng, the sole stockholder of Genex.
  In
        accordance with the terms of the Merger Agreement, on February 14, 2005,
        MTECH
        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 of 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.  Contingent payment of
        additional shares of Technest common stock was to be paid each of the three
        years following the merger date based on amounts equal to 30% of Gross Revenue,
        as defined, in excess of Gross Revenue for the year ended December 31, 2004.
        The
        number of shares of Technest common stock to be used was based on the average
        volume-weighted closing bid price of Technest common stock on the OTC Bulletin
        Board for the twenty (20) trading days prior to the day before the date of
        the
        Agreement.  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 bearing 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
        related to the status of regulatory audits, the impact of certain internal
        control deficiencies and the non-disclosure of ongoing government
        investigations into certain conduct by Mr. Geng and Genex prior to Technest's
        acquisition, among others. 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. In addition, Mr. Geng’s employment
        with Genex was terminated and the Company has ceased paying his salary under
        the
        employment agreement. 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. In
        consideration of the unresolved contingencies and in accordance with SFAS
        No.
        141, “Business Combinations”, paragraphs 25-27, Technest has excluded from its
        purchase accounting the promissory note, the contingent additional Markland
        share consideration, the contingent payments of Technest common stock or
        the
        contingent additional cash payments.
  F-22
  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 $784,482
              
              $
              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
  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 7).
 
 The
        appraisal method used in valuing in-process research and development
        (“IPR&D”) was Discounted Economic Income Computation Discount
        Rate.
 
 The
        discount rate of 24 percent was developed from the Weighted Average Cost
        of
        Capital using the following assumptions:
  **WACC
        Equation**
 WACC
              =
              SE(Kse)+
                  D(Kd)(1-t)Where:
              SE
              =
              Percentage
                  Of Stockholder Equity
              100
                  %Kse
              =
              Return
                  on Equity (Build-Up)
              24
                  %D
              =
              Percentage
                  Of Capital Debt
              0
                  %Kd
              =
              Marginal
                  Corporate Interest Rate
              7
                  %t
              =
              Marginal
                  Corporate Tax Rate
              40
                  %And:
              WACC
              =
              
              24
                  %
  F-23
  The
        return on stockholder equity was computed using the Build-Up
        Method:
  Build-Up
        Equation
 Kse
              =
              Rf
                  + Rp1 + Rp2 + Rp3Where:
              Rf
              =
              Risk
                  Free Rate Of Return
              4.5
                  %Rp1
              =
              Equity
                  Risk Premium
              5.9
                  %Rp2
              =
              Size
                  Premium
              4.0
                  %Rp3
              =
              Additional
                  Risk Premium
              9.6
                  %And:
              Kse
              =
              
              24.0
                  %
  **Timing
        Of Cash Flows**
  Management
        provided a valuation firm a list of 25 projects in-house at the valuation
        date
        of which 11 were classified as IPRD. For each of the 25 projects, management
        provided a timeline for revenue generation for fiscal years 2006 to 2010.
        Management also provided company-wide financial projections for fiscal years
        2006 to 2010. Using management’s projected timeline for revenue generation,
        appropriate expenses were allocated to the IPRD projects by the valuation
        firm.
  **Description
        Of Each IPRD Project**
  1.
              Electronic
                  Funnel/contraband detection2.
              Miniature
                  Optical Sensor - Darpa/Navair3.
              Smart
                  Obstacle Avoidance Sensor Systems - Navy/Special Forces4.
              Chemical
                  Detection Trainers - Army/Marines5.
              NoseCam
                  - Commercial6.
              NailCam
                  - Commercial7.
              Prototypes
                  And Product Development: Navigation8.
              Prototypes
                  And Product Development: Intelligence and Surveillance9.
              Prototypes
                  And Product Development: Explosive/Chemical Detection10.
              Prototypes
                  And Product Development: Intelligent Surveillance Sensors11.
              Prototypes
                  And Product Development: Explosive/Chemical Detection
  Because
        the nature of many of these IPR&D projects are classified by the Department
        of Defense, the Company reports on these projects collectively as a mass
        asset.
  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 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 1). Markland acquired EOIR on June 29, 2004.  EOIR generated
        approximately 97% of Markland’s revenue for its latest fiscal year ended June
        30, 2005. In conjunction with Markland’s acquisition of EOIR, Markland granted
        certain stock-based compensation to the employees of EOIR. As of February
        14,
        2005, there was unearned compensation related to these Markland issuances
        of
        $2,175,542 (see Note 7).
  F-24
  Pro
        Forma Information
  Unaudited
        pro forma financial information for the six months ended June 30, 2005 had
        the
        acquisitions of Genex and EOIR been completed as of January 1, 2005, is as
        follows:
  Six
                  months ended
                June
                  30, 2005Revenues
              
              $
              33,779,982Net
                  loss
              
              $
              (32,488,450
              )Deemed
                  dividends on beneficial conversionto
                  preferred stockholders
              
              $
              --Net
                  loss applicable to common stockholders
              
              $
              (32,488,450
              )Net
                  loss applicable to common stockholders per common share
              
              $
              (2.30
              )
  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 7) represent a
        collaborative group brought together to promote the acquisition of Genex,
        the
        push-down basis of accounting has been applied to the acquisition of Technest
        by
        Markland. In accordance with the push-down basis of accounting, Technest
        recorded Genex’s net assets at their estimated fair values as of the date of
        acquisition which resulted in the basis of the net assets acquired being
        adjusted as disclosed per the allocation summary shown in the Purchase of
        Genex
        Technologies, Inc. above and Technest’s accumulated deficit was reset to zero as
        of the acquisition date. The purchase price was allocated to the estimated
        fair
        value of Genex’s assets and liabilities by management in consideration of a
        number of factors including an independent purchase price allocation
        analysis.
  The
        excess of the purchase price of Genex over the fair value of net tangible
        assets
        acquired is $8,702,148. Of this amount, $4,876,038 was allocated to goodwill,
        $2,095,000 to in-process research and development and $1,570,000 to amortizable
        intangible assets (see Note 4) comprised of contracts, customer relationships
        and commercialized patents.
  Included
        in the statement of loss for the six months ended June 30, 2005 is selling,
        general and administrative expenses of approximately $2,250 related to the
        period from January 1, 2005 to February 14, 2005 prior to the application
        of
        push-down accounting.
  F-25
  **4.
        DEFINITE-LIVED INTANGIBLE ASSETS**
  Definite-lived
        intangible assets consist of the following at June 30, 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
                
                
                1015,038,054Accumulated
                    amortization
                
                
                (3,485,525
                )Net
                    definite-lived intangible asset
                
                $
                11,552,529
  Patents
        are amortized over their estimated useful life but not to exceed the legal
        life
        of the patent. Customer relationships and contracts are amortized over the
        contractual term of the existing contracts plus anticipated contract renewals
        in
        accordance with EITF 02-17. In determining the estimate useful life of the
        customer relationships and contracts, the Company considered a number of
        factors
        including, its history with these customers which dates back to 1993, the
        remaining term of existing contracts, the status of outstanding bids submitted
        for additional contracts or contract extensions, the stage of development
        of the
        major tasks covered by existing contracts, the likelihood of receiving
        additional contracts or contract extensions and the term over which the Company
        could reasonably predict future revenues from existing
        customers.
  Amortization
        expense was $1,747,347 and $611,471, for the year ended June 30, 2006 and
        the
        six months ended June 30, 2005, respectively. Future amortization expense
        related to the definite-lived intangible asset over the next five years is
        $1,786,046 per year.
  **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 No. 00-19, the
        warrants did not meet the definition of equity instruments.
  Upon
        issuance, the relative fair value of the warrants, net of issuance costs,
        $1,059,000, was recorded as a derivative liability. The warrants were
        marked-to-market each period with changes in the fair value being charged
        (credited) to the statement of operations. As of June 30, 2005, the fair
        value
        of the warrants was determined to be $26,963,616.
  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.
  In
        the
        year ended June 30, 2006 and the six months ended June 30, 2005, changes
        in the
        fair value of the warrants recorded as derivative (income) loss in the
        statements of operations was $25,046,489 and ($30,212,400),
        respectively.
  F-26
  In
        the
        six months ended June 30, 2005, the Company issued 208,910 shares of common
        stock upon exercise of warrants. The then fair value of the warrants of
        $4,307,784 was reclassified to par value of common stock and additional paid-in
        capital upon exercise.
  The
        fair
        value of the warrants was determined using the Black-Scholes option pricing
        model and the assumptions described in Note 8. The warrants do not include
        provisions allowing for net-cash settlement, the Company has never net-cash
        settled any warrants and has settled all warrants to date through the issuance
        of unregistered shares.
  **6.
        LONG TERM DEBT**
  Notes
        Payable
  On
        June
        29, 2004, EOIR issued notes guaranteed by Markland in the face amount of
        $11,000,000 in connection with Markland’s 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. In the year ended June 30, 2006 and the
        six
        months ended June 30, 2005, the Company amortized $293,592 and $110,097 to
        non-cash interest expense respectively. The face value of the notes and the
        unamortized discount at June 30, 2006 was $6,608,411 and $880,773, respectively.
        Interest expense related to these notes was approximately $533,205 and $324,000,
        in the year ended June 30, 2006 and the six months ended June 30, 2005,
        respectively. Subsequent to June 30, 2006, the Company repaid a significant
        portion of these notes (see Note 16). As of June 30, 2006, amounts due to
        employees of EOIR, including Dr. Mackin, the Company’s CEO, total $
        2,019,305.
  During
        2003, the Company issued an 8% convertible demand note in the principal amount
        of $57,158. In April 2004, the Company issued an 8% demand note in the principal
        amount of $10,000. On February 8, 2005, these notes and accrued interest
        of
        $7,690 were satisfied by the issuance of Series A Convertible Preferred Stock
        (see Note 7). There was no interest expense related to these notes for the
        year
        ended June 30, 2006 or six months ended June 30, 2005.
  Other
        Long-Term Bank Debt
  The
        Company's other long-term bank debt consists of the following as of June
        30,
        2006:
  First
                  Market Bank, secured by research equipment, dated October, 2002with
                  monthly payments of $3,715 including interest at LIBOR plus2.75%
                  (6.27% at June 30, 2006)
              
              $
              19,758First
                  Market Bank, dated July, 2002 with monthly payments of $15,278plus
                  interest at LIBOR plus 2.75%, (6.27% at June 30, 2006)
              
              
              31,127$
              50,885
 
 Interest
        expense related to other long-term debt in the year ended June 30, 2006 and
        the
        six months ended June 30, 2005 was approximately $5,527 and $9,000
        respectively.
  Future
        debt maturities for all notes payable and long-term debt are as follows for
        the
        years ending:
 
 June
                  30,2007
              
              $
              50,8852008
              
              
              2,203,0002009
              
              
              2,203,0002010
              
              
              2,202,411Total
              
              
              6,659,296Less:
                  debt discount
              
              
              (880,773
              )$
              5,778,523
  F-27
  Line
        of Credit
 
 A
        $500,000 line of credit was established with Virginia Community Bank in October
        1999 that was extended and increased to $600,000. It was secured by current
        accounts receivable and required interest at the prime lending rate. The
        line
        was repaid in full and closed in September 2004. Interest expense on the
        Line of
        Credit for the six months ended June 30, 2005 was approximately
        $3,000.
 
 Refinancing
  Subsequent
        to year-end, the Company obtained additional bank financing and repaid a
        significant portion of the notes payable above (see Note 16). Had the financing
        been obtained as of June 30, 2006, the pro forma current and non-current
        portion
        of long-term debt would have been as follows:
  Current
                  portion of long-term debt
              
              $
              2,982,448Non-current
                  portion of long-term debt
              
              
              3,676,848Total long-term debt
              
              $
              6,659,296
  After
        repaying a portion of the notes payable, the Company received initial net
        cash
        proceeds from the additional bank financing of approximately $2,493,000.
  **7.
        STOCKHOLDERS' EQUITY (DEFICIT)**
  Series
        A Convertible Preferred Stock
  On
        February 8, 2005, the Company's Board of Directors designated 150 shares
        of
        preferred stock as Series A Convertible Preferred Stock (“Series A Preferred
        Stock”). The Series A Preferred Stock is non-interest bearing, is not entitled
        to receive dividends and is not redeemable. The Series A Preferred Stock
        has a
        liquidation preference of $1,000 per share. The holders of Series A Preferred
        Stock have no voting rights except that they will be entitled to vote as
        a
        separate class on any amendment to the terms or authorized number of shares
        of
        Series A Preferred Stock, the issuance of any equity security ranking senior
        to
        the Series A Preferred Stock and the redemption of or the payment of a dividend
        in respect of any junior security. At any time, holders of Series A Preferred
        Stock may elect to convert their Series A Preferred Stock into common stock.
        Each share of Series A Preferred Stock is currently convertible into 4,735.3
        shares of common stock provided that, following such conversion, the total
        number of shares of common stock then beneficially owned by such holder and
        its
        affiliates and any other persons whose beneficial ownership of Common Stock
        would be aggregated with the holder's for purposes of Section 13(d) of the
        Exchange Act, does not exceed 4.999% of the total number of issued and
        outstanding shares of common stock. The Series A Preferred Stock ranks pari
        passu with the Company's Series B and C Preferred Stock.
  On
        February 8, 2005, the Company entered into an Exchange Agreement and a
        Securities Purchase Agreement with Garth LLC pursuant to which we agreed
        to
        issue 99.325 shares of our Series A Preferred Stock in exchange for $25,000
        in
        cash and the surrender of certain of our 8% Promissory Notes held by Garth
        LLC
        (the "Notes"). Immediately prior to their surrender, the Notes had an aggregate
        outstanding principal balance plus accrued interest of $74,848. The Company
        received net cash proceeds of $25,000 from this private placement.
  On
        February 8, 2005, the Company entered into a Securities Purchase Agreement
        with
        Verdi Consulting, Inc. pursuant to which we sold twenty five (25) shares
        of our
        Series A Preferred Stock for the aggregate consideration of $25,000.
  The
        proceeds from the issuance of the Series A Preferred Stock were used to reduce
        accounts payable.
  Verdi
        Consulting has certain piggy-back registration rights with respect to the
        common
        stock issuable upon conversion of the Series A Preferred Stock. These piggy-back
        registration rights expire when the shares of Common Stock issued pursuant
        to
        conversion of the Series A Shares can be sold without volume restrictions
        pursuant to Rule 144(k) of the Act.
  During
        the year ended June 30, 2006, 59.694 shares of Series A Preferred Stock were
        converted into 282,669 shares of the Company’s common stock.
 
 At
        June
        30, 2006, there were 64.631 shares of Series A Preferred Stock issued and
        outstanding.
  F-28
  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), an investor group consisting
        of
        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 $6.48 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 were $5,000,000. >From these
        proceeds, the Company paid a finder’s fee of $1,200,000 and legal fees related
        to the financing of $287,578.
  The
        Series B Preferred Stock will be convertible into Markland common stock upon
        the
        earlier to occur of February 14, 2006 or the trading day immediately following
        the first period of five trading days during which Markland common stock
        has a
        closing bid price of $2.50 or higher on each day, if any. The number of shares
        to be issuable upon conversion of each share of Series B preferred stock
        will be
        equal to approximately 4.35 divided by the lower of $0.60 and the average
        closing bid price for the 20 trading days preceding such conversion. Shares
        of
        the Series B Preferred Stock have a liquidation preference of $2.175 per
        share,
        may only vote on changes to the rights, privileges and priority of the Series
        B
        Preferred Stock, do not accrue dividends and are not redeemable. The Series
        B
        Preferred Stock shall rank pari passu with the Company's Series A and C
        Preferred Stock.
  The
        Series C Preferred Stock is convertible into Technest common stock at any
        time
        at the option of the stockholder. The number of shares of Technest common
        stock
        into which each share of Series C Preferred Stock is convertible is determined
        by dividing $2.175 by the Series C Conversion Price. The Series C Conversion
        Price is $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
        shall
        rank 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 all of the common stock issuable upon
        conversion of the Series C preferred stock, (b) all of the common stock issuable
        upon exercise of the common stock purchase warrants, and (c) common stock
        which
        may become issuable to selling stockholders as liquidated damages for breach
        of
        covenants contained in or as a result of adjustments contemplated by the
        securities purchase agreement and the registration rights agreement. Technest
        agreed to use its best efforts to cause the registration statement to be
        declared effective as promptly as possible thereafter. On September 30, 2005,
        the Company amended the terms of this Registration Rights Agreement so that
        liquidated damages could only be paid for in the Company’s common stock at
        a rate
        of 4% of the initial subscription amount for any month (see Note
        5).
  Technest
        agreed to issue additional shares of its common stock to the Investors if
        the
        units did not have a market value of $6.525 at the end of one year. If the
        units
        did not have a market value of $6.525 on February 14, 2006, Technest would
        be
        obligated to issue in exchange for each unit a number of shares of common
        stock
        determined by dividing (i) the amount by which $6.525 exceeds the sum of
        the
        average closing bid prices of Markland’s and Technest’s common stock for the
        period beginning 10 trading days prior to the reset date and ending 10 trading
        days after the reset date by (ii) the average closing bid price of our common
        stock during that period. Effective October 25, 2005, there no longer any
        units
        outstanding and the Company was not obligated to issue any additional common
        stock.
  On
        June
        20, 2005, Markland entered into definitive exchange agreements with DKR
        Soundshore Oasis Holding Fund, Ltd., DKR Soundshore Strategic Holding Fund,
        Ltd., Verdi Consulting, Inc. ("Verdi"), and ipPartners, Inc., pursuant to
        which Markland exchanged 632,182 shares of Technest Series B Preferred
        Stock for 2,750 shares of Markland Series D Preferred Stock.  Subsequently,
        the Technest Series B Preferred shares held by Markland were
        cancelled.
  In
        the
        year ended June 30, 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.
  F-29
  In
        the
        year ended June 30, 2006, 517,240 shares of shares of Technest Series C
        preferred stock were converted to 517,240 shares of common stock.
 
 On
        June
        30, 2006, the Company had -0- shares of Series B Preferred Stock and
        632,185 shares of Series C Preferred Stock issued and
        outstanding.
 
 In
        the
        year ended June 30, 2006, the Company incurred liquidated damages of $2,329,466
        which was charged to interest expense related to the Company's failure to
        have
        an effective registration statement. The Company settled $2,104,461 of this
        obligation through the issuance of 410,888 shares of Technest common stock
        and
        there is $195,000 included in accrued expenses and other current liabilities
        at
        June 30, 2006.
  Beneficial
        Conversion Features
  Based
        on
        the effective conversion price of the Series A Preferred Stock, the Company
        determined that there was a beneficial conversion feature of approximately
        $8,500,000. The beneficial conversion feature was limited to $124,848, the
        proceeds received from the Series A Preferred Stock. This beneficial conversion
        feature has been reflected as a deemed dividend to the Series A Preferred
        stockholders in the statement of loss for the six months ended June 30,
        2005.
  The
        Company allocated the proceeds received in the Investor Financing, on a relative
        fair value basis, to the Series B Preferred Stock, the Series C Preferred
        stock
        and the warrants. For purposes of this allocation, the Company estimated
        the
        fair value of the Series B and C Preferred Stock based on the fair value
        of the
        common stock into which these shares could convert. The Company estimated
        the
        fair value of the warrants using the Black-Scholes pricing model. Using the
        effective conversion price of the Series C Preferred Stock, the Company
        determined that there was a beneficial conversion feature of approximately
        $9,672,000. The beneficial conversion feature was limited to $2,465,000,
        the
        allocated proceeds received from the Series C Preferred Stock. This beneficial
        conversion feature has been reflected as a deemed dividend to the Series
        C
        Preferred stockholders in the statement of operations for the six months
        ended
        June 30, 2005. As additional paid-in capital includes amounts from both common
        and preferred stock, there is no net impact to stockholders’ equity as a result
        of the deemed dividend. Since the Series B Preferred Stock converts into
        common
        stock of Markland, there was considered to be no beneficial conversion feature
        or deemed dividend with respect to the common stockholders of
        Technest.
  Common
        Stock Issuances
  On
        February 14, 2005, Technest issued to Markland 1,954,023 shares of its common
        stock in exchange for 10,168,764 shares of Markland common stock in accordance
        with the
        terms
        of a Securities Purchase Agreement between Markland and Technest (see
        Note 3). On this date, Technest
        became a majority owned subsidiary of Markland. Markland
        also agreed to issue additional shares of its common stock with a value of
        $5,000,000 to Technest upon conversion of Technest's Series B Preferred
        Stock.
  In
        conjunction with this Securities Purchase Agreement, Technest and Markland
        entered into a Registration Rights Agreement, dated February 14, 2005. Technest
        has agreed to use its best efforts to file a registration statement on Form
        SB-2
        as soon as possible after it receives a request for registration from Markland
        (or the holder of a majority of the registrable securities if Markland transfers
        some or all of its shares) and to cause the registration statement to be
        declared effective. Pursuant to this agreement, Technest also agreed to keep
        the
        registration statement effective until the earlier of (a) thirty-six (36)
        months
        following the date of the agreement or (b) such time that the securities
        cease
        to be registrable securities due to the elimination of their transfer
        restrictions.
  Markland,
        a homeland defense, armed services and intelligence contractor, is a public
        company with a class of equity securities registered pursuant to Section
        12(g)
        of the Exchange Act.
  On
        June
        22, 2005, the Company issued 104,455 shares each to ipPartners and Verdi
        Consulting in a net-share exercise of warrants issued in conjunction with
        the
        Company Series B and C Convertible Preferred Stock to purchase 267,366 shares
        of
        the Company’s common stock. The net-share settlement feature was permitted as
        the Company failed to effect a registration statement by the prescribed date
        there under.
  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.
  F-30
  During
        the year June 30, 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-
              410,888
                  shares with a fair value of $2,104,461 in connection with liquidated
                  damages, included in non-cash interest expense.
  On
        January 19, 2006, the Board of Directors of Technest adopted a resolution
        preventing the Company from designating, authorizing or issuing any series
        of
        preferred stock, or any other security, instrument or contract, convertible
        or
        exercisable, either directly or indirectly into shares of common stock, unless
        the maximum number of shares of common stock potentially issuable upon such
        conversion can be determined at the time of designation, authorization, or
        issuance.
  The
        Company has established the following reserves for the future issuance of
        common
        stock as follows:
  Reserve
                  for the exercise of warrants
              
              
              374,286Reserve
                  for conversion of Series A Convertible Preferred Stock
              
              
              306,047Reserve
                  for conversion of Series C Convertible Preferred Stock
              
              
              632,185Total
                  reserves
              
              
              1,312,518
 
 Markland
        Stock Options
 
 On
        June
        29, 2004, Markland issued options to purchase its common stock to eleven
        former
        minority owners of EOIR who continued employment with EOIR. These options
        have a
        ten year term and vest ratably over a five year period. Ten of these employees
        received options to purchase 9,345,737 shares of Markland common stock at
        a
        price of $.3775. On the date of grant, the intrinsic value of these options,
        $3,528,016, was recorded as unearned stock-based compensation and additional
        paid in capital. This intrinsic value will be amortized to stock compensation
        over the five year vesting period.
  One
        employee received five options, each of which allows for the purchase of
        a
        number of Markland shares equal to .11799575 times a fraction of $1,600,000
        divided by the fair value of Markland’s stock on the vesting date. One of these
        options vests each year for the next five years. The exercise price of these
        options will be one-half the fair value of Markland’s stock on the vesting date.
        The intrinsic value of these options based on the fair value of Markland’s stock
        on June 30, 2005 is $471,983. This intrinsic value has been recorded as unearned
        stock-based compensation and additional paid in capital. Due to the variable
        nature of the exercise price and number of Markland shares to be issued under
        these options, the intrinsic value will be remeasured each period until the
        terms are fixed. The intrinsic value of each option will be amortized over
        the
        vesting periods. As of June 30, 2005, the maximum number of Markland shares
        issuable under these options is 7,866,383.
  During
        the three months ended December 31, 2004, 3,009,574 options were cancelled
        due
        to the departure of four employees. In conjunction with the departure of
        two of
        these employees, Markland modified the options so that the employees were
        immediately vested in 40% of the options held. Without modification, these
        options would have been cancelled upon termination. As a result of this
        modification, EOIR remeasured the intrinsic value on the remeasurement date
        and
        determined that there was no incremental value. Therefore, the Company fully
        amortized the remaining unearned portion of the vested options upon
        modification. The cancellation of the remaining unvested options resulted
        in a
        reduction in unearned compensation and additional paid-in capital of $1,136,099.
 
 In
        conjunction with an employment agreement with Dr. Mackin, Markland accelerated
        the vesting of Dr. Mackin’s options to purchase 1,250,286 shares of the
        Markland’s common stock at a price of $.3775 per share. As a result of this
        modification, the Company remeasured the intrinsic value of the modified
        options
        and determined that there was no additional intrinsic value. The Company
        fully
        amortized the unearned compensation related to these options. In May 2005,
        Markland allowed Dr. Mackin to exchange options to purchase 1,250,286 shares
        of
        common stock for the same number of shares of common stock. As a result,
        the
        Company has recorded additional paid-in capital and stock compensation, included
        in selling, general and administrative expenses, of $137,534, equal to the
        fair
        value of the Markland common stock on the date of grant.
  F-31
  In
        accordance with AICPA Accounting Interpretation 1, *Stock
        Plans Established by a Principal Stockholder* ,
        of APB
        Opinion No. 25 and FASB Interpretation (FIN) No. 44, *Accounting
        for Certain Transactions Involving Stock Compensation* ,
        paragraph 14, the Company has recognized the same amount of compensation
        expense
        for these awards as has been recognized by Markland in those consolidated
        financial statements. For the year ended June 30, 2006 and six months ended
        June
        30, 2005, the Company recorded in selling, general and administrative expense
        $96,339 and $634,052, respectively, in stock-based compensation relating
        to
        these options. As of December 31, 2005 all these options were cancelled.
        The
        expense recognized through the cancellation date approximated the portion
        of the
        options that were fully vested upon cancellation. Therefore, there was no
        reversal of expense upon cancellation. As of June 30, 2006 and 2005, unearned
        compensation related to these options was $0 and $1,541,490, respectively.
 
 Markland
        Common Stock Issuances
 
 In
        the
        six months ended June 30, 2005, Markland issued 2,754,597 shares of its common
        stock to employees of EOIR. As a result, the Company has recorded additional
        paid-in capital and stock compensation, included in selling, general and
        administrative expenses, of $272,926, equal to the fair value of the Markland
        common stock on the date of grant.
  Reverse
        stock split
  On
        June
        2, 2005, the Board of Directors of Technest and the holders of a majority
        of the
        common stock of Technest approved a 1-for-211.18 reverse split (the "Reverse
        Split"). The Reverse Split became effective at the close of business on July
        19,
        2005. All share and per share information has been retroactively restated
        to
        reflect the Reverse Split. The total authorized shares of common stock of
        495,000,000 did not change as a result of the Reverse 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 year ended June 30,
        2006
        and the six months ended June 30, 2005.
  F-32
  Summary
        information with respect to stock options and warrants granted is as follows:
  Weighted
                  AverageNumber
                  of Shares
              
              Exercise
                  PriceBalance,
                  December 31, 2004
              
              
              3,896
              
              $
              504.72Issued
              
              
              1,149,425
              
              
              6.50Expired
              
              
              (80
              )
              $
              (4,434.78
              )Exercised
              
              
              (267,366
              )
              
              6.33Balance,
                  June 30, 2005
              
              
              885,875
              
              
              8.12Exercised
              
              
              (507,773
              )
              
              (6.50
              )Expired
              
              
              (3,816
              )
              
              3,259.17Balance,
                  June 30, 2006
              
              
              374,286
              
              $
              6.50
  The
        following table summarizes the Company's warrants outstanding at June 30,
        2006:
  Warrants
        outstanding and exercisable
 
 Exercise
                  price
              
              Number
              
              Expiration
                  Date$   
                  6.50
              
              374,286
              
              02/14/2010Weighted
                  average remaining life
              3.75
                  years
 
  As
        of
        June 30, 2006 all warrants are exercisable.
  In
        connection with the Investor Financing on February 14, 2005 (see Note 7),
        the
        Company issued five year warrants to purchase 1,149,425 shares of Technest
        common stock at an exercise price of $6.50 per share. In accordance with
        the
        stock purchase warrant agreement, in the event a registration statement covering
        these shares is not declared effective within four months of the warrant
        issuance date, the warrant holders may exercise the warrants on a net share
        settlement basis. The Company did not have an effective registration statement
        covering these shares as of June 30, 2006. The relative fair value of these
        warrants of $1,508,000 was estimated using the Black-Scholes model and the
        following assumptions:
  Exercise
                  price
              $
                  6.50Expected
                  dividend yield
              0%Expected
                  lives of warrants (in years)
              5.0Volatility
              50%Risk-free
                  interest rate
              3.53%
  The
        Company estimated its expected volatility in consideration of a number of
        factors including its historical volatility and the volatility of comparable
        companies in terms of size and industry.
 
 Upon
        issuance, these warrants were recorded as derivative liabilities (see Note
        5).
 
 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.
  F-33
  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.
  In
        the
        year ended June 30, 2006, in conjunction with employment agreements, five
        executives of Technest were granted 267,000 shares of the Company’s common
        stock. These shares are restricted and vest 33.33% on each of April 1, July
        1
        and October 1, 2007. The fair value of these shares, $1,361,700, is being
        recorded as stock-based compensation in selling, general and administrative
        expenses on a straight line basis over the vesting period. In the year ended
        June 30, 2006, the Company recorded $257,619 related to these restricted
        stock
        grants.
  In
        the
        year ended June 30, 2006, the Company granted 100 shares of restricted common
        stock to each of its employees. As a result, the Company is obligated to
        issue
        16,800 shares of its common stock. These shares vest on May 7, 2007. The
        fair
        value of these shares, $85,680, is being recorded as stock-based compensation
        in
        selling, general and administrative expenses on a straight line basis over
        the
        vesting period. In the year ended June 30, 2006, the Company recorded $21,809
        related to these restricted stock grants.
  **9.
        NET (LOSS) INCOME PER SHARE**
  Securities
        that could potentially dilute basic earnings per share ("EPS") and that were
        not
        included in the computation of diluted EPS because to do so would have been
        anti-dilutive for the six months ended June 30, 2005, consist of the following:
  Shares
                  PotentiallyIssuableSeries
                  A Convertible Preferred Stock
              
              
              588,716Series
                  C Convertible Preferred Stock
              
              
              1,149,425Stock
                  options
              
              
              3,816Warrants
              
              
              882,059Total
                  as of June 30, 2005
              
              
              2,624,016
  **10.
        COMMITMENTS AND CONTINGENCIES**
  Facility
        Rental
  Technest
        has a three-year lease for executive offices of approximately 2,000 square
        feet
        in Boston, Massachusetts, which expires December 31, 2009. The monthly rental
        amount for this facility is approximately $4,500.
  Genex
        Technologies, Inc., a wholly-owned subsidiary of Technest, 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, increasing annually by 3%. 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.
  F-34
  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.
  Rent
        expense for the year ended June 30, 2006 and the six months ended June 30,
        2005
        was $642,313 and $220,381, respectively.
  The
        future minimum rental payments required under operating leases that have
        noncancellable or original lease terms in excess of one year as of June 30,
        2006
        as are follows:
 
 June
                  30,2007
              $
              674,5042008
              
              662,3592009
              
              571,5622010
              
              353,1442011
              
              190,821Total
              $
              2,452,390
  Government
        Contracts - Genex
  The
        Company's billings and revenue on time and material contracts are based on
        provisional fringe, general & administrative and overhead rates which are
        subject to audit by the contracting government agency.  During an audit
        conducted in November 2004 covering the fiscal year 2002, the Defense Contract
        Audit Agency (“DCAA”) discovered significant deficiencies in Genex’s accounting
        system that resulted in misclassified and unallowable costs. Their
        examination disclosed eight significant deficiencies in Genex’s accounting
        system that resulted in misclassified costs. They were as
        follows:
  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.
  F-35
  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 has accrued $68,017 for overpayments for 2002 and has extended the
        analysis of misclassified and unallowed costs to June 30, 2005, after which
        there were no additional misclassified or unallowable costs. T he
        Company has 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 June 30, 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.
  Lien
        on Assets
 
 The
        holders of the outstanding Sellers Notes of EOIR (see Note 6) have a primary
        lien on all the assets of EOIR. The balance outstanding on these Notes as
        of
        June 30, 2006 was $6,608,411. Subsequent to June 30, 2006, the Company repaid
        a
        significant portion of these notes (see Note 16).
  Letter
        of Credit
 
 EOIR
        has
        a letter of credit in the amount of $250,000 issued in favor of a bank in
        conjunction with corporate credit cards.
 
 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 June 30, 2006, no shares had
                  been
                  issued to either Dr. Mackin or Mr.
                  Pereira.
  F-36
  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. At June 30, 2006, the Company has accrued bonuses of $173,000 related
        to
        Dr. Mackin and Mr. Pereira.
  The
        employment agreements provide that in the event that the executive's employment
        with Technest is terminated by Technest without cause (as that term is defined
        in 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. As of June 30, 2006, the
        outstanding principal amount on Dr. Mackin’s note is $608,957. 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.
  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.
  F-37
  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.
  **11.
        INCOME TAXES**
  There
        was
        no provision for federal income taxes for the year ended June 30, 2006 and
        the
        six months ended June 30, 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, computes 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.
  At
        June
        30, 2006, the Company had net operating loss carryforwards for federal income
        tax purposes of approximately $11,000,000, which will expire in various amounts
        through 2026.
  A
        reconciliation of the provision (benefit) for income taxes to taxes at the
        federal statutory rate is as follows:
  F-38
  2006
              
              2005Tax
                  provision (benefit) at statutory rate
              
              $
              6,886,000
              
              $
              (11,568,000
              )Permanent
                  differences due to :Derivative
                  income (loss)
              
              
              (8,516,000
              )
              
              10,272,000Stock-based
                  compensation
              
              
              95,000
              
              
              358,000In-process
                  research and development
              
              
              --
              
              
              718,000Non-deductible
                  interest
              
              
              587,000
              
              
              --Losses
                  providing no tax benefit
              
              
              915,000
              
              
              --Amortization
                  of definite lived intangibles
              
              
              --
              
              
              210,000Other
              
              
              33,000
              
              
              10,000$
              --
              
              $
              --
  Deferred
        income taxes reflect the net tax effects of temporary differences between
        the
        carrying amounts of assets and liabilities for financial reporting purposes
        and
        the amounts used for income tax purposes. Significant components of the
        Company's deferred tax assets and liabilities at June 30, 2006 and June 30,
        2005
        are as follows:
  2006
              
              2005Net
                  operating loss carryforward
              
              $
              4,200,000
              
              
              3,500,000Non-deductible
                  EOIR intangibles
              
              
              (4,100,000
              )
              
              --Valuation
                  allowance
              
              
              (100,000
              )
              
              (3,500,000
              )Net
                  deferred tax assets
              
              $
              -
              
              $
              -
  For
        financial reporting purposes, the Company has recorded a valuation allowance
        against deferred tax assets as management has determined that it is not more
        likely than not that the deferred tax assets for which the allowance has
        been
        established will materialize. In the year ended June 30, 2006, the valuation
        allowance decreased $3,400,000 as a result of Technest's acquisition of
        EOIR on August 17, 2005 and EOIR's related deferred tax liability. In the
        six
        months ended June 30, 2005, there was no change in the valuation
        allowance.
  F-39
  **12.
        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 year ended June 30, 2006 and six months ended June 30, 2005, the Company
        recorded as selling, general and administrative expense a management fee
        of
        $1,000,000 and $562,500, respectively, to Markland for administrative support
        services, engineering services and services rendered by executive officers
        of
        Markland who also functioned as executive officers of the Company (see Note
        10).
  During
        the year ended June 30, 2006, EOIR made payments to Markland of approximately
        $2,350,000 in conjunction with the intercompany transactions described
        above.
  At
        June
        30, 2006, the Company also had amounts due to Markland for cash advances,
        for
        payment of shared expenses and transfer of inventory between Markland and
        Technest, in the amount of $595,782. At June 30, 2005, the Company had amounts
        due Markland in the amount of $2,254,960.
  **13.
         EMPLOYEE BENEFIT PLANS**
  Genex
        maintains a Simplified Employee Pension (the SEP Plan) for all employees
        who
        have attained the age of 21 and have completed three years of service.
        Participants may make voluntary contributions up to the maximum amount allowed
        by law, but not to exceed 15% of each participant’s eligible compensation. The
        combined totals of participant and Genex contributions may not exceed $30,000
        by
        law. Genex contributions vest immediately to the participants.
  Genex
        also maintains a defined contribution 401(k) profit sharing plan (the 401(k)
        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.
  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.
  C ontributions
        and other costs of these plans in the twelve months ended June 30, 2006 and
        the
        six months ended June 30, 2005 were $832,020 and $257,876
        respectively.
 
 **14. 
        LITIGATION**
 
 *Technest
        Holdings, Inc.*
 
 On
        or
        about July 23, 1998, H & H Acquisition Corporation, individually and
        purportedly on behalf of Technest Holdings, commenced an action in United
        States
        District Court, Southern District of New York entitled “H & H Acquisition
        Corp., individually and on behalf of Technest Holdings, Inc. v. Financial
        Intranet Holdings, Inc. Technest Holdings, Inc., F/K /A Financial Intranet,
        Inc., Ben Stein, Interwest Transfer Co., Steven A. Sanders, Michael Sheppard,
        Maura Marx, Henry A. Schwartz, Leonard Gotshalk, Gotshalk Enterprises, Law
        Office of Steven A. Sanders, P.C. and Beckman, Millman & Sanders, LLP, 98
        Civ. 5269”. The plaintiffs are purporting to act on behalf of Technest in the
        context of a shareholder’s derivative suit. The action’s principal basis appears
        to be a claim that Ben Stein, a former director and Secretary of Technest,
        wrongfully claims ownership of shares of common stock that Stein agreed to
        purchase from H&H. According to H&H, these shares belong to them.
        H&H asserts sixteen causes of action. Only some make allegations against
        Technest Holdings, Inc., Michael Sheppard and Maura Marx, former officers
        of
        Technest.
  F-40
  Technest,
        Mr. Sheppard and Ms. Marx believe that the claims against Technest, Mr. Sheppard
        and Ms. Marx are without merit and are vigorously defending the action.
        Technest, Mr. Sheppard and Ms. Marx have filed responses to the claims against
        them. The responses deny all material allegations of the complaint and the
        claim
        asserted by the transfer agent, and asserts a variety of defenses. We cannot
        make any assurances about the litigation’s outcome.
 
 In
        June
        2006, the court directed the parties to address the court’s continuing subject
        matter jurisdiction over Technest in the H&H matter. Technest has responded
        to the court’s direction and believes that as a result of intervening corporate
        actions, the injunctive relief sought by the plaintiff which gives rise the
        court’s subject matter jurisdiction in this case has been rendered moot, thereby
        depriving the court of continuing subject matter jurisdiction. Technest believes
        that the case as currently styled is fundamentally a dispute between H&H
        Acquisition Corp. and Ben Stein.
 
 As
        of
        October 9, 2006, Technest has not been notified of a trial date for this
        matter.
 
 On
        or
        about May 30, 2006, Deer Creek Fund LLC filed a claim for Interference with
        Contract and Breach of the Implied Covenant of Good Faith and Fair Dealing
        against Technest, seeking unspecified monetary damages.  Deer Creek alleges
        misconduct on the part of Technest related to a proposed sale by Deer Creek
        of
        157,163 shares of Technest common stock at $7.00 per share and the applicability
        of certain selling restrictions under a registration rights agreement entered
        into between the parties. Technest believes that the allegations in this
        lawsuit are entirely without merit. Technest has been aggressively defending
        this action, and has filed an answer denying Deer Creek’s allegations and
        vigorously opposes all relief sought.
 
 *EOIR
        Technologies, Inc.*
 
 On
        or
        about September 16, 2004, Joseph R. Moulton, Sr. initiated a lawsuit in the
        Circuit Court of Spotsylvania County, Virginia, against Markland, EOIR, and
        our
        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.
  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.
  On
        August
        3, 2006, Mr. Moulton, Technest, Markland, EOIR and Robert Tarini reached
        a
        settlement agreement pursuant to which upon payment of $120,000 and the
        pre-payment of certain EOIR outstanding promissory notes, the parties each
        dismissed their claims against one another. The payments required by the
        settlement agreement were made on August 10, 2006.
  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 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 Williams’ motion for summary
        judgment. On May 4, 2006, the court granted the Williams’ motion for summary
        judgment with regard to liability on Count I of the Williams’ claim regarding
        severance payment and Count III of their claim regarding Markland’s failure to
        register shares of Markland’s common stock underlying their options. We have,
        and continue to assert that Count III of the Williams’ complaint does not allege
        wrongdoing by EOIR and thus, we believe that we have no liability on that
        claim.
        Count II of the claim, which seeks a declaration that the promissory notes
        issued to Mr. and Mrs. Williams in connection with the acquisition of EOIR
        by
        Markland on June 29, 2004 are in default and an acceleration of the payments
        due
        under those notes, was not addressed by the court’s order.
  On
        July
        27, 2006, the Company entered into an agreement with the Williams pursuant
        to
        which the Company paid them $246,525 in satisfaction of their claims for
        severance under Count I and agreed to pay the outstanding balance of their
        promissory notes, along with all accrued but unpaid interest, in satisfaction
        of
        Count II which was paid on August 10, 2006. The Williams continue to assert
        claims against us for attorney’s fees and costs on all three counts of their
        complaint. Count III was not addressed by this agreement.
  F-41
  On
        September 1, 2006, the Company entered into an agreement with Markland pursuant
        to which we agreed to indemnify Markland against any judgment for damages
        or
        attorney’s fees ordered by the Court pursuant to Counts I or II and Markland
        agreed to indemnify the Company against any judgment for damages or attorney’s
        fees ordered by the Court pursuant to Count III.
  The
        case
        is currently set for trial on November 14, 15 and 16, 2006, at which time
        the
        damages, if any, for Count III will be determined as well as costs and
        attorney’s fees, if applicable, for Counts I, II and III.
  In
        the
        event that Mr. and Mrs. Williams prevail in any of their claims against
        Markland, Technest shares owned by Markland would be among the assets available
        to satisfy a resulting judgment.
  **15.
        TRANSITION PERIOD**
  On
        June
        30, 2005, the Company elected to change its fiscal year-end from December
        31 to
        June 30 resulting in a six-month transition period. As a result, the unaudited
        statements for the comparable period in 2004 are set forth below.
  TECHNEST
                    HOLDINGS, INC. AND SUBSIDIARIESCONDENSED
                    CONSOLIDATED STATEMENT OF OPERATIONS(Unaudited)Six
                    Months EndedJune
                    30, 2004Revenues
                
                $
                -General
                    and administrative expenses
                
                
                5,787Loss
                    from operations
                
                
                (5,787
                )Net
                    loss
                
                $
                (5,787
                )NET
                    LOSS PER COMMON SHARE:BASIC
                    AND DILUTED
                
                $
                (0.05
                )WEIGHTED
                    AVERAGE NUMBER OF SHARES:
                
                
                117,951
  F-42
  TECHNEST
                  HOLDINGS, INC. AND SUBSIDIARIESCONDENSED
                  CONSOLIDATED STATEMENT OF CASH FLOWS(Unaudited)Six
                  Months Ended June 30, 2004CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  income (loss) from operations
              
              $
              (5,787
              )Changes
                  in assets and liabilities:Accounts
                  payable and accrued expenses
              
              
              (3,867
              )NET
                  CASH USED IN OPERATING ACTIVITIES
              
              
              (9,654
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Proceeds
                  from notes payable
              
              
              10,000NET
                  CASH PROVIDED BY FINANCING ACTIVITIES
              
              
              10,000NET
                  INCREASE IN CASH
              
              
              346CASH
                  - BEGINNING OF PERIOD
              
              
              988CASH
                  - END OF PERIOD
              
              $
              1,334
  **16** . **SUBSEQUENT
        EVENTS**
  ***Common
        Stock Issuances***
 
 Subsequent
        to June 30, 2006, the Company has issued 273,974 shares of common stock with
        a
        fair value of $706,990 in satisfaction of liquidated damages under our
        Registration Rights Agreement dated February 14, 2005, as amended on October
        3,
        2005 and February 27, 2006 for the months of June through September,
        2006.
 
 ***Bank
        Financing***
 
 On
        August
        10, 2006, Technest, EOIR and Genex, closed on a financing (the “Financing”)
        under two Loan and Security Agreements with Silicon Valley Bank (the “Bank”)
        executed on August 4, 2006 (the “Credit Agreements”). One Credit Agreement
        provides for a term loan facility under which the Company may borrow term
        loans
        with an initial minimum loan of $3,000,000 (the “Term Loan Facility”). Subject
        to the Bank’s receipt of additional documentation for the period through the
        month ending December 31, 2006 and if no event of default under the Credit
        Agreement has occurred or is continuing, we may borrow up to an additional
        $1,000,000 under the Term Loan Facility on or before February 15, 2007. The
        other Credit Agreement provides for a one year revolving line of credit for
        up
        to $8,750,000 (the “Revolver”), provided that the Company’s borrowing under the
        Revolver is limited to 80% of eligible accounts receivable. In addition,
        the
        maximum amount outstanding under both Credit Agreements at any time may not
        exceed $10,000,000. Both the Term Loan Facility and the Revolver are secured
        by
        all of the Company’s assets and the assets of its subsidiaries, including all
        intellectual property.
  F-43
  Upon
        the
        date of closing under the Credit Agreements, the Company borrowed the entire
        $3,000,000 available under the Term Loan Facility and borrowed approximately
        $4,445,000 under the Revolver.
  Interest
        on all outstanding amounts under the Term Loan is payable monthly at a rate
        equal to the Bank’s prime rate plus 2.75%. This interest rate will be reduced to
        (i) the Bank’s prime rate plus 2.00% if we achieve a Fixed Charge Coverage Ratio
        (as defined in the Credit Agreement with respect to the Term Loan Facility)
        of
        at least 1.75 to 1.0 for three consecutive fiscal quarters after August 4,
        2006
        or (ii) the Bank’s prime rate plus 1.50% if we achieve a Fixed Charge Coverage
        Ratio of at least 2.0 to 1.0 for three consecutive fiscal quarters after
        August
        4, 2006. Each loan under the Term Loan Facility is repayable in 36 equal
        monthly
        principal installments plus accrued interest.
 
 The
        Revolver will bear interest at a rate equal to the Bank’s prime rate plus 0.50%
        per annum, but the Company must pay a minimum quarterly amount equal to the
        interest on an outstanding balance of $1,400,000. In addition, the Company
        will
        pay a monthly collateral handling fee of 0.10% per month on financed
        receivables. Interest and handling fees are paid as invoices are
        collected.
  The
        financial covenants under the Term Loan require that the Company maintain,
        on a
        monthly basis tested as of the last day of each month, a minimum quick ratio
        (representing the ratio of quick assets (or cash and accounts receivable)
        plus
        total marketable securities to current liabilities, plus all short-term
        indebtedness to the Bank but excluding subordinated debt and debt from
        affiliates) of 0.70 to 1.0 through November 30, 2006, 0.85 to 1.0 from December
        31, 2006 through May 31, 2007, 1.0 to 1.0 from June 30, 2007 through August
        31,
        2007 and 1.20 to 1.0 from September 30, 2007 and all monthly reporting periods
        thereafter. If the Company does not maintain these ratios, then the sum of
        the
        Company’s cash plus 80% of eligible accounts receivable minus borrowings under
        the Revolver must exceed $2,000,000. The Company must maintain a Fixed Charge
        Coverage Ratio measured on the last day of every month for the three month
        period ending on the last day of such month, of at least 1:0 to 1:0 through
        periods ending November 30, 2006; at least 1.25:1.0 for periods ending on
        December 31, 2006 through May 31, 2007; and at least 1.50:1.0 for all periods
        thereafter. In addition, the Credit Agreements contain affirmative and negative
        covenants concerning the Company operations including restrictions on our
        ability to dispose of our assets, change our business, ownership or management,
        incur other indebtedness, create or permit liens on the Company’s property, make
        investments, pay dividends, redeem stock or engage in transactions with
        affiliates.
 
 Markland
        has entered into an Unconditional Guaranty pursuant to which Markland agreed
        to
        guaranty up to $6,000,000 of the principal obligations plus interest thereon
        and
        related expenses under the Credit Agreements and a Stock Pledge Agreement
        pursuant to which Markland pledged to the Bank 1,739,130 shares of Technest
        common stock currently owned by Markland, which had a market value of $6,000,000
        as of August 4, 2006. The Guaranty and the Stock Pledge Agreement terminate
        August 3, 2008 if no event of default has occurred.
 
 ***Pre-Payment
        of Promissory Notes and Settlement of Moulton
        Litigation***
 
 The
        Company used a portion of the proceeds of the Financing to pre-pay the
        outstanding principal of $4,952,526 of certain EOIR promissory notes issued
        in
        June 2004. After these payments, there remains outstanding EOIR notes issued
        in
        June 2004 having a total outstanding principal balance of $1,655,893, of
        which
        $608,957 is outstanding principal owed to Technest’s current Chief Executive
        Officer and one of the Company’s directors, Joseph P. Mackin. The security
        interest securing these remaining notes was subordinated to the Bank’s first
        priority security interest.
  In
        addition, the Company used a portion of the proceeds of the Financing to
        fully
        settle the lawsuit initiated by Joseph R. Moulton, Sr. in the Circuit Court
        of
        Spotsylvania County, Virginia, against Markland, EOIR, and Technest’s former
        Chief Executive Officer and former director, Robert Tarini, in his capacity
        as
        Markland’s Chief Executive Officer. Upon an additional payment to Mr. Moulton of
        $120,000 and the pre-payment in full of certain outstanding EOIR notes issued
        in
        June 2004 as stated above, the parties agreed to dismiss their claims against
        one another.
  ***Unregistered
        Sale of Equity Securities***
 
 As
        consideration for the Credit Agreements and in connection with the closing
        of
        the Financing, the Company issued the Bank a Warrant to purchase 75,000 shares
        of Technest common stock at an exercise price of $5.85 per share. The Warrant
        expires August 3, 2013. We also entered into a Registration Rights Agreement
        with the Bank pursuant to which we granted “piggy-back” and S-3 registration
        rights for the shares of Technest common stock underlying the Warrant. This
        transaction was not registered under the Securities Act, but was made in
        reliance upon the exemptions from the registration requirements of the
        Securities Act set forth in Section 4(2) thereof. The fair value of this
        warrant
        will be recorded as a debt issuance cost and amortized to interest expense
        over
        the term of the debt.
  F-44
  As
        consideration for the subordination of the security interest to the Bank
        and in
        connection with the closing of the Financing, the Company issued to the seven
        remaining EOIR subordinated note holders a total of 99,779 shares of the
        Company’s common stock having a fair value of $289,359, of which our current
        Chief Executive Officer and one of the Company’s directors, Joseph P. Mackin,
        received 23,913 shares. Of the remaining six other note holders, five are
        employees and one is a consultant. This transaction was not registered under
        the
        Securities Act, but was made in reliance upon the exemptions from the
        registration requirements of the Securities Act set forth in Section 4(2)
        thereof. The fair value of these shares will be recorded as debt issuance
        costs
        and amortized to interest expense over the term of the Financing.
 
 On
        July
        17, 2006, the Company entered into an agreement with Crystal Research Associates
        to have an Executive Informational Overview independently written about the
        company. As part of the consideration, the Company issued Crystal Research
        a
        warrant to purchase 200,000 shares of Technest common stock at an exercise
        price
        of 110% of the closing price of the Company’s stock on July 17, 2006 or $1.89.
        The fair value of this warrant will be charged to expense as the services
        are
        performed.
  F-45
  **Item
        8. Changes in and Disagreements with Accountants on Accounting and Financial
        Disclosure**
  None.
  **Item
        8A. Controls and Procedures**
  Based
        on
        our management's evaluation, 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 Controls Over Financial Reporting**
  There
        was
        no change in our internal control over financial reporting during the quarter
        ended June 30, 2006 that has materially affected, or is reasonably likely
        to
        materially affect, our internal control over financial reporting. 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.
  **ITEM
        8B. Other Information.**
  None.
  -37-
  **PART
        III**
  **Item
        9.****Directors
        and Executive Officers of the Registrant****;
        Compliance with Section 16(a) of the Exchange Act.**
  The
        information called for by this item is incorporated by reference to our Proxy
        Statement for the 2006 annual meeting of stockholders.
  **Item
        10. Executive Compensation.**
  The
        information called for by this item is incorporated by reference to our Proxy
        Statement for the 2006 annual meeting of stockholders.
  **Item
        11.****Security
        Ownership of Certain Beneficial Owners and Management.**
  The
        information called for by this item is incorporated by reference to our Proxy
        Statement for the 2006 annual meeting of stockholders.
  **Item
        12. Certain Relationships and Related
        Transactions.**
  The
        information called for by this item is incorporated by reference to our Proxy
        Statement for the 2006 annual meeting of stockholders.
  -38-
  **Item
        13. Exhibits.**
 Exhibit
                    No.
                Description
                Filed
                    with this 10-KSB
                Incorporated
                    by referenceForm
                Filing
                    Date
                Exhibit
                    No.2.1
                Securities
                    Purchase Agreement by and among Technest Holdings, Inc. and Southridge
                    Partners LP, Southshore Capital Fund Limited, ipPartners, Inc,
                    Verdi
                    Consulting, Inc., DKR Soundshore Oasis Holding Fund, Ltd., DKR
                    Soundshore
                    Strategic Holding Fund, Ltd. and Deer Creek Fund LLC, dated February
                    14,
                    2005
                
                8-K
                February
                    15, 2005
                2.12.2
                Securities
                    Purchase Agreement between Markland Technologies, Inc. and Technest
                    Holdings, Inc., dated February 14, 2005
                
                8-K
                February
                    15, 2005
                2.22.3
                Agreement
                    and Plan of Merger by and between Technest Holdings, Inc., MTECH
                    Acquisition, Inc., Genex Technologies, Inc. and Jason Geng, dated
                    February
                    14, 2005
                
                8-K
                February
                    15, 2005
                2.32.4
                2001
                    Stock Option Plan
                
                DEF
                    14A
                June
                    14, 2001
                C3.1
                Restated
                    Articles of Incorporation dated December 22, 1998
                
                SB-2
                February
                    26, 1999
                3.13.2
                Restated
                    Articles of Incorporation of Registrant, dated as of December
                    14, 2000, as
                    filed with the Secretary of State of the State of Nevada on March
                    2,
                    2001.
                
                10-KSB
                April
                    16, 2001
                3.23.3
                Certificate
                    of Amendment to Articles of Incorporation
                
                8-K
                August
                    9, 2001
                3.1
  -39-
  3.4
                Amended
                    and Restated By-Laws dated May 21, 2001.
                
                DEF
                    14A
                June
                    14, 2001
                B4.1
                Form
                    of Common Stock Certificate
                
                SB-2
                February
                    26, 1999
                4.14.2
                Series
                    A Convertible Preferred Stock Certificate of Designations, filed
                    with the
                    Secretary of State of Nevada on February 8, 2005.
                
                8-K
                February
                    14, 2005
                4.14.3
                Registration
                    Rights Agreement between Markland Technologies, Inc. and Southridge
                    Partners LP, Southshore Capital Fund Limited, ipPartners, Inc,
                    Verdi
                    Consulting, Inc., DKR Soundshore Oasis Holding Fund, Ltd., DKR
                    Soundshore
                    Strategic Holding Fund, Ltd. and Deer Creek Fund LLC for Markland
                    Common
                    Stock, dated February 14, 2005
                
                8-K
                February
                    15, 2005
                4.14.4
                Registration
                    Rights Agreement between Technest Holdings, Inc. and Markland
                    Technologies, Inc., dated February 14, 2005
                
                8-K
                February
                    15, 2005
                4.24.5
                Registration
                    Rights Agreement between Technest Holdings, Inc. and Southridge
                    Partners
                    LP, Southshore Capital Fund Limited, ipPartners, Inc, Verdi Consulting,
                    Inc., DKR Soundshore Oasis Holding Fund, Ltd., DKR Soundshore
                    Strategic
                    Holding Fund, Ltd. and Deer Creek Fund LLC for Technest Series
                    C Preferred
                    Stock and Warrants for Technest common stock, dated February
                    14,
                    2005
                
                8-K
                February
                    15, 2005
                4.34.6
                Registration
                    Rights Agreement between Technest Holdings, Inc. and Jason Geng
                    for
                    registration of Earnout Shares, dated February 14, 2005
                
                8-K
                February
                    15, 2005
                4.4
  -40-
  4.7
                Registration
                    Rights Agreement between Markland Technologies, Inc. and Jason
                    Geng, dated
                    February 14, 2005
                
                8-K
                February
                    15, 2005
                4.54.8
                Form
                    of Technest Common Stock Purchase Warrant
                
                8-K
                February
                    15, 2005
                4.64.9
                Technest
                    Series B Convertible Preferred Stock Certificate of Designations
                    filed
                    with the Secretary of State of Nevada on February 14, 2005.
                
                8-K
                February
                    15, 2005
                4.74.10
                Technest
                    Series C Convertible Preferred Stock Certificate of Designations
                    filed
                    with the Secretary of State of Nevada on February 14, 2005
                
                8-K
                February
                    15, 2005
                4.84.11
                Amendment
                    No. 1 to the Registration Rights Agreement dated October 3, 2005
                    among
                    Technest Holdings, Inc., Verdi Consulting, Inc., ipPartners,
                    Inc.,
                    Southridge Partners LP and Southshore Capital Fund, Ltd., amending
                    the
                    Registration Rights Agreement dated February 14, 2005 among these
                    parties.
                
                8-K
                October
                    7, 2005
                4.24.12
                Amendment
                    No. 2 to Registration Rights Agreement dated February 27, 2006
                    among
                    Technest Holdings, Inc., Verdi Consulting, Inc., ipPartners,
                    Inc.,
                    Southridge Partners LP and Southshore Capital Fund, Ltd., amending
                    the
                    Registration Rights Agreement dated February 14, 2005 among these
                    parties.
                
                8-K
                March
                    2, 2006
                4.24.13
                Technest
                    Common Stock Warrant issued to Silicon Valley Bank dated August
                    4,
                    2006.
                
                8-K
                August
                    14, 2006
                4.14.14
                Registration
                    Rights Agreement between Technest Holdings, Inc. and Silicon
                    Valley Bank
                    dated August 4, 2006.
                
                8-K
                August
                    14, 2006
                4.24.15
                Technest
                    Common Stock Warrant issued to Crystal Research Associates LLC
                    dated July
                    17, 2006
                x
  -41-
 
 4.16
                Registration
                    Rights Agreement between Technest Holdings, Inc. and Crystal
                    Research
                    Associates LLC dated July 17, 2006.
                x10.1
                Securities
                    Purchase Agreement between the registrant and Verdi Consulting
                    dated
                    February 8, 2005.
                
                8-K
                February
                    14, 2005
                10.110.2
                Form
                    of 8% Promissory Note between the registrant and Garth
                    LLC.
                
                8-K
                February
                    14, 2005
                10.210.3
                Exchange
                    Agreement between the registrant and Garth LLC dated February
                    8,
                    2005.
                
                8-K
                February
                    14, 2005
                10.310.4
                Securities
                    Purchase Agreement between the registrant and Garth LLC dated
                    February 8,
                    2005.
                
                8-K
                February
                    14, 2005
                10.410.5
                Escrow
                    Agreement between Markland Technologies, Inc. Technest Holdings,
                    Inc.
                    Genex Technologies, Inc., Jason Geng, and Wilmington Trust Company,
                    dated
                    February 14, 2005.
                
                8-K
                February
                    15, 2005
                10.110.6*
                Form
                    of Option to be granted under the 2004 Markland Stock Incentive
                    Plan
                
                8-K
                February
                    15, 2005
                10.610.7
                Stock
                    Purchase Agreement between Markland Technologies, Inc. and Technest
                    Holdings, Inc. dated August 17, 2005
                
                8-K
                August
                    18, 2005
                10.110.8
                Night
                    Vision Electronic Sensors Directorate (NVESD) Omnibus Contract
                    between
                    E-OIR Technologies, Inc. and****United
                    States Army Night Vision and Electronic Sensors
                    Directorate
                
                10-QSB
                November
                    21, 2005
                10.210.9
                Stock
                    Purchase Agreement by and between Markland and EOIR, dated June
                    30,
                    2004
                
                10-QSB
                November
                    21, 2005
                10.310.10
                Form
                    of Promissory Note made by EOIR Technologies, Inc. and dated
                    June 29,
                    2004
                
                10-QSB
                November
                    21, 2005
                10.4
  -42-
 
 10.11
                Security
                    Agreement by and between EOIR and sellers of EOIR stock, dated
                    June 30, 2004
                
                10-QSB
                November
                    21, 2005
                10.510.12
                Pledge
                    and Security Agreement, by and between Markland, EOIR and the
                    Sellers
                    thereon, dated June 29, 2004
                
                10-QSB
                November
                    21, 2005
                10.610.13
                Lease
                    Agreement between Branch Banking and Trust Company of Virginia
                    and
                  E-OIR
                    Technologies, dated May 31, 2002
                
                10-QSB
                February
                    21, 2006
                10.110.14
                First
                    Amendment to Lease by and between Branch Banking and Trust Company
                    of
                    Virginia and E-OIR Technologies, Inc. dated October 1,
                    2005
                
                10-QSB
                February
                    21, 2006
                10.210.15
                Jackson
                    Square Office Park Deed of Lease by and between LJ Holding, L.C.
                    and E-OIR
                    Technologies, Inc., dated September 22, 2004
                
                10-QSB
                February
                    21, 2006
                10.310.16
                Deed
                    of Commercial Office Lease Agreement between BDC Spotsylvania
                    LLC and
                    E-OIR Technologies, Inc., dated May 16, 2005
                
                10-QSB
                February
                    21, 2006
                10.410.17
                First
                    Amendment to Deed of Commercial Office Lease Agreement between
                    BDC
                    Spotsylvania LLC and E-OIR Technologies, Inc. dated September
                    29,
                    2005
                
                10-QSB
                February
                    21, 2006
                10.510.18
                Lease
                    between Paul J Kingston, Trustee of M.P.A. Realty Trust, and
                    Technest
                    Holdings, Inc., dated December 31, 2005
                
                10-QSB
                February
                    21, 2006
                10.610.19
                Office
                    Lease Agreement between Motor City Drive, LLC and Genex Technologies,
                    Inc., dated December 20, 2005
                
                10-QSB
                February
                    21, 2006
                10.7
  -43-
 
 10.20
                Stockholders’
                    Agreement between Markland Technologies, Inc. and Technest Holdings,
                    Inc.
                    dated March 13, 2006.
                
                8-K
                March
                    17, 2006
                10.110.21
                License
                    Agreement between Markland Technologies, Inc. and Technest Holdings,
                    Inc.
                    dated March 13, 2006.
                
                8-K
                March
                    17, 2006
                10.210.22*
                Employment
                    Agreement between Joseph P. Mackin and Technest Holdings, Inc.
                    dated March
                    13, 2006.
                
                8-K
                March
                    17, 2006
                10.310.23*
                Employment
                    Agreement between Gino M. Pereira and Technest Holdings, Inc.
                    dated March
                    13, 2006.
                
                8-K
                March
                    17, 2006
                10.410.24*
                Form
                    of Restricted Stock Agreement between Joseph P. Mackin and Technest
                    Holdings, Inc.
                
                8-K
                March
                    17, 2006
                10.510.25*
                Form
                    of Restricted Stock Agreement between Gino M. Pereira and Technest
                    Holdings, Inc.
                
                8-K
                March
                    17, 2006
                10.610.26*
                Release
                    and Indemnification Agreement between Robert Tarini and Technest
                    Holdings,
                    Inc. dated March 13, 2006.
                
                8-K
                March
                    17, 2006
                10.710.27*
                Technest
                    Holdings, Inc. 2006 Stock Award Plan.
                
                8-K
                March
                    17, 2006
                10.810.28
                Loan
                    and Security Agreement for Term Loan among Silicon Valley Bank,
                    Technest
                    Holdings, Inc., E-OIR Technologies, Inc. and Genex Technologies,
                    Inc.
                    dated August 4, 2006.
                
                8-K
                August
                    14, 2006
                10.110.29
                Loan
                    and Security Agreement for Working Capital Line of Credit among
                    Silicon
                    Valley Bank, Technest Holdings, Inc., E-OIR Technologies, Inc.
                    and Genex
                    Technologies, Inc. dated August 4, 2006.
                
                8-K
                August
                    14, 2006
                10.210.30
                Intellectual
                    Property Security Agreement among Silicon Valley Bank, Technest
                    Holdings,
                    Inc., E-OIR Technologies, Inc. and Genex Technologies, Inc. dated
                    August
                    4, 2006.
                
                8-K
                August
                    14, 2006
                10.3
  -44-
 
 10.31
                Unconditional
                    Guaranty by Markland Technologies, Inc. dated August 4,
                    2006.
                
                8-K
                August
                    14, 2006
                10.410.32
                Stock
                    Pledge Agreement between Markland Technologies, Inc. and Silicon
                    Valley
                    Bank dated August 4, 2006.
                
                8-K
                August
                    14, 2006
                10.510.33*
                Agreement
                    relating to Certain Promissory Notes between Technest Holdings,
                    Inc. and
                    Joseph P. Mackin dated August 4, 2006.
                
                8-K
                August
                    14, 2006
                10.610.34*
                First
                    Allonge to Promissory Note of Joseph P. Mackin dated August 4,
                    2006.
                
                8-K
                August
                    14, 2006
                10.710.35*
                Restricted
                    Stock Grant Agreement between Technest Holdings, Inc. and Joseph
                    P. Mackin
                    dated August 4, 2006.
                
                8-K
                August
                    14, 2006
                10.810.36
                Indemnification
                    Agreement between Technest Holdings, Inc. and Markland Technologies,
                    Inc.
                    dated September 1, 2006
                x16.1
                Letter
                    from Sherb & Co.
                
                8-K/A
                August
                    25, 2005
                16.121.1
                List
                    of the Subsidiaries of Technest Holdings, Inc.
                x31.1
                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
 * Indicates
        a management contract or compensatory plan.
  -45-
  **Item
        14. Principal Accountant Fees and Services**
  The
        information called for by this item is incorporated by reference to our Proxy
        Statement for the 2006 annual meeting of stockholders.
  -46-
  **Signatures**
   In
        accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused
        this Report to be signed on its behalf by the undersigned, thereunto duly
        authorized on October 13, 2006.
 
 TECHNEST
        HOLDIINGS, INC.
 
 By: /s/
        Joseph P.
        Mackin
 Joseph
        P.
        Mackin
 Chief
        Executive Officer
  In
        accordance with the Exchange Act, this Report has been signed below by the
        following persons on behalf of the Registrant and in the capacities and on
        the
        dates indicated.
 
 **Signature**
              
              **Title**
              
              **Date**/s/
                  Joseph P. Mackin
              
              Chief
                  Executive Officer, President and
              
              October
                  13, 2006Joseph
                  P. Mackin
              
              Chairman
                  of the Board of Directors/s/
                  Gino Miguel Pereira
              
              Chief
                  Financial Officer, Principal
              
              October
                  13, 2006Gino
                  Miguel Pereira
              
              Accounting
                  Officer and Director/s/Darlene
                  M. Deptula-Hicks
              
              Director
              
              October
                  13, 2006Darlene
                  M. Deptula-Hicks/s/
                  David R. Gust
              
              Director
              
              October
                  13, 2006David
                  R. Gust/s/
                  Robert Doto
              
              Director
              
              October
                  13, 2006Robert
                  Doto
   -47-