10-KSB

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 years
Computer equipment			3 years
Furniture and fixtures			5-7 years
Leasehold improvements			Shorter of useful life or lease term
Vehicles			5 years

Property and equipment consisted of the following at June 30, 2006:

Software	$	169,077
Computer equipment		665,111
Furniture and fixtures		345,275
Leasehold improvements		222,338
Vehicles		33,670
		1,435,471
Less 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		15,228,294
Series A Convertible Preferred Stock		306,047
Series C Convertible Preferred Stock		632,178
Warrants to purchase common stock		99,968
Total 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, 2005
Net 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			634,052
Deduct: 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	$0.12
Exercise price	$0.06
Expected dividend yield	0%
Expected lives (in years)	9
Volatility	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	$	3,300,000
Shares of Markland Technologies, Inc. common stock		6,101,258
Total Purchase Price	$	9,401,258

Fair value allocation to net assets acquired:

Fair value of assets acquired -
Current assets, including cash of $784,482	$	1,199,402
Property and equipment		44,000
Fair value of liabilities assumed -
Accounts payable & accrued expenses		(544,292	)
Fair value of identifiable net tangible assets acquired		699,110
Intangible assets - intellectual property		161,110
In-process research and development		2,095,000
Commercialized patents		440,000
Contracts and customer relationships		1,130,000
Goodwill		4,876,038
Total	$	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 + Rp3

Where:	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 detection
2.	Miniature Optical Sensor - Darpa/Navair
3.	Smart Obstacle Avoidance Sensor Systems - Navy/Special Forces
4.	Chemical Detection Trainers - Army/Marines
5.	NoseCam - Commercial
6.	NailCam - Commercial
7.	Prototypes And Product Development: Navigation
8.	Prototypes And Product Development: Intelligence and Surveillance
9.	Prototypes And Product Development: Explosive/Chemical Detection
10.	Prototypes And Product Development: Intelligent Surveillance Sensors
11.	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, 2005
Revenues	$	33,779,982

Net loss	$	(32,488,450	)

Deemed dividends on beneficial conversion
to 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		5
Patents - Genex - other		161,110		15
Customer relationships and contracts - Genex		1,130,000		5
Customer relationships and contracts - EOIR- Sensor Technologies		11,755,000		9
Customer relationships and contracts - EOIR- Chemical Detection		1,551,944		10
		15,038,054
Accumulated 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, 2002 with monthly payments of $3,715 including interest at LIBOR plus 2.75% (6.27% at June 30, 2006)	$	19,758
First Market Bank, dated July, 2002 with monthly payments of $15,278 plus 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	$	50,885
2008		2,203,000
2009		2,203,000
2010		2,202,411
Total		6,659,296
Less: 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	$	2,982,448
Non-current portion of long-term debt		3,676,848
Total 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			374,286
Reserve for conversion of Series A Convertible Preferred Stock			306,047
Reserve for conversion of Series C Convertible Preferred Stock			632,185
Total 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 Average
	Number of Shares			Exercise Price
Balance, December 31, 2004		3,896		$	504.72
Issued		1,149,425			6.50
Expired		(80	)	$	(4,434.78	)
Exercised		(267,366	)		6.33
Balance, June 30, 2005		885,875			8.12
Exercised		(507,773	)		(6.50	)
Expired		(3,816	)		3,259.17
Balance, 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	02/14/2010
Weighted 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	$ 6.50
Expected dividend yield	0%
Expected lives of warrants (in years)	5.0
Volatility	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 Potentially
	Issuable
Series A Convertible Preferred Stock		588,716
Series C Convertible Preferred Stock		1,149,425
Stock options		3,816
Warrants		882,059
Total 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	$	674,504
2008		662,359
2009		571,562
2010		353,144
2011		190,821
Total	$	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:

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

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

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

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

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

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

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

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

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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. The 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.

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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.

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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.

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:

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	2006			2005
Tax provision (benefit) at statutory rate	$	6,886,000		$	(11,568,000	)
Permanent differences due to :
Derivative income (loss)		(8,516,000	)		10,272,000
Stock-based compensation		95,000			358,000
In-process research and development		--			718,000
Non-deductible interest		587,000			--
Losses providing no tax benefit		915,000			--
Amortization of definite lived intangibles		--			210,000
Other		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			2005
Net operating loss carryforward	$	4,200,000			3,500,000
Non-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.

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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.

Contributions 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.

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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.

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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 SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)

	Six Months Ended
	June 30, 2004

Revenues	$	-

General and administrative expenses		5,787

Loss 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

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TECHNEST HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)

	Six Months Ended June 30, 2004

CASH 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		10,000

NET CASH PROVIDED BY FINANCING ACTIVITIES		10,000

NET INCREASE IN CASH		346

CASH - BEGINNING OF PERIOD		988

CASH - 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.

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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.

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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.

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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 reference
Exhibit No.	Description	Filed with this 10-KSB	Form	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	2.1
2.2	Securities Purchase Agreement between Markland Technologies, Inc. and Technest Holdings, Inc., dated February 14, 2005		8-K	February 15, 2005	2.2
2.3	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	2.3
2.4	2001 Stock Option Plan		DEF 14A	June 14, 2001	C
3.1	Restated Articles of Incorporation dated December 22, 1998		SB-2	February 26, 1999	3.1
3.2	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	3.2
3.3	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	B
4.1	Form of Common Stock Certificate	SB-2	February 26, 1999	4.1
4.2	Series A Convertible Preferred Stock Certificate of Designations, filed with the Secretary of State of Nevada on February 8, 2005.	8-K	February 14, 2005	4.1
4.3	Registration Rights Agreement between Markland Technologies, Inc. and Southridge Partners LP, Southshore Capital Fund Limited, ipPartners, Inc, Verdi Consulting, Inc., DKR Soundshore Oasis Holding Fund, Ltd., DKR Soundshore Strategic Holding Fund, Ltd. and Deer Creek Fund LLC for Markland Common Stock, dated February 14, 2005	8-K	February 15, 2005	4.1
4.4	Registration Rights Agreement between Technest Holdings, Inc. and Markland Technologies, Inc., dated February 14, 2005	8-K	February 15, 2005	4.2
4.5	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	4.3
4.6	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	4.5
4.8	Form of Technest Common Stock Purchase Warrant		8-K	February 15, 2005	4.6
4.9	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	4.7
4.10	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	4.8
4.11	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	4.2
4.12	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	4.2
4.13	Technest Common Stock Warrant issued to Silicon Valley Bank dated August 4, 2006.		8-K	August 14, 2006	4.1
4.14	Registration Rights Agreement between Technest Holdings, Inc. and Silicon Valley Bank dated August 4, 2006.		8-K	August 14, 2006	4.2
4.15	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.	x
10.1	Securities Purchase Agreement between the registrant and Verdi Consulting dated February 8, 2005.		8-K	February 14, 2005	10.1
10.2	Form of 8% Promissory Note between the registrant and Garth LLC.		8-K	February 14, 2005	10.2
10.3	Exchange Agreement between the registrant and Garth LLC dated February 8, 2005.		8-K	February 14, 2005	10.3
10.4	Securities Purchase Agreement between the registrant and Garth LLC dated February 8, 2005.		8-K	February 14, 2005	10.4
10.5	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	10.1
10.6*	Form of Option to be granted under the 2004 Markland Stock Incentive Plan		8-K	February 15, 2005	10.6
10.7	Stock Purchase Agreement between Markland Technologies, Inc. and Technest Holdings, Inc. dated August 17, 2005		8-K	August 18, 2005	10.1
10.8	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	10.2
10.9	Stock Purchase Agreement by and between Markland and EOIR, dated June 30, 2004		10-QSB	November 21, 2005	10.3
10.10	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	10.5
10.12	Pledge and Security Agreement, by and between Markland, EOIR and the Sellers thereon, dated June 29, 2004	10-QSB	November 21, 2005	10.6
10.13	Lease Agreement between Branch Banking and Trust Company of Virginia and E-OIR Technologies, dated May 31, 2002	10-QSB	February 21, 2006	10.1
10.14	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	10.2
10.15	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	10.3
10.16	Deed of Commercial Office Lease Agreement between BDC Spotsylvania LLC and E-OIR Technologies, Inc., dated May 16, 2005	10-QSB	February 21, 2006	10.4
10.17	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	10.5
10.18	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	10.6
10.19	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	10.1
10.21	License Agreement between Markland Technologies, Inc. and Technest Holdings, Inc. dated March 13, 2006.	8-K	March 17, 2006	10.2
10.22*	Employment Agreement between Joseph P. Mackin and Technest Holdings, Inc. dated March 13, 2006.	8-K	March 17, 2006	10.3
10.23*	Employment Agreement between Gino M. Pereira and Technest Holdings, Inc. dated March 13, 2006.	8-K	March 17, 2006	10.4
10.24*	Form of Restricted Stock Agreement between Joseph P. Mackin and Technest Holdings, Inc.	8-K	March 17, 2006	10.5
10.25*	Form of Restricted Stock Agreement between Gino M. Pereira and Technest Holdings, Inc.	8-K	March 17, 2006	10.6
10.26*	Release and Indemnification Agreement between Robert Tarini and Technest Holdings, Inc. dated March 13, 2006.	8-K	March 17, 2006	10.7
10.27*	Technest Holdings, Inc. 2006 Stock Award Plan.	8-K	March 17, 2006	10.8
10.28	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	10.1
10.29	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	10.2
10.30	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	10.4
10.32	Stock Pledge Agreement between Markland Technologies, Inc. and Silicon Valley Bank dated August 4, 2006.		8-K	August 14, 2006	10.5
10.33*	Agreement relating to Certain Promissory Notes between Technest Holdings, Inc. and Joseph P. Mackin dated August 4, 2006.		8-K	August 14, 2006	10.6
10.34*	First Allonge to Promissory Note of Joseph P. Mackin dated August 4, 2006.		8-K	August 14, 2006	10.7
10.35*	Restricted Stock Grant Agreement between Technest Holdings, Inc. and Joseph P. Mackin dated August 4, 2006.		8-K	August 14, 2006	10.8
10.36	Indemnification Agreement between Technest Holdings, Inc. and Markland Technologies, Inc. dated September 1, 2006	x
16.1	Letter from Sherb & Co.		8-K/A	August 25, 2005	16.1
21.1	List of the Subsidiaries of Technest Holdings, Inc.	x
31.1	Certification by CFO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).	x
31.2	Certification by CEO of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a).	x
32.1	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, 2006
Joseph P. Mackin	Chairman of the Board of Directors


/s/ Gino Miguel Pereira	Chief Financial Officer, Principal	October 13, 2006
Gino Miguel Pereira	Accounting Officer and Director


/s/Darlene M. Deptula-Hicks	Director	October 13, 2006
Darlene M. Deptula-Hicks


/s/ David R. Gust	Director	October 13, 2006
David R. Gust


/s/ Robert Doto	Director	October 13, 2006
Robert Doto

-47-

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

Calendar Year	High	Low

2004
First Quarter	$27.43	$4.22
Second Quarter	$4.22	$4.22
Third Quarter	$12.66	$2.11
Fourth Quarter	$21.10	$2.11

2005
First Quarter	$63.29	$10.55
Second Quarter	$40.08	$12.66
Third Quarter	$52.74	$5.15
Fourth Quarter	$5.50	$4.50

2006
First Quarter	$11.35	$4.40
Second Quarter	$4.80	$2.20
Third Quarter	$3.52	$1.60

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

ASSETS

Current Assets
Cash and cash equivalents	$	3,362,210
Accounts receivables		9,374,879
Unbilled receivables		2,054,121
Inventory and work-in-process		20,235
Restricted cash		250,000
Prepaid 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		75,250
Definite-lived intangible assets - Net of accumulated amortization of $3,485,525		11,552,529
Goodwill		14,035,551
Total Other Assets		25,663,330

Total Assets	$	41,651,411


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities
Accounts payable	$	13,245,437
Accrued expenses and other current liabilities		4,848,935
Due to related parties, net		595,782
Current 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

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)		632
Common Stock - par value $.001 per share;
495,000,000 shares authorized; 15,867,911 shares issued and outstanding		15,867
Additional paid-in capital		32,404,174
Accumulated deficit		(15,237,939	)
Total Stockholders’ Equity		17,182,734

Total Liabilities and Stockholders’ Equity	$	41,651,411

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

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

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

	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			5,809,945
Research and development		159,209			2,395,950
Amortization 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			40,567
Interest 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		--			124,848
Deemed 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

					Series A					Series B
					Convertible					Convertible
	Common Stock				Preferred Stock					Preferred Stock
	Shares		Amount		Shares			Amount		Shares			Amount

Balance - 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			1,149
Exchange 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			517
Conversion 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		$	-		-		$	-

	Series C
	Convertible						Subscription			Unearned
	Preferred Stock						Receivable			Compensation
	Shares			Amount			Amount			Amount

Balance- 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		-			-			-			634,052
Issuance 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		-			-			-			1,541,490
Stock based compensation related to restricted stock grants		-			-			-			-
Reclassification of derivative liability to equity		-			-			-			-
Net income		-			-			-			-
Balance - June 30, 2006		632,185		$	632		$	-		$	-

	Additional						Total
	Paid-In			Accumulated			Stockholders'
	Capital			Deficit			Equity (Deficit)
	Amount			Amount			Amount

Balance - January 1, 2005	$	15,229,318		$	(15,531,599	)	$	(309,177	)
Issuance of Series A Convertible Preferred Stock		124,848			-			124,848
Net 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			184,330
Acquisition of EOIR		16,533,761			(1,466,566	)		12,903,653
Amortization and remeasurement of stock based compensation		158,832			-			792,884
Issuance of common stock to Markland in connection with the Genex acquisition		6,099,304			-			6,101,258
Issuance of Series B and C Convertible Preferred Stock and warrants		2,451,124			-			2,453,422
Exchange of Series B Convertible Preferred Stock for Markland Series D Preferred Stock		632			-			-
Common Stock issued in conjunction with warrant exercises		4,307,575			-			4,307,784
Net 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			-			2,104,461
Exchange of Series B Convertible Preferred Stock for Markland Series D Preferred Stock		517			-			-
Amortization and forfeiture of stock based compensation		(1,445,151	)		-			96,339
Stock based compensation related to restricted stock grants		279,428			-			279,428
Reclassification of derivative liability to equity		1,917,127			-			1,917,127
Net income		-			20,252,664			20,252,664
Balance June 30,2006	$	32,404,174		$	(15,237,939	)	$	17,182,734

	2006			2005 (Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:

Net income (loss)	$	20,252,664		$	(34,026,287	)

Adjustment to reconcile net income (loss) to net
cash provided by operating activities:
Derivative (income) loss		(25,046,489	)		30,212,400
Common stock issued in settlement of liquidated damages		2,104,461			--
Depreciation of property and equipment		385,032			120,524
Accrued interest on note payable paid in Series A Convertible Preferred Stock		--			7,690
Amortization of intangible assets		1,747,347			611,471
Acquired in-process research and development		--			2,095,000
Stock-based compensation		375,767			1,044,512
Non-cash interest expense		293,592			110,097
Changes 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	)		295,638
Accounts payable		2,795,528			4,464,187
Accrued expenses and other current liabilities		3,183,845			326,307
NET CASH PROVIDED BY OPERATING ACTIVITIES		903,036			4,424,824

CASH 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.		--			1,916,079
Purchase 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		--			50,000
Proceeds from sale of Series B and C Convertible Preferred Stock and warrants, net		--			3,512,422
Payment of note payable and long-term debt		(2,858,891	)		(1,709,683	)
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES		(2,858,891	)		1,852,739

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(2,250,398	)		5,612,469
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD		5,612,608			139

CASH AND CASH EQUIVALENTS - END OF PERIOD	$	3,362,210		$	5,612,608

	2006		2005 (Restated)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Cash paid during the periods for:
Interest	$	576,620	$	325,503

Taxes	$	--	$	500
Non-cash investing and financing activities:

Conversion of notes payable and accrued interest into Series A
Preferred Stock	$	--	$	74,848

Common Stock issued in exchange for shares of Markland
Technologies, Inc. used in conjunction with the acquisition of
Genex Technologies, Inc.	$	--	$	6,101,258
Common Stock issued in conjunction with the acquisition
of E-OIR Technologies, Inc.	$	--	$	12,903,653

Deemed dividend Preferred Stock - beneficial conversion
feature - Series A	$	--	$	124,848

Deemed dividend Preferred Stock - beneficial conversion
feature - Series C	$	--	$	2,465,000

Reclassification of derivative liability to equity	$	1,917,127	$	4,307,784

Inventory transferred to Markland	$	105,218		--

Accounts receivable	$	166,557
Inventory and work in process		222,957
Prepaid expenses and other current assets		25,403
Property and equipment		44,000
Intangible assets, goodwill and in-process research and development		8,702,149
Accounts 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

Accounts receivable	$	7,044,264
Prepaid expenses and other current assets		73,406
Property and equipment		873,640
Intangible assets and goodwill		21,371,550
Accounts 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

	As originally stated			Impact of EOIR			Impact of derivatives			Total impact of restatement
Net 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	)