SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

|X|  ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(D) OF THE  SECURITIES  EXCHANGE
     ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
                        COMMISSION FILE NUMBER: 000-32925

                              AVATAR SYSTEMS, INC.
            (Name of Small Business Issuer Specified in Its Charter)

         Texas                                            75-2796037
(State of incorporation)                    (IRS Employer Identification Number)

5728 LBJ Freeway, Suite 270, Dallas, Texas 75240               75240
    (Address of principal executive offices)                (Zip Code)

                                 (972) 720-1800
              (Registrant's telephone number, including area code)

         Securities registered under Section 12(b) of the Exchange Act:
                                      None

         Securities registered under Section 12(g) of the Exchange Act:
                          $.001 Par Value Common Stock


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

     As of March 14, 2005,  8,838,152  shares of the  Issuer's  $0.001 par value
common stock were  outstanding and the aggregate  market value of the share held
by non-affiliates  was approximately  $260,000 based upon a closing bid price of
$.40 per share of Common Stock on the OTC Bulletin Board.


     Indicate by check mark if disclosure of delinquent  filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best  of  the  registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in part III of this Form  10-KSB or any
amendment to this Form 10-KSB.


     The Issuer's revenue for its most recent fiscal year was $2,661,370.


     The following documents are incorporated by reference: None



<PAGE>


PART I.........................................................................1
   Item 1. Business............................................................1
   Item 2. Properties..........................................................9
   Item 3. Legal Proceedings..................................................10
   Item 4. Submission of Matters To A Vote Of Security Holders................10
PART II.......................................................................10
   Item 5. Market For The Registrant's Common Equity And Related
           Shareholder Matters................................................10
   Item 6. Management's Discussion And Analysis Of Financial Condition
           Or Plan Of Operations..............................................11
   Item 7. Financial Statements...............................................16
   Item 8. Changes In And Disagreements With Accountants On Accounting And
           Financial Disclosure...............................................34
   Item 8a. Controls And Procedures...........................................34
   Item 8b. Other Information.................................................34
PART III......................................................................34
   Item 9. Directors And Executive Officers Of The Registrant;
           Compliance With Section 16(A) Of The Exchange Act..................34
   Item 10. Executive Compensation............................................37
   Item 11. Security Ownership Of Certain Beneficial Owners And Management....38
   Item 12. Certain Relationships And Related Transactions....................39
   Item 13. Exhibits..........................................................39
   Item 14. Principal Accountant Fees And Services............................41
   Signatures.................................................................41




<PAGE>


                                     PART I

Item 1. Business

     Business Development

     Avatar Systems, Inc. ("Avatar", the "Company", or "we") provides enterprise
resource solution software to companies engaged in the petroleum exploration and
production  industry.  We offer integrated software solutions for automating and
integrating  data and work flows across the petroleum  industry,  as well as the
information flows between the petroleum  organization and external parties.  Our
products are intended to increase operational  efficiency,  improve the accuracy
of client information, and enable better decision-making.  Each solution focuses
on specific  mission-critical  functions of the  petroleum  organization  and is
tailored to meet the needs of the  particular  client,  as  determined  by size,
properties under management and complexity of the petroleum industry.

     Avatar Systems, Inc. began business on September 1, 1996 as Avatar Systems,
Ltd.,  a Texas  limited  partnership,  in  connection  with the  acquisition  of
Information Resources, Inc.

     On July 7, 2000, the limited partners assigned their respective partnership
interests  to  Avatar  International,   Inc.  for  6,399,000  shares  of  Avatar
International's  common stock.  The  partnership  assigned all of its assets and
liabilities to Avatar International and was dissolved.  On July 10, 2000, Avatar
International changed its name to Avatar Systems, Inc.

     On November 14, 2000,  HCI  Acquisition  1998-2,  Inc.  acquired all of the
outstanding  common  stock  of  Avatar  Systems,  Inc.  pursuant  to a plan  and
agreement of merger.  The Avatar Systems common stock was acquired from its four
shareholders in exchange for 8,000,000 shares of HCI's common stock representing
approximately  92% of the HCI's  common  stock.  HCI, as the  surviving  entity,
changed its name to Avatar Systems, Inc., its sole officer and director resigned
and HCI's  shareholders  elected  five new  directors,  who were also serving as
directors of Avatar Systems.

     HCI Acquisition 1998-2,  Inc., (HCI) was incorporated in Texas on August 7,
1998 as a wholly-owned  subsidiary of  Hospitality  Companies,  Inc.,  which was
engaged in the leasing,  sale and servicing of  refrigeration,  air conditioning
and restaurant equipment.

     Avatar's  stock symbol is AVSY.OB.  Our common  stock began  trading on the
Over-the-Counter  Pink  Sheets  on April 2,  2001.  On  November  5,  2001,  our
Registration Statement on Form 10-SB became effective and our stock was approved
for trading December 19, 2001 on the NASD OTC Bulletin Board.

     On  our  investor   relations  web  site,   which  is  accessible   through
www.avatarsystems.net,  we post  the  following  filings  as soon as  reasonably
practicable  after  they  are  electronically  filed  with or  furnished  to the
Securities and Exchange Commission  ("SEC"):  our annual reports on Form 10-KSB,
our quarterly  reports on Form 10-QSB,  our current  reports on Form 8-K and any
amendments to those reports. All such filings on our investor relations web site
are available free of charge. Information contained or referenced on our website
is not  incorporated  by  reference  in and does not form a part of this  Annual
Report on Form 10-KSB.  The SEC maintains an Internet site at  www.sec.gov  that
contains  reports,  proxy and  information  statements,  and  other  information
regarding issuers that is filed electronically with the SEC.

     Our principal executive offices are located at 5728 LBJ Freeway, Suite 270,
Dallas, Texas 75240, and our telephone number is (972) 720-1800.

                                       1
<PAGE>

     Industry Background

The petroleum  industry is a  data-intensive  and complex global  industry.  The
industry consists of three distinct sectors: upstream, midstream and downstream.

     o    Upstream activities include  exploration,  producing and selling crude
          oil, natural gas and gas liquids.
     o    Midstream activities typically include the gathering,  transportation,
          and storage of petroleum products.
     o    Downstream  activities  include  refining  crude  oil  into  petroleum
          products,  trading crude oil and petroleum  products and  distributing
          and marketing refined products.


     Within the upstream sector, the exploration and production divisions of oil
and gas  companies  are  chartered  with  finding,  developing  and managing the
production of oil and gas reserves.  Petroleum companies need to continually add
new  reserves  of oil  and gas at a  faster  rate  than  existing  reserves  are
depleted.  Optimizing a portfolio of oil and gas reserves is an ongoing process,
whereby,  petroleum  companies  explore,  evaluate,  develop,  manage and divest
petroleum interests.

     The discovery, evaluation,  acquisition and processing of properties within
the  upstream   petroleum  industry  are  typically   cumbersome,   costly,  and
time-consuming and are characterized by:

     o    Data-Intensive,  Paper-Based  Process.  Large amounts of geotechnical,
          engineering,  land-related,  financial  and  accounting  data  must be
          compiled and integrated from disparate, non-standardized,  paper-based
          and digital sources in order to evaluate and manage properties.
     o    Geographic   Dispersion  of  Resources.   Many  new   exploration  and
          development  projects  are  conducted  in remote  parts of the  world,
          creating  significant  costs  and  numerous   insufficiencies  in  the
          management of an upstream business.
     o    Lack of Back Office  Interconnectivity.  The ability of  companies  to
          exchange data  electronically and effect  transactions in an efficient
          manner is currently  limited by the numerous  incompatible back office
          land, production and accounting systems.

     The energy  application  market has grown, as major U.S. oil companies have
divested  many of their  U.S.-based  assets,  in order to  pursue  opportunities
abroad.  These  divestitures  have  opened  the door for small  independent  oil
companies to acquire the assets of the major oil  companies.  There is a growing
demand for oil and gas accounting and financial  software  because of the growth
of these small independent oil companies.

     The computer  infrastructure within the petroleum industry has been allowed
to age beyond what is  traditionally  considered the useful life span of many of
its component elements. The challenges facing the petroleum industry are: how to
take advantage of the  anticipated  increase in demand,  confront the problem of
aging IT infrastructure,  and deal with the ongoing attrition of the work force.
These challenges will be met by changes in the business processes of oil and gas
companies to work with fewer people, make efficient use of technology,  and move
away from  capital-intensive  computing systems.  The oil industry will become a
more streamlined and efficient  industry based upon technology and services,  an
enterprise  wide  resource  solution,   supplied  through   application  service
providers  (ASP's).  These ASP's will offer  enhanced  outsourcing  capabilities
including not only  applications,  but through  professional  services including
consulting, implementation, integration, software and industry training.

     Narrative Description of Business

     Products

     Avatar    provides   the   petroleum    industry    with    solutions   for
accounting/financial  management,  production and land  management,  oil and gas
marketing  and  electronic  data  exchange  on both a  licensed  basis and as an
application service provider (ASP).


                                       2
<PAGE>


     We  provide  technology  products  and  services  to  support  the  ongoing
management of an upstream petroleum business and to facilitate the processing of
oil and gas transactions through the back office systems of buyers, sellers, and
traders. We offer a full line of accounting and resource management software for
the petroleum  industry through our Avatar400 and  Petroware2000  product lines.
Our  products  offer a  variety  of  applications  specific  to the  accounting,
billing,  financial  analysis,  and  land,  royalty  and  production  management
functions of a petroleum company.

     Petroware2000

     Petroware2000  runs on all major  operating  systems  and  hardware  types,
including Microsoft Windows,  Hewlett Packard,  and IBM products.  Petroware2000
runs on  virtually  any  platform  and is  available  in single  and  multi-user
licenses  and  on  an  ASP  basis.  Petroware2000  utilizes  the  speed,  power,
flexibility,  and infinite  expandability  of IBM's DB2 database  environment to
insure  reliability,   extended  product  longevity  and  substantially   faster
processing  speeds.  Our  Petroware2000  product is  designed  for the small- to
medium-sized petroleum company.

     Avatar400

     Avatar 400 provides a comprehensive  accounting system, which delivers real
time information from the database to users. This product takes advantage of the
scalability  and  security  of the IBM AS400 line of servers  and  utilizes  the
advanced features of IBM technology allowing energy customers to obtain accurate
and timely information. Avatar400, which was designed primarily for use by major
petroleum  companies,  provides an extensive array of data elements and multiple
sorting capabilities.  It automatically  generates a host of reports,  including
lease/well  management  reports,   financial  reports  and  accounting  reports.
Avatar400 offers a complete selection of real-time  accounting  software modules
which include general ledger,  accounts payable,  accounts  receivable,  revenue
accounting,  joint interest billing,  partnership accounting,  depletion (cost &
statutory),   fixed  assets  (GAAP  &  tax),   budgeting  and  revenue  accrual.
Additionally,  our  Avatar400  product  provides  functionality  for  production
management,  oil and gas marketing, field inventory and data exchange interfaces
between accounting and engineering systems.

     RAPID and Petroware2000 ASP Products

     Our RAPID, or Remote Access Private Integrated Datalink,  and Petroware2000
application service provider (ASP) systems deliver enterprise resource solutions
to petroleum  companies on a worldwide basis. Our ASP products were developed to
reduce  the  high  costs of oil and gas  accounting  software  ownership.  Users
remotely  connect  to our IBM AS400 or Citrix  farm  servers  on a  subscription
basis, thereby,  eliminating the need for expensive in-house hardware solutions,
software purchases,  and eventual upgrades.  Our ASP solutions provide access to
high  availability,  secure,  fast  processing  servers  for a  limited  monthly
expenditure and reduce, or eliminate, the need for an expensive in-house.

     Support and Maintenance Services

     Due to the mission-critical  nature of our products,  most clients purchase
annual support and  maintenance,  which  entitles them to technical  support and
product upgrades as they become  available.  We continually  upgrade and enhance
our  products  to  respond  to  changing  market  needs,   evolving   regulatory
requirements, and new technologies.

     Professional Services

     Professional services consist of consulting,  implementation,  integration,
custom report writing,  and training.  Many of our clients  purchase  consulting
services from us to support their  implementations,  assist in the conversion of
their  historical  data and provide ongoing  training and education.  We believe
that consulting  services facilitate a client's early success with our products,
strengthen the relationship with the client,  and generate valuable feedback for
our product development group.

     Growth Strategy

     Leveraging Existing Customer Relationships

     We have an installed  base of more than 350 customers.  Existing  customers
expanding or upgrading their information  solutions provide us with a market for
additional  software  solutions and  services.  The majority of our revenues are
generated from existing customers.


                                       3
<PAGE>



     Developing and Enhancing New Technologies

     Our product  development efforts are focused on developing new solutions as
well as enhancing and broadening our current software  solutions.  New solutions
will continue to emphasize state-of-the-art technologies for Internet-enablement
and information  exchange.  During fiscal 2005, our product  development efforts
will include  development  of  production  /land  modules for our  Petroware2000
product  and  integration  of new  imaging  functionality  in both our AS400 and
Petroware2000 products.

     Pursuing Acquisitions and Strategic Alliances

     We  have  successfully  completed  two  acquisitions  since  1996.  We will
continue to evaluate  potential  acquisitions of other companies or technologies
to further expand our solutions,  services, or market penetration.  In addition,
as we  expand in our  markets,  we intend  to enter  into  additional  sales and
marketing  strategic  alliances in such  markets.  We believe that new technical
skills, expanded software  functionality,  a broader client base and an expanded
geographic presence may result from these activities.

     Expanding ASP Hosting Business

     We have offered our AS400 RAPID ASP services  since 1999. We began offering
our  Petroware2000  product as an ASP service in early 2004.  Our ASP  offerings
allow  customers to free up resources to concentrate on their core  competencies
and strategic projects. The ASP business model provides us with a growing source
of  recurring  revenues.  Our ASP  hosting  centers  allows us to meet  customer
demands as well as offer off-site backup and disaster  recovery  capabilities to
our customers.

     Sales and Marketing

     Our  marketing  plan is geared  to  penetrate  the  energy  market.  We use
regional  distributors,  trade  shows,  advertising,  conferences,  direct mail,
telemarketing,  referral base, and a written  incentive-based  compensation plan
for our sales  representatives  to grow our market share. We maintain a database
of  over  15,000  domestic  oil and  gas  companies  registered  with  Dunn  and
Bradstreet.  Additionally, we have engaged research consultants to access public
records  as filed  with  state  regulatory  agencies  by oil and gas  companies.
Product demonstrations can be provided via the Internet, direct modem connection
to customer site, in person at the customer site or at our office in Dallas.

     To discover  opportunities  to sell our products  and Internet  integration
solutions,  we call on our existing  customer  base, as well as leads we receive
from  customers,  inquiries in response to  tradeshows  and  advertisements.  We
conduct a variety of  marketing  programs to educate our target  market,  create
awareness, and attract visitors to our products.

     Our web site (www.avatarsystems.net) provides customer leads and to promote
our  products  and  services  over the  Internet.  Our web site is also  used to
provide  current  customers  information  on new products and services,  product
training dates and company sponsored seminars.

     Competition

     The market for enterprise  information solutions is intensely  competitive,
subject to rapid change and significantly  affected by new product introductions
and other  market  activities  of  industry  participants.  We face  direct  and
indirect  competition  from a broad  range  of  competitors,  many of whom  have
greater  financial,  technical  and  marketing  resources  than  we do.  We face
competition  from other  traditional oil and gas service  providers,  as well as
from  Internet  companies  who have  established  websites  and who are pursuing
various e-commerce initiatives in bringing accounting solutions to the petroleum
industry.  Many of our competitors are large well-financed companies who provide
an array of  accounting  and  financial  management  solutions to the  petroleum
industry.


                                       4
<PAGE>


     Customers

     The Company  completed a hardware  sale with one  customer  during 2004 for
$739,826 and one other  customer  during 2003 for $188,532.  Total revenues from
those  customers  were $773,457 in 2004 and $211,697 in 2003  accounting for 29%
and 10% of total revenues,  respectively.  The Company completed  hardware sales
with three customers during 2004 for $941,329 that accounted for 86% of hardware
revenue  and 35% of total  revenue for the year ended  December  31,  2004.  The
Company had a separate  customer in 2004 and a 2003 that accounted for more than
10% of revenues.

     Suppliers

     Our primary supplier is IBM. We purchase most of our equipment for internal
use and  resale  purposes  from  IBM.  Additionally,  we  purchase  from IBM the
database  product and other value added  enhancements  used in our Avatar400 and
Petroware2000  products.  We do not believe the loss of IBM, as a supplier  will
have a material  adverse  effect on our business  since the products we purchase
from IBM are readily available from a number of other vendors.

     Licenses, Franchises,  Concessions,  Royalty Agreement, Patents, Trademarks
     or Labor Contracts

     Our success  depends  significantly  upon our  proprietary  technology.  We
currently rely on a combination of copyright and trademark laws,  trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary
rights. We hold copyrights to all of our products including,  Avatar400,  RAPID,
Petroware2000,  and Petroware  Version 6. In addition,  we have  trademarks  for
Avatar400,  Petroware2000,  and  Petroware  Version 6. We  generally  enter into
confidentiality  agreements  with  our  employees  and with  our  resellers  and
customers.  We seek to protect our  software,  documentation  and other  written
materials  under trade  secret and  copyright  laws,  which  afford only limited
protection.  Despite these efforts,  it may be possible for  unauthorized  third
parties to copy  certain  portions  of our  products  or to reverse  engineer or
otherwise obtain and use our proprietary information.

     We also rely on  certain  software  that we  license  from  third  parties,
including  software that is integrated  with internally  developed  software and
used in our  solutions  to perform key  functions.  These  third-party  software
licenses may not continue to be available to us on commercially reasonable terms
and  the  related  software  may not  continue  to be  appropriately  supported,
maintained  or  enhanced by the  licensors.  The loss of licenses to use, or the
inability of licensors to support,  maintain,  and enhance, any of such software
could result in increased  costs,  delays or  reductions  in software  shipments
until equivalent software could be developed or licensed and integrated.

     Regulatory and Environmental Matters

     Few laws or regulations are currently directly  applicable to our access to
or our conducting business on the Internet.  However,  because of the Internet's
popularity and increasing  use, new laws and  regulations  may be adopted.  Such
laws and regulations may cover issues such as: user privacy,  pricing,  content,
copyrights,  distribution,  and  characteristics  and  quality of  products  and
services.  Currently,  we do not need any governmental approval for our products
or services.

     In addition,  the growth of the Internet and electronic  commerce,  coupled
with  publicity  regarding  Internet  fraud,  may lead to the  enactment of more
stringent consumer  protection laws. These laws may impose additional burdens on
our business. The enactment of any additional laws or regulations may impede the
growth of the  Internet,  which  could  decrease  our  potential  revenues  from
electronic  commerce  or  otherwise  adversely  affect our  business,  financial
condition, and operating results.

     Laws and regulations directly applicable to electronic commerce or Internet
communications  are becoming more prevalent.  Congress recently enacted Internet
laws  regarding  on-line  copyright  infringement.  Although  not  yet  enacted,
Congress is considering laws regarding Internet taxation.  In addition,  various
state jurisdictions are considering  legislation directed to electronic commerce
which if enacted could affect our business.  The  applicability of many of these
laws to the Internet is uncertain and could expose us to substantial  liability.
Any new legislation or regulation regarding the Internet,  or the application of
existing laws and  regulations to the Internet,  could  materially and adversely
affect us. If we were  alleged to violate  federal,  state or foreign,  civil or
criminal  law,  even if we  could  successfully  defend  such  claims,  it could
materially and adversely affect us.


                                       5
<PAGE>


     Several telecommunications  carriers are seeking to have telecommunications
over the Internet regulated by the Federal Communications Commission in the same
manner  as other  telecommunications  services.  Additionally,  local  telephone
carriers  have  petitioned  the Federal  Communications  Commission  to regulate
Internet service  providers and online service  providers in a manner similar to
long distance telephone carriers and to impose access fees on such providers. If
either of these petitions are granted, the cost of communicating on the Internet
could increase substantially. This, in turn, could slow the growth of use of the
Internet.  Any such  legislation  or regulation  could  materially and adversely
affect our business, financial condition and operating results.

     Product Development

         Our capitalized software development costs have been focused on the
development of our Avatar400 and Petroware2000 products. We capitalize software
development costs applicable to each product after technological feasibility has
been established until the product is released to the market. It was necessary
for us to develop a Windows-based application to gain a competitive edge and
have successful sales in the oil and gas market. In 2004 and 2003, our product
development expenditures were $624,948 and $576,540 respectively.

     Employees

     As of December 31,  2004,  we had 11  employees,  of which 1 was engaged in
professional services, 5 in product development and customer support, 3 in sales
and marketing and 2 in finance and administration. We believe our future success
will depend,  in part,  on our  continued  ability to attract and retain  highly
qualified  personnel  in a  competitive  market  for  experienced  and  talented
software engineers and sales and marketing personnel.  Our success depends, to a
significant  extent,  upon the continued  contributions of our senior management
and other key personnel, many of whom would be difficult to replace. None of our
employees  are  represented  by a labor  union or are  subject  to a  collective
bargaining agreement. We believe that our employee relations are strong.

     Risk Factors and Other Trends and Uncertainties Affecting Future Operations

     Investors should carefully consider the risks described below before making
an investment  decision.  These risks are not the only ones we face.  Additional
risks we are not presently aware of or that we currently  believe are immaterial
may also impair our business operations.  Our business could be harmed by any of
these risks.  The trading  price of our common stock could decline due to any of
these risks. In assessing these risks,  investors should also refer to the other
information  contained or  incorporated by reference in this Form 10-KSB report,
including our financial statements and related notes.

WE INTEND TO GROW OUR BUSINESS BY ACQUIRING OTHER COMPANIES OR TECHNOLOGIES.  IF
WE ARE UNABLE TO SUCCESSFULLY IDENTIFY,  ACQUIRE, AND INTEGRATE NEW COMPANIES OR
TECHNOLOGIES, OUR BUSINESS WILL BE HARMED.

     We have grown our  business  primarily  through  the  acquisition  of other
companies  and  assets  and  plan  to  continue  this  growth  strategy  for the
foreseeable  future.  If we are  unsuccessful  in  identifying,  acquiring,  and
integrating  other  companies,  we may not  achieve  our  anticipated  levels of
growth. A substantial  portion of our current revenue is derived from businesses
or  technologies  that  we  have  acquired.  Although  we  continually  evaluate
acquisition  opportunities,  we may be unable to identify  suitable  acquisition
candidates or successfully negotiate or finance any future acquisitions.  We may
also be unable to effectively integrate any acquired companies.

     Acquiring  other   companies  or  technologies   involves  many  risks  and
difficulties, including:

     o    diversion of  management's  attention  from our existing  business;
     o    increased fixed costs, which could cause profits to decrease;
     o    assumption of unknown material liabilities of acquired companies;
     o    large  write-offs and  amortization  expenses  related to goodwill and
          other  intangible  assets;
     o    difficulty in integrating an acquired company's  personnel and culture
          with our  personnel  and  culture;
     o    difficulty  in  integrating  an  acquired  company's   accounting  and
          information systems with our accounting and information systems;
     o    difficulty in maintaining standards, controls, procedures and policies
          across the combined companies;
     o    issuances of equity  securities  that may dilute your  interest in our
          company;
     o    incurring  additional  debt; and
     o    disruption of our ongoing business and operations,  which could, among
          other  things,  impair  our  reputation  and  our  relationships  with
          customers and employees and potentially  cause the loss of our own key
          employees or those of an acquired company.


                                       6
<PAGE>


FAILURE TO MANAGE OUR GROWTH COULD RESULT IN INEFFICIENT OPERATIONS.

     Our  acquisition  strategy  could  strain our  infrastructure,  management,
internal  controls  and  financial  systems.  We may not be able to  effectively
manage our present growth or any future expansion, which could cause substantial
increases in our operating costs without corresponding increases in our revenue.
To support our growth,  we will need to continue to hire qualified  employees in
all areas of our  business.  This planned  strategy  could strain our ability to
integrate  and properly  train our new  employees.  Inadequate  integration  and
training of our  employees may result in an  inefficient  workforce and may harm
our operating results.

OUR  STRATEGY OF  DISTRIBUTING  SOFTWARE AND  ANALYSIS  TOOLS AS AN  APPLICATION
SERVICE PROVIDER IS UNPROVEN AND MAY NOT BE SUCCESSFUL.

     We intend to establish  ourselves  as an ASP serving the software  needs of
industry  professionals,  as well as the general  enterprise  resource  planning
needs of the upstream  petroleum  industry.  The ASP model is a new and unproven
distribution strategy,  particularly in our marketplace.  To fully implement our
ASP model, we will need to develop additional  technology,  as well as establish
relationships  with developers and distributors of software  products,  which we
may be unable to do on a  cost-effective  basis,  if at all. If we are unable to
implement  our ASP model,  or if our ASP  distribution  model does not  generate
sufficient  revenue to cover the costs of creating,  deploying,  and  supporting
this distribution model, our operating results will be harmed. In addition,  ASP
revenue accounting  generally recognizes revenue over the life of the particular
contract.

WE MUST CONTINUE TO INTRODUCE NEW PRODUCTS AND PRODUCT ENHANCEMENTS.

     The market for our products is characterized by rapid technological change,
changes in customer demands and evolving industry standards.  New products based
on new  technologies  or new industry  standards  can render  existing  products
obsolete and  unmarketable.  As a result,  our future  success will  continue to
depend  upon our ability to develop new  products or product  enhancements  that
address the future needs of our target  markets and to respond to these changing
standards and practices. We may not be successful in developing, introducing and
marketing new products or product  enhancements  on a timely and cost  effective
basis,  or at  all,  and our  new  products  and  product  enhancements  may not
adequately   meet  the   requirements  of  the  marketplace  or  achieve  market
acceptance.  Delays in the commencement of commercial  shipments of new products
or  enhancements  may  result  in  client  dissatisfaction  and delay or loss of
product  revenues.  If we are unable,  for  technological  or other reasons,  to
develop and introduce  new products or  enhancements  of existing  products in a
timely manner in response to changing market conditions or client  requirements,
or if new  products or new versions of existing  products do not achieve  market
acceptance,  our business would be seriously harmed. In addition, our ability to
develop new products and product  enhancements is dependent upon the products of
other software  vendors,  including  certain system  software  vendors,  such as
Microsoft Corporation, IBM and development tool vendors. If the products of such
vendors  have  design  defects  or  flaws,  are  unexpectedly  delayed  in their
introduction,  or are  unavailable  on acceptable  terms,  our business could be
seriously harmed.  Our software products are complex and may contain  undetected
defects  or errors  when  first  introduced  or as new  versions  are  released.
Although we have not  experienced  adverse  effects  resulting from any software
errors, we cannot be sure that,  despite testing by us and our clients,  defects
or errors will not be found in new products  after  commencement  of  commercial
shipments,  resulting  in loss of or delay in  market  acceptance,  which  could
seriously harm our business.


                                       7
<PAGE>


FAILURES OF HARDWARE SYSTEMS OR SOFTWARE COULD UNDERMINE CUSTOMER  CONFIDENCE IN
THE RELIABILITY OF OUR PRODUCTS AND SERVICES,  WHICH COULD HARM OUR BUSINESS AND
REPUTATION.

     There are a number of  circumstances  that can lead to a customer having an
unsatisfactory experience with our solutions.

     Some of our products and services  require our  customers to access our web
site through the Internet.  To do so, they must be connected to the Internet and
have sufficiently current hardware,  operating system software, web browsers and
other  software.  Because of the complex nature of software and hardware and the
rapidly  evolving  nature  of  technology,   a  customers'   system  may  become
incompatible  with our  products or  services.  As a result,  a customer  may be
unable to access our products or services or their access may be  interrupted or
delayed while using our products or services.

     A significant  disruption in our Internet  services or the Internet service
of our customers  could seriously  undermine  their  confidence in our business.
During a  disruption,  participants  may lose  their  online  connection  for an
extended period and be unable to access our Internet marketplace.

     Many of our products and services  depend on complex  software that is both
internally  developed and licensed from third  parties.  Complex  software often
contains  defects,  particularly  when first introduced or when new versions are
released.  Although we test our software,  we may not discover  software defects
that affect  current or planned  services or  enhancements  until after they are
deployed. These defects could cause service interruptions.

     Any of these events could lead to customer dissatisfaction with one or more
of our solutions, damage our reputation, increase our service costs, cause us to
lose revenue, delay market acceptance, result in legal proceedings against us or
divert our  development  resources,  any of which  could  cause our  business to
suffer.

SECURITY  RISKS AND CONCERNS  MAY DETER THE USE OF THE  INTERNET FOR  CONDUCTING
BUSINESS.

     A significant  barrier to commerce and communications  over public networks
is the secure  transmission  of confidential  information.  Advances in computer
capabilities,  new  discoveries in the field of  cryptography or other events or
developments  could result in compromises or breaches of our security systems or
those  of  other  web  sites  to  protect   proprietary   information.   If  any
well-publicized  compromises of security were to occur, it could have the effect
of   substantially   reducing   the  use  of  the   internet  for  commerce  and
communications.   Anyone   who   circumvents   our   security   measures   could
misappropriate proprietary information or cause interruptions in our services or
operations. The internet is a public network, and data is sent over this network
from many sources. In the past, computer viruses, software programs that disable
or impair  computers,  have been  distributed  and have rapidly  spread over the
internet.  Computer viruses could be introduced into our systems or those of our
customers or other third parties, which could disrupt or make it inaccessible to
customers.  We may be required to expend significant capital and other resources
to protect  against the threat of security  breaches  or to  alleviate  problems
caused by breaches.  To the extent that our  activities  may involve the storage
and transmission of proprietary  information,  security breaches could expose us
to a risk of loss or litigation and possible  liability.  Our security  measures
may be inadequate to prevent security breaches, and our business would be harmed
if our security were breached.

IF WE ARE  UNABLE TO PROTECT  OUR  INTELLECTUAL  PROPERTY,  WE MAY BE SUBJECT TO
INCREASED COMPETITION THAT COULD SERIOUSLY HARM OUR BUSINESS.

     Our success  depends  significantly  upon our  proprietary  technology.  We
currently rely on a combination of copyright and trademark laws,  trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary
rights.  We generally enter into  confidentiality  agreements with our employees
and  with  our  resellers  and  customers.  We seek  to  protect  our  software,
documentation and other written materials under trade secret and copyright laws,
which afford only limited protection.  Despite these efforts, it may be possible
for  unauthorized  third parties to copy certain  portions of our products or to
reverse  engineer or otherwise  obtain and use our proprietary  information.  In
addition,  we cannot be  certain  that  others  will not  develop  substantially
equivalent or superseding  proprietary  technology,  or that equivalent products
will not be marketed in  competition  with our products,  thereby  substantially
reducing the value of our  proprietary  rights.  Litigation  may be necessary to
protect our proprietary  technology.  This litigation may be time-consuming  and
expensive.


                                       8
<PAGE>


WE  MUST  RETAIN  KEY  EMPLOYEES  AND  RECRUIT  QUALIFIED  TECHNICAL  AND  SALES
PERSONNEL.

     We believe that our success will depend on the continued  employment of our
senior management and other key personnel.  Additionally,  our continued success
depends,  in part,  on our ability to identify,  attract,  motivate,  and retain
qualified  technical,  sales and other personnel.  Because our future success is
dependent on our ability to continue to enhance and introduce  new products,  we
are  particularly  dependent on our ability to identify,  attract,  motivate and
retain  qualified  engineers  with  the  requisite  education,  backgrounds  and
industry  experience.  The loss of the services of a  significant  number of our
engineers or sales  people could be  disruptive  to our  development  efforts or
business  relationships  and could  seriously harm our business.  We may also be
required to create additional  performance and retention  incentives in order to
retain our  employees,  including  the granting of  additional  stock options to
employees at current prices or issuing  incentive cash bonuses.  Such incentives
may  either  dilute  our  existing  stockholder  base or  result  in  unforeseen
operating expenses, which may cause our stock price to fall.

OUR  OFFICERS,  DIRECTORS  AND  MAJOR  STOCKHOLDERS  AND THEIR  AFFILIATES  HAVE
SUBSTANTIAL CONTROL OVER OUR BUSINESS.

     Our executive officers, directors, and major stockholders beneficially own,
in the aggregate,  approximately 92% of our common stock. These stockholders, if
they vote together,  will be able to  significantly  influence  matters that our
stockholders   must  approve,   including   electing   directors  and  approving
significant  corporate  transactions.  This  concentration of ownership may also
have the effect of delaying or preventing us from effecting a change in control,
which could cause our stock price to decline.

RECENTLY  ENACTED AND PROPOSED  CHANGES IN SECURITIES LAWS AND REGULATIONS  WILL
INCREASE OUR COSTS.

     The  Sarbanes-Oxley Act ("the Act") of 2002, which became law in July 2002,
requires changes in some of our corporate  governance and securities  disclosure
and/or compliance practices.  As part of the Act's requirements,  the Securities
and  Exchange  Commission  has  been  promulgating  new  rules on a  variety  of
subjects,  in addition to other rule proposals,  and the NASDAQ Stock Market has
enacted  new  corporate  governance  listing  requirements.   We  believe  these
developments  will increase our accounting and legal  compliance costs and could
expose us to additional  liability.  These  developments  may make retention and
recruitment of qualified persons to serve on our board of directors or executive
management more difficult. We are presently evaluating and monitoring regulatory
and  legislative  developments  and  cannot  reliably  estimate  the  timing  or
magnitude  of  additional  cost we will  incur as a  result  of the Act or other
related legislation or regulation.

AN ACTIVE TRADING MARKET MAY NOT DEVELOP FOR OUR COMMON STOCK.

     There is not an established  active public market for our common stock.  No
assurance can be given that an active market will exist for our common stock.

Item 2. Properties

     The  Company  leases its 7,004  square foot  facility at 5728 LBJ  Freeway,
Suite 270, Dallas,  Texas, 75240. The lease for the corporate office was entered
into on August 29, 2000 for a  sixty-month  lease term  commencing  on August 1,
2000 and expiring on September 30, 2005.  The company leases a 1,496 square foot
facility at 6 Desta Drive, Suite 3350,  Midland,  Texas 79705. The lease for the
Midland facility was entered into on September 27, 2004 for a twelve-month lease
term  commencing  on October 1, 2004 and  expiring on September  30,  2005.  The
company  leases a 250 square foot  facility at 1901 Rickety,  Suite 216,  Tyler,
Texas. The lease for the Tyler facility was entered into on April 27, 2004 for a
twelve-month lease term commencing on May 1, 2004 and expiring on May 30, 2005.


                                       9
<PAGE>


Item 3. Legal Proceedings

     From time to time, we are involved in litigation  incidental to the conduct
of our  business.  We are not party to any lawsuit or  proceeding  that,  in our
opinion, is likely to seriously harm our business.

Item 4. Submission of Matters To A Vote Of Security Holders

     On September 17, 2004, Avatar Systems, Inc. held its 2004 Annual Meeting of
Shareholders.  The  results  of the  ballots  cast in  person or by proxy at the
Meeting are as follows:

         PROPOSAL I: For the election as director of all nominees listed below:

------------------------   ---------   ------------------   -------------------
                              For           Against              Abstain
------------------------   ---------   ------------------   -------------------

Robert C. Shreve, Jr       8,136,781                 --                    --
------------------------   ---------   ------------------   -------------------

Charles Timothy Allen      8,136,781                 --                    --
------------------------   ---------   ------------------   -------------------

Orville Gregory Allen      8,136,781                 --                    --
------------------------   ---------   ------------------   -------------------

Stephen A. Komlosy         8,136,781                 --                    --
------------------------   ---------   ------------------   -------------------

John J. May                8,136,781                 --                    --
------------------------   ---------   ------------------   -------------------

     As of July 26, 2004, the record date,  there were  8,695,652  common shares
issued  and  outstanding.  A quorum  consists  of a  majority  of  these  shares
outstanding,  or 4,347,827 shares. The number of shares voting for proposal 1 by
proxy or in  person  was  8,136,781.  The  total  number  of  shares  voted  was
8,136,781.

     Immediately following the Annual Meeting of Shareholders, the newly elected
directors by unanimous consent held their Annual Meeting.  At the Annual Meeting
of Directors,  the following  officers were elected to serve in the positions as
indicated  below  until the next  Annual  Meeting of  Directors  or until  their
successors shall have been duly elected and qualified:

----------------------- ----------------- --------------------------------------
Name                           Age                 Position(s)
----------------------- ----------------- --------------------------------------
Robert C. Shreve, Jr.          42         President, Chief Executive
                                          Officer, Chairman of the Board of
                                          Directors, and Chief Financial Officer
----------------------- ----------------- --------------------------------------
Cindy Skelton                  46         Secretary
----------------------- ----------------- --------------------------------------

                                     PART II


Item 5.  Market  For The  Registrant's  Common  Equity And  Related  Shareholder
         Matters

     Our common stock began trading on the Over-the-Counter Pink Sheets on April
2, 2001. On November 5, 2001,  our  Registration  Statement on Form 10-SB became
effective  and our stock was approved  for trading on December 19, 2001,  on the
NASD OTC  Bulletin  Board.  During 2004,  there was only nominal  trading in the
shares of our common stock. As of March 14, 2005, the last reported trade in our
stock was at $0.42.  No assurance  can be given that an active market will exist
for our common stock in the future.  On March 14, 2005,  the last date  reported
for our common stock,  the closing bid price was $0.40 and the closing ask price
was $0.51. Our trading symbol is AVSY.OB.

     Holders

     As of March 14, 2005, the Company had  approximately  450  shareholders  of
record,  its  common  stock had a closing  bid price of $0.40 per  share,  and a
closing asked price of $.51 per share.


                                       10
<PAGE>

     Dividends


         We have not declared any  dividends on our common stock during the last
two fiscal  years and we do not expect to declare  dividends  in the near future
since we intend to utilize our earnings,  if any, to finance our future  growth,
including possible acquisitions.

Item 6. Management's  Discussion And Analysis Of Financial  Condition Or Plan Of
        Operations

     Forward Looking Statements

     This report  contains  forward-looking  statements,  other than  historical
facts,  which  reflect the view of Company's  management  with respect to future
events.  Such  forward-looking  statements are based on assumptions  made by and
information currently available to the Company's management. Although management
believes that the expectations reflected in such forward-looking  statements are
reasonable,  it can give no assurance that such  expectations will prove to have
been  correct.  Important  factors  that could  cause  actual  results to differ
materially from such expectations  include,  without limitation,  the ability of
the Company i) to generate  levels of revenue and  adequate  cash flows from its
operations to support and maintain its current cost structure and ii) to develop
and deliver products that are  competitive,  accepted by its markets and are not
rendered  obsolete  by  changing  technology.   The  forward-looking  statements
contained  herein  reflect the current  views of the Company's  management  with
respect to future  events  and are  subject to these  factors  and other  risks,
uncertainties and assumptions relating to the operations,  results of operations
and  financial  position of the Company.  The Company  assumes no  obligation to
update the  forward-looking  statements or to update the reasons  actual results
could differ from those contemplated by such forward-looking statements.

     Critical Accounting Policies and Estimates

     Use of Estimates and Certain Significant Estimates

     The  preparation  of financial  statements  in conformity  with  accounting
principles   generally  accepted  in  the  United  States  of  America  requires
management to make estimates and assumptions that affect the reported amounts of
assets and  liabilities  and disclosure of contingent  assets and liabilities at
the date of the financial  statements  and the reported  amounts of revenues and
expenses  during the reporting  period.  Actual  results could differ from those
estimates.   Significant   assumptions   and   estimates  are  required  in  the
capitalization  and amortization of software  development  costs. It is at least
reasonably  possible those estimates could be revised in the near term and those
revisions could be material.

     Concentrations of Credit Risk

     Financial   instruments   that   potentially   subject   the   Company   to
concentrations  of credit risk consist  primarily of trade accounts  receivable.
Products are sold to customers  located  principally in the United  States.  The
Company continually  evaluates the  creditworthiness of its customers' financial
condition and generally does not require  collateral.  The Company evaluates the
collectability of its accounts  receivable based on a combination of factors. In
circumstances where the Company is aware of a specific  customer's  inability to
meet its financial  obligations,  the Company records a specific reserve for bad
debts against amounts due. The Company has not experienced significant losses on
uncollectible accounts receivable.

     Fair Value of Financial Instruments

     In  accordance  with the reporting  requirements  of Statement of Financial
Accounting Standards ("SFAS") No. 107, Disclosures About Fair Value of Financial
Instruments, the Company calculates the fair value of its assets and liabilities
which qualify as financial  instruments  under this  statement and includes this
additional  information in the notes to consolidated  financial  statements when
the  fair  value  is  different  than the  carrying  value  of  these  financial
instruments.  The estimated fair value of accounts receivable,  accounts payable
and accrued liabilities approximate their carrying amounts due to the relatively
short maturity of these  instruments.  The carrying value of short and long-term
debt also  approximates  fair value since these instruments bear market rates of
interest. None of these instruments are held for trading purposes.i



                                       11
<PAGE>

     Marketable Securitiesi

     Marketable  securities at December 31, 2004 consisted of corporate equities
in exchange  traded index funds and corporate  bond mutual funds.  SFAS No. 115,
Accounting  for  Certain  Investments  in Debt and Equity  Securities,  requires
certain investments be recorded at fair value or amortized cost. The appropriate
classification of the investments in marketable equity is determined at the time
of purchase  and  re-evaluated  at each balance  sheet date.  As of December 31,
2004, the Company's marketable securities were classified as available-for-sale,
which are carried at fair value,  with  unrealized  gains and losses reported as
other  comprehensive  income  within  the  stockholders'  equity  section of the
accompanying  balance  sheets,  net of the  related  tax  effect.  The  cost  of
marketable  equity  securities  sold is determined on a specific  identification
basis. The fair value of marketable  equity securities is based on quoted market
prices.i

     Software Development Costsi

     The  Company  capitalizes  the  costs  of  developing  and  testing  new or
significantly  enhanced  software  products in accordance with the provisions of
SFAS No. 86 Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise  Marketed.  Under  SFAS  No.  86,  all  costs  incurred  to  establish
technological  feasibility  of a computer  product are charged to  operations as
incurred.  After technological  feasibility is established,  costs of developing
the computer software product are capitalized until the product is available for
general release to customers.  The Company capitalized  $624,948 and $576,540 of
software  development  costs during the years ended  December 31, 2004 and 2003,
respectively.  Capitalized  software  development  costs  are  amortized  by the
straight-line  method  over a  period  of  seven  years.  The  amount,  by which
unamortized  software  costs  exceed  the  net  realizable  value,  if  any,  is
recognized in the period the excess is determined.  Amortization  of capitalized
software  charged to expense was  $335,952  and  $262,588  for the years  ending
December 31, 2004 and 2003, respectively.i

     Impairment of Long-Lived Assetsi

     The  Company  reviews  its  long-lived  assets  and  certain   identifiable
intangibles for impairment when events or changes in circumstances indicate that
the  carrying  amount of the assets may not be  recoverable.  Recoverability  of
assets to be held and used is measured by a comparison  of the carrying  amounts
of an asset to future net cash flows  expected to be generated by the asset.  If
such assets are considered impaired, the impairment to be recognized is measured
by the amount by which the carrying  amount of the asset  exceeds the fair value
of the assets  based on  estimated  future  cash  flows.  During the years ended
December 31, 2004 and 2003, the Company recorded no impairment charges.i

     Revenue Recognitioni

     The Company's revenue recognition policies are in accordance with Statement
of Position ("SOP") 97-2, Software Revenue Recognition,  as amended by SOP 98-9,
Modification of SOP 97-2,  Software Revenue  Recognition with Respect to Certain
Transactions,  Staff Accounting  Bulletin ("SAB") No. 104, Revenue  Recognition,
and Emerging  Issues Task Force  ("EITF") No. 00-21,  Revenue  Arrangement  with
Multiple Deliverables.

     The  Company  recognizes  revenue  from  the  licensing  of  software  when
persuasive  evidence of an arrangement  exists,  the product has been delivered,
the fee is fixed and determinable, and collection of the resulting receivable is
reasonably assured.

     Maintenance  agreements are renewable on an annual basis, include rights to
upgrades, when and if available,  telephone support, updates, enhancements (when
not separately priced and marketed), and bug fixes. Maintenance fees are charged
in the  initial  licensing  year  and for  renewals  of  annual  maintenance  in
subsequent  years.  Revenue  is  recognized  for  maintenance  ratably  over the
contract term.



                                       12
<PAGE>

     Other  recurring  revenue  services  are  offered on a  subscription-basis.
Subscription-based  revenues  are  recognized  ratably  over  the  term  of  the
agreement.

     Professional   services   including   implementation,    data   conversion,
integration,  custom report  writing and training are generally  billed based on
hourly rates together with reimbursement for travel and accommodation  expenses.
Professional  services  offered are not  essential to the  functionality  of the
software sold.

     Inflation

     We do not believe that  inflation  has  materially  affected our results of
operations.

     Results of Operations

     Revenues

     Our  net  revenues  include  four  components:   software  licensing  fees,
maintenance,  professional services, and hardware. Our net revenues for the year
ended December 31, 2004 increased 27.4% to $2,661,370 compared with net revenues
of $2,088,950 for the year ended  December 31, 2003.  Our overall  revenues were
primarily affected by higher hardware sales during 2004.

         Software. Software sales for the year ended December 31, 2004 decreased
2.1% to $360,746 compared with software sales of $368,615 in 2003.

     Maintenance.  Maintenance  revenue  for the year ended  December  31,  2004
increased 4.8% to $1,029,131  compared with  maintenance  revenue of $981,874 in
2003.  The increase in  maintenance  revenue was related to the higher number of
customers from software sales.

     Professional  services.  Professional  service  revenue  for the year ended
December  31,  2004  increased  15.7% to  $180,234  compared  with  professional
services  revenue of $155,776 in 2003.  Professional  services  increased during
2004  because of higher  training  and  system  conversion  services  related to
software sales.

     Hardware.  Hardware  sales for the year ended  December 31, 2004  increased
87.3% to $1,091,259  compared with hardware sales of $582,685 in 2003.  Hardware
sales increased  dramatically during 2004 because of three transactions with our
larger  customers that expanded  operations  during a period of rising petroleum
prices.  We cannot determine with any certainty whether demand for hardware will
remain strong.

         Cost of Revenues

     Our cost of revenues  includes four components:  cost of software,  cost of
maintenance revenue, cost of professional  services, and cost of hardware sales.
Our cost of revenues  for the year ended  December 31, 2004  increased  64.3% to
$1,235,370  compared with cost of revenues of $752,082 in 2003. Cost of revenues
as a percentage of net revenues  increased to 46.4% for the year ended  December
31, 2004 from 36.0% in 2003.  The  increase in cost of revenues  was impacted by
the higher volume of hardware sales.

         Cost of software. Cost of software increased 11.7% to $109,117 for the
year ended December 31, 2004 from $97,664 in 2003. Cost of software as a
percentage of the related revenues increased to 30.2% for the year ended
December 31, 2004 compared to 26.5% in 2003. The increase in cost of software
was related to an increase in commissions on higher software sales during the
third quarter offset by a decrease in royalty costs under an expired royalty
contract.

     Cost of  maintenance.  Cost  of  maintenance  revenue  decreased  14.7%  to
$152,309  for the year ended  December 31, 2004 from  $178,456 in 2003.  Cost of
maintenance  revenue as a percentage of the related  revenue  decreased to 14.8%
for the year ended December 31, 2004, compared to 18.2% for the same period last
year.  The  decreases  in  cost  of  maintenance  and  percentages  of  cost  of
maintenance  as a percentage  of the related  revenues are due to  reductions in
personnel costs providing maintenance support.



                                       13
<PAGE>

         Cost of professional services. Cost of professional services increased
64.6% to $63,252 for the year ended December 31, 2004, compared with $38,423 in
2003. Cost of professional services as a percentage of the related revenue
increased to 35.1% for the year ended December 31, 2004, compared to 24.7% in
2003. The increase in cost of professional services was related to increases in
demand for training and systems conversions services.

     Hardware. Cost of hardware sold increased 108.1% to $910,692 for year ended
December  31,  2004,  compared  with  $437,539  in 2003.  Cost of  hardware as a
percentage of the related revenue increased to 83.5% for the year ended December
31,  2004,  compared  with 75.1% in 2003.  The  increase  in cost of hardware is
directly related to higher hardware sales. The increase in percentage of cost of
hardware is attributable to lower margins on larger product sales.

     Operating Expenses

     Sales and  Marketing.  Our sales and marketing  expenses for the year ended
December 31, 2004  decreased  30.8% to $159,903  compared with $231,029 in 2003.
Sales and marketing  expenses as a percentage of net revenues  decreased to 6.0%
for the year ended  December 31, 2004 from 11.1% in 2003.  The decrease in sales
and marketing was due to an increased marketing effort completed during 2003.

     General and Administrative. Our general and administrative expenses for the
year ended December 31, 2004  increased  7.3% to $459,466  compared with general
and  administrative  expenses of $428,371  in 2003.  General and  administrative
expenses as a percentage  of net  revenues  decreased to 17.% for the year ended
December 31, 2004, compared with 20.5% in 2003.i

     Investment  Income.  Investment  income  was  $12,493  for the  year  ended
December 31, 2004 compared to $3,980 in 2003. The increase in investment  income
was due to restructuring  of investment  assets into higher yielding bond mutual
funds and exchange  traded  equity  index funds during 2004 and higher  invested
balances.

     Loss on investments.  Loss on investments of $2,271includes a realized loss
on the sale in 2004 of an investment in a mutual fund investing in variable rate
mortgages.

     Interest  Expense.  Interest expense was $5,524 for the year ended December
31, 2004,  compared to $2,197 in 2003.  The increase is due to higher amounts of
debt outstanding  during 2004 related to the addition of equipment to expand our
ASP hosting capability.

         Provision for Income Taxes. For the year ended December 31, 2004, we
recorded a deferred tax provision on income before income taxes of $98,681
compared to $84,678 in 2003. The increase in deferred tax expense is directly
attributable to the increase in income before income tax.i

     Liquidity and Capital Resourcesi

     Our cash and cash  equivalents  and  marketable  securities at December 31,
2004 were $617,909 compared with $492,737 at December 31, 2003.i

     Cash flows from Operating Activitiesi

     Our cash flows from  operating  activities  represent the most  significant
source of funding for our operations. Operating activities provided $853,052 and
$759,210  in 2004  and  2003,  respectively.  Our  cash  provided  by  operating
activities was impacted primarily by an increase in hardware sales during 2004.i

     Our accounts receivable balance increased to $145,770 in 2004 from $129,104
at the end of 2003  primarily  due to  higher  hardware  sales  and  maintenance
revenue.

     The  major  use of our  operating  cash is to fund  obligations  that  flow
through our accounts payable and accrued liabilities, such as funding of payroll
and related benefits,  rent, facilities costs, insurance,  professional fees and
other costs incurred in our normal operations.

         We expect cash provided by operating activities to remain relatively
stable in future periods due primiarily to the stability of our recurring
maintenance revenues, but will be impacted by fluctuations in software and
hardware sales.

     Cash Flows from Investing Activities

     Net cash used in investing  activities in 2004 of  $1,033,341  consisted of
software development costs of $624,948,  equipment purchases of $97,467, and net
marketable securities we purchased of $310,926.

     Net cash used in  investing  activities  in 2003 of $681,412  consisted  of
$576,540 in software development costs and $104,872 primarily in computer



                                       14
<PAGE>

     Cash Flows from Financing Activities

     Net cash used in financing activities in 2004 was $21,302 was for principal
payments on capital lease obligations and notes payable.

     Net cash provided by financing  activities in 2003 of $19,683 reflected the
issuance of a note to purchase an automobile offset by reductions in payments on
that note of $17,331.i

     At December 31, 2004, we had $321,491 in working capital,  up from $262,232
at December 31, 2003. We currently have no significant capital commitments other
than  commitments  under  our  capital  lease  obligations,  note  payment,  and
operating leases.

     Based upon our past performance and current  expectations,  we believe that
our cash and cash  equivalents,  marketable  securities  and cash generated from
operations  will be sufficient  to satisfy our working  capital  needs,  capital
expenditures,  investment requirements and financing activities for at least the
next twelve months.

     Recent Accounting Pronouncements

     In December 2003, the Financial  Accounting Standards Board ("FASB") issued
interpretation  46R ("FIN  46R"),  a revision to  interpretation  46 ("FIN 46"),
Consolidation  of Variable  Interest  Entities.  FIN 46R  clarifies  some of the
provisions of FIN 46 and exempts certain entities from its requirements. FIN 46R
is  effective  at the end of the first  interim  period  after  March 15,  2004.
Entities that have adopted FIN 46 prior to this  effective  date can continue to
apply the  provisions  of FIN 46 until  the  effect  date of 46R or elect  early
adoption of FIN 46R. The Company believes that it has no such variable  interest
entities  and,  as a  result,  FIN 46 and FIN 46R did not have an  impact on the
Company's financial statements.

     In March 2004, the FASB ratified the recognition  and measurement  guidance
and certain  disclosure  requirements  for impaired  securities  as described in
Emerging   Issues   Task  Form   (EITF)   Issue  No.   03-1,   The   Meaning  of
Other-Than-Temporary  Impairment and Its Application to Certain Investments. The
Company  does not  believe  the  adoption  of the  recognition  and  measurement
guidance  in EITF  Issue  03-1 will  have a  material  impact  on the  Company's
financial statements.

     In December 2004, the FASB issued SFAS 123R,  Share-Based Payment, which is
a revision of SFAS 123 Accounting for  Stock-Based  Compensation  and supersedes
APB Opinion 25,  Accounting  for Stock  Issued to  Employees.  SFAS 123R focuses
primarily  on  share-based  payments  for  employee  services,  requiring  these
payments to be recorded  using a  fair-value-based  method.  The use of APB 25's
intrinsic  value  method of  accounting  for  employee  stock  options  has been
eliminated. As a result, the fair value of stock options granted to employees in
the  future  will be  required  to be  expensed.  The  impact on the  results of
operations of the Company will be dependent on the number of options granted and
the fair value of those options. For the Company, FASB 123R will be effective in
2006.


                                       15
<PAGE>


Item 7. Financial Statements


                              Avatar Systems, Inc.
                          Index to Financial Statements



Report of Independent Registered Public Accounting Firm                      F-2


Financial Statements

   Balance Sheets as of December 31, 2004 and 2003                           F-3

   Statements of Income for the years ended December 31, 2004 and 2003       F-4

   Statements of Stockholders' Equity for the years ended December 31,
   2004 and 2003                                                             F-5

   Statements of Cash Flows for the years ended December 31, 2004 and 2003   F-6

   Notes to Financial Statements                                     F-7 to F-16














                                       16
<PAGE>


Financial  Statements and Reports of Independent  Registered  Public  Accounting
Firms

Avatar Systems, Inc.

December 31, 2004 and 2003











                                       17
<PAGE>


             Report of Independent Registered Public Accounting Firm




To the Board of Directors and Stockholders
Avatar Systems, Inc.


     We have audited the accompanying  balance sheet of Avatar Systems,  Inc. as
of  December  31,  2004  and  the  related  statements  of  income,  changes  in
stockholders'  equity and cash flows for the year then  ended.  These  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audit.

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

     In our opinion,  the financial statements referred to above present fairly,
in all material  respects,  the financial  position of Avatar  Systems,  Inc. at
December 31, 2004 and the results of its  operations  and its cash flows for the
year then ended, in conformity with accounting  principles generally accepted in
the United States of America.



/s/ Whitley Penn

Dallas, Texas
February 4, 2005
















                                       F-1


<PAGE>

             Report of Independent Registered Public Accounting Firm



To the Board of Directors and Stockholders
Avatar Systems, Inc.


We have audited the  accompanying  balance sheet of Avatar  Systems,  Inc. as of
December 31, 2003 and the related statement of income,  changes in stockholders'
equity and cash flows for the year then ended.  These  financial  statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the financial  position of Avatar  Systems,  Inc. as of
December 31, 2003 and the results of operations and cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United
States of America.


HEIN & ASSOCIATES LLP


Dallas, Texas
March 8, 2004












                                       F-2



<PAGE>
<TABLE>
<CAPTION>

                              Avatar Systems, Inc.
                                 BALANCE SHEETS

                                                                                         December 31,
                                                                                   -----------------------
                                                                                      2004         2003
                                                                                   ----------   ----------
<S>                                                                                <C>          <C>
                                     ASSETS
CURRENT ASSETS
Cash and cash equivalents                                                          $  291,146   $  492,737
Marketable securities                                                                 326,763         --
Accounts receivable, net of allowance of $14,368 and $4,106, respectively             145,770      129,104
Prepaid expense                                                                        15,303        7,340
Deferred income taxes                                                                  11,101       12,340
                                                                                   ----------   ----------
Total current assets                                                                  790,083      641,521

PROPERTY AND EQUIPMENT, net of accumulated depreciation                               263,247      183,385
    of $496,920 and $401,125, respectively
PURCHASED SOFTWARE, net of accumulated amortization
of $769,791 and $680,447, respectively                                                 91,871      181,215
SOFTWARE DEVELOPMENT COSTS, net of accumulated amortization
of $982,953 and $647,001, respectively                                              2,165,090    1,876,094
                                                                                   ----------   ----------
Total assets                                                                       $3,310,291   $2,882,215
                                                                                   ==========   ==========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
Accounts payable                                                                   $   72,028   $   56,275
Accrued expenses                                                                       93,618       50,690
Current maturities of long-term debt                                                    7,280        6,996
Current maturities of capital lease obligations                                        24,938         --
Deferred revenue                                                                      270,728      265,328
                                                                                   ----------   ----------
Total current liabilities                                                             468,592      379,289

DEFERRED INCOME TAXES                                                                 338,802      235,203

LONG-TERM DEBT
    Long-term debt                                                                     18,839       26,120
    Long-term capital lease obligations                                                38,947         --
                                                                                   ----------   ----------
Total long-term debt                                                                   57,786       26,120
                                                                                   ----------   ----------
Total liabilities                                                                     865,180      640,612

COMMITMENTS  AND CONTINGENCIES                                                           --           --

STOCKHOLDERS' EQUITY
    Preferred stock, $0.001 par value, 10,000,000 shares authorized; none issued         --           --
Common stock, $0.001 par value; 30,000,000 shares authorized;
 8,838,152 and 8,695,652, shares issued and outstanding, respectively                   8,839        8,696
Paid-in capital                                                                     1,768,202    1,768,345
Retained earnings                                                                     656,119      464,562
Accumulated other comprehensive income                                                 11,951         --
                                                                                   ----------   ----------
Total stockholders' equity                                                          2,445,111    2,241,603
                                                                                   ----------   ----------
Total liabilities and stockholders' equity                                         $3,310,291   $2,882,215
                                                                                   ==========   ==========
</TABLE>

                See accompanying notes to financial statements.

                                       F-3


<PAGE>
<TABLE>
<CAPTION>
                                              Avatar Systems, Inc.
                                              STATEMENTS OF INCOME

                                                                   Year ended December 31,
                                                                 --------------------------
                                                                     2004           2003
                                                                 -----------    -----------
<S>                                                              <C>            <C>
Revenue:
Software                                                         $   360,746    $   368,615
Maintenance                                                        1,029,131        981,874
Consulting                                                           180,234        155,776
Hardware                                                           1,091,259        582,685
                                                                 -----------    -----------
Total revenues                                                     2,661,370      2,088,950

Cost of Sales:
Software                                                             109,117         97,664
Maintenance                                                          152,309        178,456
Consulting                                                            63,252         38,423
Hardware                                                             910,692        437,539
                                                                 -----------    -----------
                                                                   1,235,370        752,082
                                                                 -----------    -----------
Gross profit                                                       1,426,000      1,336,868

Operating Expenses:
Sales and Marketing                                                  159,903        231,029
General and administrative                                           459,466        428,371
Depreciation and amortization                                        521,091        430,199
                                                                 -----------    -----------
                                                                   1,140,460      1,089,599
                                                                 -----------    -----------
Operating income                                                     285,540        247,269

Other income (expense):
Investment income                                                     12,493          3,980
Loss on investments                                                   (2,271)          --
Interest expense                                                      (5,524)        (2,197)
                                                                 -----------    -----------
                                                                       4,698          1,783

Income before income taxes                                           290,238        249,052

Deferred income tax expense                                           98,681         84,678
                                                                 -----------    -----------

NET INCOME                                                       $   191,557    $   164,374
                                                                 ===========    ===========

Net income  per share - basic and diluted                        $      0.02    $      0.02
                                                                 ===========    ===========

Weighted average common shares outstanding - basic and diluted     8,790,652      8,695,652
                                                                 ===========    ===========
</TABLE>

                See accompanying notes to financial statements.

                                       F-4


<PAGE>
<TABLE>
<CAPTION>

                              Avatar Systems, Inc.
                  STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

                     Years ended December 31, 2004 and 2003


                                                                                                 Accumulated
                                      Common stock                                                  other
                               -----------------------------      Paid-in         Retained      Comprehensive
                                   Shares          Amount         capital         earnings      Income (Loss)       Total
                               -------------   -------------   -------------    -------------   -------------   -------------
<S>                            <C>             <C>             <C>              <C>             <C>             <C>
Balance at January 1, 2003         8,695,652   $       8,696   $   1,768,345    $     300,188   $        --     $   2,077,229

Net income                              --              --              --            164,374            --           164,374
                               -------------   -------------   -------------    -------------   -------------   -------------

Balance at December 31, 2003       8,695,652           8,696       1,768,345          464,562            --         2,241,603

Exchange of 5,700,000
common stock warrants
with an exercise price of $1
expiring in July 2005
for 142,500 shares of
common stock                         142,500             143            (143)            --              --              --

Change in unrealized gain
on available-for-sale
investments, net of tax                 --              --              --               --            11,951          11,951

Net income                              --              --              --            191,557            --           191,557
                               -------------   -------------   -------------    -------------   -------------   -------------

Balance at December 31, 2004       8,838,152   $       8,839   $   1,768,202    $     656,119   $      11,951   $   2,445,111
                               =============   =============   =============    =============   =============   =============
</TABLE>






                See accompanying notes to financial statements.

                                       F-5

<PAGE>
<TABLE>
<CAPTION>

                              Avatar Systems, Inc.
                            STATEMENTS OF CASH FLOWS

                                                                           Year ended December 31,
                                                                         --------------------------
                                                                             2004            2003
                                                                         -----------    -----------
<S>                                                                      <C>            <C>
Cash flows from operating activities
Net income                                                               $   191,557    $   164,374
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization                                                521,091        430,199
Loss on investments                                                            2,271           --
Deferred income taxes                                                         98,681         84,678
Changes in operating assets and liabilities
Accounts receivable                                                          (16,666)        69,998
Prepaid expenses                                                              (7,963)           263
Accounts payable                                                              15,753        (19,662)
Accrued expenses                                                              42,928           (952)
Deferred revenue                                                               5,400         30,312
                                                                         -----------    -----------
Net cash provided by operating activities                                    853,052        759,210

Cash flows from investing activities
Software development costs capitalized                                      (624,948)      (576,540)
Purchase of property and equipment                                           (97,467)      (104,872)
Purchases of marketable securities                                          (512,215)          --
    Sales of marketable securities                                           201,289           --
                                                                         -----------    -----------
Net cash used in investing activities                                     (1,033,341)      (681,412)

Cash flows from financing activities
Principal payments on capital lease obligations                              (14,305)          --
Proceeds from long-term debt                                                    --           37,014
Principal payments on long-term debt                                          (6,997)       (17,331)
                                                                         -----------    -----------
Net cash provided by (used in ) financing activities                         (21,302)        19,683

Net increase (decrease) in cash and cash equivalents                        (201,591)        97,481

Cash and equivalents at beginning of year                                    492,737        395,256
                                                                         -----------    -----------

Cash and cash equivalents at end of year                                 $   291,146    $   492,737
                                                                         ===========    ===========

Supplemental disclosure of cash paid for:
Interest                                                                 $     5,524    $     2,197
                                                                         ===========    ===========

Supplemental disclosure of noncash investing and financing activities:
  Purchase of equipment with capital lease                               $    78,190    $      --
   Issuance of capital stock in exchange for outstanding warrants to
   purchase common stock                                                 $       143    $      --
 Change in unrealized gain on marketable securities                      $    18,108    $      --

</TABLE>


                 See accompanying notes to financial statements

                                       F-6

<PAGE>

                              Avatar Systems, Inc.

                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 2004 and 2003


NOTE A - ORGANIZATION AND SUMMARY OF ACCOUNTING POLICIES

Nature of Business
------------------

Avatar Systems, Inc. and its predecessor,  Avatar Systems,  Ltd.  (collectively,
the "Company") was formed in 1996 to provide Enterprise  Resource Planning (ERP)
accounting  software  to small to  medium-sized  oil and gas  producers  located
throughout the United States.

Use of Estimates and Certain Significant Estimates
--------------------------------------------------

The preparation of financial statements in conformity with accounting principles
generally  accepted in the United States of America requires  management to make
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities  and disclosure of contingent  assets and liabilities at the date of
the  financial  statements  and the  reported  amounts of revenues  and expenses
during the reporting  period.  Actual results could differ from those estimates.
Significant  assumptions  and estimates are required in the  capitalization  and
amortization of software  development costs. It is at least reasonably  possible
those  estimates  could be revised in the near term and those revisions could be
material.

Concentrations of Credit Risk
-----------------------------

Financial  instruments that potentially subject the Company to concentrations of
credit risk consist primarily of trade accounts receivable. Products are sold to
customers  located  principally  in the United States.  The Company  continually
evaluates  the  creditworthiness  of  its  customers'  financial  condition  and
generally does not require collateral.  The Company evaluates the collectability
of its accounts  receivable based on a combination of factors.  In circumstances
where  the  Company  is aware of a  specific  customer's  inability  to meet its
financial  obligations,  the  Company  records a specific  reserve for bad debts
against  amounts  due.  The Company has not  experienced  significant  losses on
uncollectible accounts receivable.

Fair Value of Financial Instruments
-----------------------------------

In  accordance  with  the  reporting  requirements  of  Statement  of  Financial
Accounting Standards ("SFAS") No. 107, Disclosures About Fair Value of Financial
Instruments, the Company calculates the fair value of its assets and liabilities
which qualify as financial  instruments  under this  statement and includes this
additional  information in the notes to financial statements when the fair value
is  different  than  the  carrying  value of these  financial  instruments.  The
estimated  fair value of  accounts  receivable,  accounts  payable  and  accrued
liabilities  approximate  their  carrying  amounts due to the  relatively  short
maturity of these  instruments.  The carrying  value of short and long-term debt
also  approximates  fair value since  these  instruments  bear  market  rates of
interest. None of these instruments are held for trading purposes.

Cash Equivalents
----------------

The Company  considers  all highly liquid  investments  with a maturity of three
months or less when  purchased  to be cash  equivalents.  The Company  maintains
deposits  primarily  in one  financial  institution,  which may at times  exceed
amounts  covered by insurance  provided by the U.S.  Federal  Deposit  Insurance
Corporation  ("FDIC").  At December 31, 2004 and 2003, the uninsured  portion of
these  deposits was  approximately  $224,000  and  $105,000,  respectively.  The
Company  has not  incurred  any  losses  related  to its  cash on  deposit  with
financial institutions.




                                       F-7

<PAGE>

                              Avatar Systems, Inc.

                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 2004 and 2003


Marketable Securities
---------------------

Marketable  securities at December 31, 2004,  consisted of corporate equities in
exchange  traded  index funds and  corporate  bond mutual  funds.  SFAS No. 115,
Accounting  for  Certain  Investments  in Debt and Equity  Securities,  requires
certain investments be recorded at fair value or amortized cost. The appropriate
classification of the investments in marketable equity is determined at the time
of purchase  and  re-evaluated  at each balance  sheet date.  As of December 31,
2004, the Company's marketable securities were classified as available-for-sale,
which are carried at fair value,  with  unrealized  gains and losses reported as
other  comprehensive  income  within  the  stockholders'  equity  section of the
accompanying  balance  sheet,  net  of the  related  tax  effect.  The  cost  of
marketable  equity  securities  sold is determined on a specific  identification
basis. The fair value of marketable  equity securities is based on quoted market
prices.

Software Development Costs
--------------------------

The Company capitalizes the costs of developing and testing new or significantly
enhanced  software  products in accordance  with the  provisions of SFAS No. 86,
Accounting  for the Costs of Computer  Software to be Sold,  Leased or Otherwise
Marketed.  Under SFAS No.  86, all costs  incurred  to  establish  technological
feasibility of a computer  product are charged to operations as incurred.  After
technological  feasibility  is  established,  costs of  developing  the computer
software  product are  capitalized  until the product is  available  for general
release to customers.  The Company capitalized $624,948 and $576,540 of software
development   costs  during  the  years  ended   December  31,  2004  and  2003,
respectively.  Capitalized  software  development  costs are amortized using the
greater  of the amount  computed  by the ratio of  current  year net  revenue to
estimated  future net  revenue of the  product,  or the amount  computed  by the
straight-line  method over a period which  approximates  the estimated  economic
life of the products,  which  historically has been seven years. The amount,  by
which  unamortized  software costs exceed the net realizable  value,  if any, is
recognized in the period the excess is determined.  Amortization  of capitalized
software  charged to expense was  $335,952  and  $262,588  for the years  ending
December 31, 2004 and 2003, respectively.

Property and Equipment
----------------------

Property and equipment are recorded at cost.  Expenditures  for  maintenance and
repairs are expensed as  incurred.  Depreciation  of property  and  equipment is
provided  primarily on the straight-line  method over the estimated useful lives
ranging from three to seven years.  Amortization  of leasehold  improvements  is
provided on the straight-line method over the shorter of the useful lives of the
assets or the terms of the corresponding leases.

Impairment of Long-Lived Assets
-------------------------------

The Company reviews its long-lived assets and certain  identifiable  intangibles
for  impairment  when  events or  changes  in  circumstances  indicate  that the
carrying amount of the assets may not be recoverable.  Recoverability  of assets
to be held and used is measured by a comparison  of the  carrying  amounts of an
asset to future net cash flows  expected to be generated  by the asset.  If such
assets are  considered  to be  impaired,  the  impairment  to be  recognized  is
measured  by the amount by which the  carrying  amount of the asset  exceeds the
fair value of the assets based on estimated future cash flows.  During the years
ended December 31, 2004 and 2003, the Company recorded no impairment charges.




                                       F-8
<PAGE>

                              Avatar Systems, Inc.

                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 2004 and 2003


Revenue Recognition
-------------------

The Company's revenue  recognition  policies are in accordance with Statement of
Position  ("SOP") 97-2,  Software Revenue  Recognition,  as amended by SOP 98-9,
Modification of SOP 97-2,  Software Revenue  Recognition with Respect to Certain
Transactions,  Staff Accounting  Bulletin ("SAB") No. 104, Revenue  Recognition,
and Emerging  Issues Task Force  ("EITF") No. 00-21,  Revenue  Arrangement  with
Multiple Deliverables.

The Company  recognizes  revenue from the licensing of software when  persuasive
evidence of an arrangement  exists,  the product has been delivered,  the fee is
fixed and determinable, and collection of the resulting receivable is reasonably
assured.

Maintenance  agreements  are  renewable on an annual  basis,  include  rights to
upgrades, when and if available,  telephone support, updates, enhancements (when
not separately priced and marketed), and bug fixes. Maintenance fees are charged
in the  initial  licensing  year  and for  renewals  of  annual  maintenance  in
subsequent  years.  Revenue  is  recognized  for  maintenance  ratably  over the
contract term.

Other  recurring   revenue   services  are  offered  on  a   subscription-basis.
Subscription-based  revenues  are  recognized  ratably  over  the  term  of  the
agreement.

Professional services including  implementation,  data conversion,  integration,
custom report  writing and training are  generally  billed based on hourly rates
together with reimbursement for travel and accommodation expenses.  Professional
services offered are not essential to the functionality of the software sold.

Stock-based Compensation
------------------------

The Company  accounts for  stock-based  awards to employees  using the intrinsic
value method  described in  Accounting  Principles  Board  Opinion (APB) No. 25,
Accounting  for  Stock  Issued to  Employees  and its  related  interpretations.
Accordingly,  no compensation  expense has been  recognized in the  accompanying
financial statements for stock-based awards to employees when the exercise price
of the award is equal to or greater than the quoted market price of the stock on
the date of the grant. SFAS No. 123, Accounting for Stock-Based Compensation and
SFAS  No.  148,  Accounting  for  Stock-Based   Compensation  -  Transition  and
Disclosure - an amendment of FASB Statement No. 123,  require  disclosures as if
the Company had applied the fair value method to employee awards rather than the
intrinsic  value method.  The fair value of  stock-based  awards to employees is
calculated using option pricing models,  which were developed for estimating the
fair value of traded options,  which have no vesting  restrictions and are fully
transferable. These models also require subjective assumptions, including future
stock price  volatility and expected time to exercise,  which greatly affect the
calculated  values.  There  were no  options  granted  in 2004 or 2003.  All the
options were vested as of January 1, 2003.

Income Taxes
------------

Deferred  income taxes are determined  using the liability  method in accordance
with SFAS No.  109,  Accounting  for  Income  Taxes.  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.  Deferred  tax  assets  and
liabilities  are measured  using enacted tax rates  expected to apply to taxable
income in the years in which  those  temporary  differences  are  expected to be
recovered  or settled.  The effect on deferred tax assets and  liabilities  of a
change in tax rates is  recognized  in income in the period  that  includes  the
enactment date. In addition,  a valuation allowance is established to reduce any
deferred  tax asset for which it is  determined  that it is more likely than not
that some portion of the deferred tax asset will not be realized.


                                       F-9




<PAGE>

                              Avatar Systems, Inc.

                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 2004 and 2003


Comprehensive Income
--------------------

The Company  reports  comprehensive  income in accordance with the provisions of
SFAS No. 130, Reporting  Comprehensive Income.  Comprehensive income consists of
net  income and  unrealized  gains  (losses)  on  available-for-sale  marketable
securities, net of the related tax effect, and is presented in the statements of
changes in stockholders' equity.

Earnings Per Share
------------------

The  Company  computes  earnings  per share in  accordance  with  SFAS No.  128,
Earnings  Per Share.  SFAS No. 128  provides  for the  calculation  of basic and
diluted earnings per share. Basic earnings per share includes no dilution and is
computed by dividing  income  available to common  stockholders  by the weighted
average number of common shares outstanding for the period. Diluted earnings per
share  reflect  the  potential  dilution of  securities  that could share in the
earnings of the Company.  The impact of dilutive  stock  options does not change
earnings per share, therefore basic and diluted earnings per share are the same.
At  December  31,  2004  and  2003,   the  Company  had  56,808  and  5,773,152,
respectively,  potentially  dilutive  securities  that were not  included in the
earnings per share calculation because they were antidilutive.

Recent Accounting Pronouncements
--------------------------------

In December  2003, the Financial  Accounting  Standards  Board  ("FASB")  issued
interpretation  46R ("FIN  46R"),  a revision to  interpretation  46 ("FIN 46"),
Consolidation  of Variable  Interest  Entities.  FIN 46R  clarifies  some of the
provisions of FIN 46 and exempts certain entities from its requirements. FIN 46R
is  effective  at the end of the first  interim  period  after  March 15,  2004.
Entities that have adopted FIN 46 prior to this  effective  date can continue to
apply the  provisions  of FIN 46 until  the  effect  date of 46R or elect  early
adoption of FIN 46R. The Company believes that it has no such variable  interest
entities  and,  as a  result,  FIN 46 and FIN 46R did not have an  impact on the
Company's financial statements.

In March 2004, the FASB ratified the recognition  and  measurement  guidance and
certain disclosure requirements for impaired securities as described in Emerging
Issues  Task Form (EITF)  Issue No.  03-1,  The Meaning of  Other-Than-Temporary
Impairment  and Its  Application  to Certain  Investments.  The Company does not
believe the adoption of the recognition  and measurement  guidance in EITF Issue
03-1 will have a material impact on the Company's financial statements.

In December 2004,  the FASB issued SFAS 123R,  Share-Based  Payment,  which is a
revision of SFAS 123 Accounting for Stock-Based  Compensation and supersedes APB
Opinion  25,  Accounting  for Stock  Issued  to  Employees.  SFAS  123R  focuses
primarily  on  share-based  payments  for  employee  services,  requiring  these
payments to be recorded  using a  fair-value-based  method.  The use of APB 25's
intrinsic  value  method of  accounting  for  employee  stock  options  has been
eliminated. As a result, the fair value of stock options granted to employees in
the  future  will be  required  to be  expensed.  The  impact on the  results of
operations of the Company will be dependent on the number of options granted and
the fair value of those  options.  FASB 123R will be  effective  in 2006 for the
Company.

Reclassifications
-----------------

Certain  amounts  in the  December  31,  2003  financial  statements  have  been
reclassified to conform with the December 31, 2004 presentations.



                                      F-10



<PAGE>
<TABLE>
<CAPTION>

                              Avatar Systems, Inc.

                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 2004 and 2003



NOTE B - MARKETABLE SECURITIES

At December 31, 2004, marketable securities are summarized as follows:


                                                                      Gross      Gross
                                                                   Unrealized Unrealized  Aggregate
                                                            Cost      Gains      Losses   Fair Value
                                                          --------   --------   --------   --------
<S>                                                       <C>        <C>        <C>        <C>
Corporate equities exchange traded index fund             $ 99,987   $ 14,463   $   --     $114,450
Corporate bond mutual fund one to three year maturities    104,079       --        1,386    102,693
Corporate bond mutual fund intermediate maturities         104,589      5,031       --      109,620
                                                          --------   --------   --------   --------

                                                          $308,655   $ 19,494   $  1,386   $326,763
                                                          ========   ========   ========   ========
</TABLE>



The  Company's  marketable  securities  are  classified  as  available-for-sale.
Management has the ability and intent,  if necessary,  to liquidate any of these
investments in order to meet liquidity  needs with the normal  operating  cycle.
Accordingly,  all marketable  securities are classified as current assets. Gross
realized losses on the sales of marketable securities were $2,271in 2004.

NOTE C - PROPERTY AND EQUIPMENT

Property and equipment are summarized as follows:


                                                                 December 31,
                                                            -------------------
                                                              2004       2003
                                                            --------   --------
Furniture and fixtures                                      $110,439   $110,439
Computer equipment and software                              515,921    418,454
Transportation                                                37,014     37,014
Telecommunication equipment                                   18,603     18,603
Assets under capital lease                                    78,190       --
                                                            --------   --------
                                                             760,167    584,510
Less accumulated depreciation                                496,920    401,125
                                                            --------   --------
Property and equipment, net                                 $263,247   $183,385
                                                            ========   ========



During  the years  ended  December  31,  2004 and  2003,  the  Company  recorded
depreciation expense of $95,795 and $55,767, respectively.  Depreciation expense
in 2004 also included the depreciation  expense on assets recorded under capital
leases.




                                      F-11



<PAGE>

                              Avatar Systems, Inc.

                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 2004 and 2003



NOTE D - PURCHASED SOFTWARE

Purchased software is summarized as follows:

                                                                December 31,
                                                            -------------------
                                                              2004        2003
                                                            --------   --------

Purchased software                                          $861,662   $861,662
Less accumulated amortization                                769,791    680,447
                                                            --------   --------
Purchased software, net                                     $ 91,871   $181,215
                                                            ========   ========



Purchased  software is recorded at cost.  Amortization of purchased  software is
provided  on the  straight-line  method  over 7 years.  During  the years  ended
December 31, 2004 and 2003, the Company recorded amortization expense of $89,344
and $111,844, respectively.

As of December 31, 2004, future purchased software amortization expense for each
calendar year ended December 31 is: $89,344 for 2005 and $2,527 in 2006.

NOTE E - SOFTWARE DEVELOPMENT COSTS

Software development costs are summarized as follows:

                                                              December 31,
                                                        -----------------------
                                                            2004         2003
                                                        ----------   ----------
Software development costs                              $3,148,043   $2,523,095
Less accumulated amortization                              982,953      647,001
                                                        ----------   ----------
Software development costs, net                         $2,165,090   $1,876,094
                                                        ==========   ==========



Software  development  costs are  recorded  at cost.  Amortization  of  software
development costs are provided on the straight-line  method over 7 years. During
the years ended  December 31, 2004 and 2003, the Company  recorded  amortization
expense of $335,952 and $262,588, respectively.

Software  development  costs in  process  at  December  31,  2004 and 2003  were
$417,197 and $550,612, respectively.

As of  December  31,  2004,  developed  software  amortization  expense for each
calendar  year ended  December  31 is:  $390,119  for 2005;  $390,119  for 2006;
$324,846 for 2007; $245,647 for 2008; $189,225 in 2009; and $625,134.











                                      F-12



<PAGE>

                             Avatar Systems, Inc.

                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 2004 and 2003



NOTE F - LONG-TERM DEBT

At December  31, 2004 and 2003  long-term  debt  consisted  of a note payable to
GMAC, collaterized by an automobile, bearing interest at 0.0% per annum, payable
in sixty  monthly  principal  payments of $683,  beginning  in June 2003 through
maturity in May 2008.

                                                                 December 31,
                                                              -----------------
                                                               2004      2003
                                                              -------   -------
Current portion of long-term debt                             $ 7,280   $ 6,996
Long-term debt                                                 18,839    26,120
                                                              -------   -------
                                                              $26,119   $33,116
                                                              =======   =======

     Future long-term debt obligations in effect at
        December 31, 2004 were as follows:
                                                               Year ending
                                                               December 31,
                                                              ---------------
                                            2005              $        7,280
                                            2006                       7,576
                                            2007                       7,884
                                            2008                       3,379
                                                              ---------------

                                                              $       26,119
                                                              ===============


NOTE G - CAPITAL LEASE OBLIGATIONS

During 2004, the Company  entered into various  capital lease  arrangements  for
computer  equipment used in our ASP hosting  facility in the aggregate amount of
$78,190.  The agreements  require monthly  payments of principal and interest of
approximately  $2,500  at  interest  rates  ranging  from 8% to 12%  and  mature
thirty-six months from the date of the lease in 2007.


                                                               December 31,
                                                            -------------------
                                                                2004       2003
                                                            --------   --------

Current portion of capital lease obligations                $ 24,938   $   --
Long-term portion of capital lease obligations                38,947       --
                                                            --------   --------
                                                            $ 63,885   $   --
                                                            ========   ========


Future minimum capital lease obligations in effect at
    December 31, 2004 were as follows:
                                                Year ending
                                                                 December 31,
                                                                 ------------
                                                   2005          $     24,938
                                                   2006                27,584
                                                   2007                11,363
                                                                 ------------

                                                                 $     63,885
                                                                 ============





                                      F-13



<PAGE>

                             Avatar Systems, Inc.

                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 2004 and 2003



NOTE H - LEASE OBLIGATIONS

The  Company  leases  office  facilities  under three  non-cancelable  operating
leases.  Future minimum  payments are $112,991 for the year ending  December 31,
2005 and none thereafter.

Rent expense under the operating  leases was $152,486 and $154,613 for the years
ended December 31, 2004 and 2003, respectively.

NOTE I - INCOME TAXES

The  Company's  income tax expense in 2004 and 2003  consisted  only of deferred
taxes. The Company had no current income tax expense  primarily because software
development  costs are charged to expense for federal  income tax  purposes  and
capitalized for financial reporting purposes.

Deferred tax assets and liabilities consist of the following:


                                                              December 31,
                                                         ----------------------
                                                            2004         2003
                                                         ---------    ---------

Deferred tax assets
     Net operating loss carryforwards                    $ 100,242    $  82,291
     Purchased software amortization                        85,145       74,299
     Accrued expenses                                       17,258       12,340
                                                         ---------    ---------
                                                           202,645      168,930

Deferred tax liabilties
     Capitalized software                                  462,682      364,424
     Property and equipment                                 61,507       27,369
     Unrealized gain on marketable securities                6,157         --
                                                         ---------    ---------
                                                           530,346      391,793

Net deferred tax liability                               $(327,701)   $(222,863)
                                                         =========    =========

  Net deferred tax asset - current                          11,101       12,340
  Net deferred tax liability - long term                  (338,802)    (235,203)
                                                         ---------    ---------

                                                         $(327,701)   $(222,863)
                                                         =========    =========



At December 31, 2004, the Company had federal net operating  loss  carryforwards
of approximately $295,000, which begin to expire in 2022.








                                      F-14



<PAGE>

                             Avatar Systems, Inc.

                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 2004 and 2003



NOTE J - RELATED PARTIES

The Company sells computer hardware and provides software maintenance, training,
and  consulting/development  services  to a company  that is  controlled  by two
members of the Company's  Board of Directors.  Total  revenues from that company
were  $22,060 and  $211,697 in 2004 and 2003,  respectively.  Revenues  for 2003
included  a hardware  sale of  $188,532.  The  Company  had  $1,861 of  accounts
receivable  at  December  31, 2004 and 2003,  respectively,  related to services
performed for that company.

In connection with the issuance of 1,600,000  shares of common stock on July 10,
2000 to London & Boston Investments,  PLC, the company issued 5,700,000 warrants
at $1.00 per share  expiring  in July  2005 to  London & Boston,  the  Company's
President/CEO,  and certain  members of the board of directors.  On December 10,
2004, the Company completed the exchange of 142,500 of its common shares for the
5,700,000  outstanding  warrants  with  London &  Boston  Investment,  PLC,  the
Company's  President/CEO,  and certain  members of the board of  directors.  The
exchange of the  warrants  for common  stock was deemed to be at the same market
value..  The exchange was  essentially a reversal of the warrants issued on July
10,  2000.  Therefore,  the  transaction  was recorded as a reduction of paid in
capital  recorded  at the  inception  of the  transaction  and  no  expense  was
recognized in the income statement for the exchange.

NOTE K - MAJOR CUSTOMERS

The Company completed a hardware sale with one customer during 2004 for $739,826
and  another  customer  during  2003 for  $188,532.  Total  revenues  from those
customers were $773,457 in 2004 and $211,697 in 2003  accounting for 29% and 10%
of total revenues, respectively. The Company completed hardware sales with three
customers during 2004 for $941,329,  which accounted for 86% of hardware revenue
and 35% of total revenue for the year ended December 31, 2004. The Company had a
one customer in 2003 that accounted for more than 10% of revenues.

NOTE L - EMPLOYEE RETIREMENT PLAN

The Company  sponsors an IRC 401(k)  Profit  Sharing  Plan (the  "Plan"),  which
covers all the Company's employees.  The Plan allows the employees to contribute
up to the maximum  amount  allowed by law,  with the  Company  making a matching
contribution  of 3% of the  employee's  salary.  Expenses  related  to  matching
contributions  to the Plan were $17,445 and $22,012 for the years ended December
31, 2004 and 2003, respectively.

















                                      F-15



<PAGE>
<TABLE>
<CAPTION>


NOTE M - STOCK COMPENSATION PLAN AND WARRANTS

In  2000,  the  Company's   shareholders   approved  the  adoption  of  a  stock
compensation  plan.  Stock options are granted at the quoted market price of the
Company's stock at the date of grant, becoming exercisable over periods of up to
three years and expire ten years from the date of grant.  No stock  options were
granted by the Company  during the years  ended  December  31, 2004 or 2003.  At
December 31,  2004,  1,443,192  shares of common stock were  reserved for future
grant under the 2000 Stock Compensation Plan.

Option  activity for the years ended December 31, 2004 and 2003 is summarized as
follows:

                                                 2004                  2003
                                           -------------------   -------------------
                                                      Weighted              Weighted
                                                       Average              Average
                                                       Exercise              Exercise
                                           Options      Price     Options     Price
                                           -----------------------------------------
<S>                                          <C>       <C>         <C>       <C>
Options outstanding at beginning of year     73,152    $  1.25     89,496    $  1.25

Options granted                                --         --         --         --
Options exercised                              --         --         --         --
Options forfeited                           (16,344)      1.25    (16,344)      1.25
                                           -----------------------------------------

Options outstanding at end of year           56,808    $  1.25     73,152    $  1.25
                                           =========================================

Options exercisable at end of year           56,808    $  1.25     73,152    $  1.25
                                           =========================================
</TABLE>



The options  outstanding at December 31, 2004 have a weighted average  remaining
life of 6 years with an exercise price of $1.25 per share.

The Company `s outstanding warrants to purchase 5,700,000 shares of common stock
with an  exercise  price of $1.00  per  share  and  expiring  in July  2005 were
exchanged for 142,500 shares of common stock  effective  December 10, 2004. (See
Note J)


















                                      F-16




<PAGE>


Item  8.  Changes  In And  Disagreements  With  Accountants  On  Accounting  And
Financial Disclosure


     (a) On November 2, 2004, Hein & Associates LLP resigned as the Registrant's
independent  registered  public  accounting  firm.  On November  10,  2004,  the
Registrant engaged Whitley Penn as its independent  registered public accounting
firm for the fiscal year ending December 31, 2004.


     (b) The  reports of Hein &  Associates  LLP on the  Registrant's  financial
statements for the fiscal years ended  December 31, 2003 and 2002,  contained no
adverse  opinion  or  disclaimer  of  opinion  nor  were  they  modified  as  to
uncertainty, audit scope, or accounting principles.


     (c) The Registrant's Board of Directors made the decision to engage Whitley
Penn.


     (d) In connection  with the audits for the fiscal years ended  December 31,
2003 and 2002,  and during the interim period from December 31, 2003 to November
2, 2004, there were no disagreements with Hein & Associates LLP on any matter of
accounting  principles or practices,  financial statement disclosure or auditing
scope or procedures, which disagreements, if not resolved to the satisfaction of
Hein & Associates  LLP,  would have caused it to make  reference  thereto in its
reports.


     (e) Neither,  the  Registrant,  nor anyone acting on its behalf,  consulted
with Whitley Penn during the fiscal years ended  December 31, 2003 and 2002, and
during the interim  period  from  December  31,  2003 to November  10, 2004 with
regard to any matter concerning the application of accounting  principles to any
specific  transactions,  either  completed  or  proposed,  or the  type of audit
opinion  that  might be  rendered  with  respect to the  Registrant's  financial
statements,  or any other matters or events set forth in Item  304(a)(2)(ii)  of
Regulation S-B.


Item 8a. Controls And Procedures


     The Chief  Executive  Officer/Chief  Financial  Officer of the  Company has
established and is currently maintaining  disclosure controls and procedures for
the Company. The disclosure controls and procedures have been designed to ensure
that material  information  relating to the Company is made known to him as soon
as it is known by others  within the  Company.  There  have been no  significant
changes in these controls within the reporting period.


     As of the date of this report, the Chief Executive  Officer/Chief Financial
Officer  conducted an update and a review and evaluation of the effectiveness of
the Company's  disclosure  controls and  procedures.  It is the Chief  Executive
Officer's/Chief  Financial  Officer's  opinion,  based  upon the  evaluation  he
completed  as of the date of this  report,  that  the  controls  and  procedures
currently  being  utilized by the Company are  sufficiently  effective to ensure
that any material  information relating to the Company would become known to him
within a reasonable time.


Item 8b. Other Information


         Not applicable.

                                    PART III


Item 9.  Directors And Executive  Officers Of The  Registrant;  Compliance  With
Section 16(A) Of The Exchange Act


     The following sets forth information concerning our officers and directors,
including their ages, present principal  occupations,  other business experience
during the last five years,  memberships on committees of the board of directors
and directorships in other publicly held companies.

             Name              Age              Position with Avatar
             ----              ---              --------------------
      Robert C. Shreve, Jr.    42       President, Chief Executive Officer,
                                        Chief Financial Officer, Chairman of the
                                        Board and Director
      Charles Timothy Allen    54       Director
      Allen D. Farris          53       Director
      Stephen A. Komlosy       64       Director
      John J. May              56       Director
      Cindy Skelton            46       Secretary

     Robert C. (Chuck) Shreve, Jr. was managing partner of Avatar Systems,  Ltd.
and an officer of Avatar Systems,  Inc., the  predecessors of our Company,  from
1996 to November 2000. He has served as the President,  Chief Executive Officer,
Chief  Financial  Officer,  Chairman  of the Board and a director of our Company
since  November 14, 2000. He has over twenty years  experience in accounting and
financial  management  with  emphasis in the oil and gas  industry  and the real
estate development industry. Mr. Shreve also has technical certifications in the
technology  field and over  eighteen  years in  PC-based  network  and IBM AS400
systems. Mr. Shreve received his BBA from the University of Texas of the Permian
Basin, and attended  graduate school at the University of Texas at Dallas.  As a
Certified Public  Accountant,  he is a member of the American Institute of CPAs,
the Texas Society of CPAs and the Dallas Chapter of the Texas Society of CPAs.

     Charles  Timothy  (Tim) Allen has served as a director of our Company since
November 14, 2000. Mr. Allen was a limited partner of Avatar  Systems,  Ltd. and
an officer of Avatar Systems,  Inc., the predecessors of our Company,  from 1996
to  November  2000.  Mr.  Allen is the  President  of Eland  Energy  Corporation
("Eland") located in Dallas,  Texas and is responsible for the financial affairs
of Eland.  He has been  employed  by Eland since 1984 in various  positions.  He
co-founded  Eland with his brother,  Orville Gregory Allen. He has been drilling
and operating  wells in Texas,  Oklahoma,  Louisiana and New Mexico for the past
twenty years. Mr. Allen formed Allen Oil Company in 1979, where he was primarily
involved in generating  prospects for other  companies.  In 1982,  Mr. Allen and
three partners started drilling and operating wells in the North Texas area with
the primary  purpose of  developing  Mississippi  reef wells using CDP  seismic,
which  resulted in over 20 Mississippi  reef  discoveries in the area. Mr. Allen
graduated  from  Texas Tech  University  with a BBA in  management  and a MBA in
finance.


     Stephen A. Komlosy has served as a director of our Company  since  November
14, 2000. He is also the Chairman of London & Boston Investments,  PLC, formerly
Cybertec  Holdings PLC., a publicly traded United Kingdom  company.  Mr. Komlosy
has served as Chairman of London & Boston Investments,  PLC since February 2000.
London & Boston  Investments,  PLC is an investment  company,  making  strategic
investments  in companies  whose growth and value can be enhanced by  management
consulting services, financial assistance or mergers with related businesses and
public  flotation's.  Mr. Komlosy currently resides in England.  Since 1967, Mr.
Komlosy has managed several family owned  businesses,  which are engaged in real
estate  acquisition and development  activities.  In 1981, he co-founded  Branon
PLC, a public  industrial  holding  company selling bonded oil drilling and pipe
handling  equipment to North Sea oil operators;  the large-scale  manufacture of
dump trucks for the Ministry of Defense;  and of road planners and oil consoles.
At Branon,  he had  specific  responsibility  for  establishing  its oil and gas
purchasing  associate Covendish Petroleum PLC that purchased 140 producing wells
in Ohio, USA. Mr. Komlosy is also a director of Energy Technique, PLC, a company
traded on the London Stock Exchange and Chairman of Netcentric  Systems PLC that
is traded on AIM in London.

     John J. May is a Fellow of the Institute of Chartered Accountants.  He is a
director of The Small Business  Bureau Ltd and The Genesis  Initiative Ltd, with
responsibility for policy.  These companies lobby Government on business matters
affecting small and medium-sized enterprises. He is also the senior partner of a
boutique  London based  chartered  accountancy  practice  specializing  in SMEs.
Currently  he is  director  of the Aim  listed  Netcentric.  Previously,  he was
finance  director of MyVal.com  PLC,  now  Interactivity  PLC,  whose shares are
traded on AIM.

     He was formerly a senior partner with the leading  accountancy  practice of
Howarth Clark Whitehill,  serving eight years on its managing board and for nine
years  being  chairman  of its Thames  Valley  offices.  In his  capacity  as UK
national marketing partner and head of its property consultancy arm, he was also
a  director  of  its  UK  and  International  Associations.  He  has  also  held
Directorships  in a  number  of  diversified  businesses  both  in  the  UK  and
internationally.


     Allen D. Farris was  appointed to the board of  directors on September  24,
2004. Mr. Farris is currently the Chief Financial Officer of Eland Energy,  Inc.
and has held that position  since  December of 1999. Mr. Farris has thirty years
of accounting and financial experience  including financial reporting,  treasury
management, cash forecasting and budgeting,  financial forecasting and modeling,
computer  system  installation  and  maintenance,   income  tax  planning,   and
maintaining banking relationships.  His experience also includes both public and
privately  owned  companies  covering  a broad  range of  industries  at  levels
including Chief Financial Officer,  Treasurer,  Controller, and Tax Manager. Two
specific  areas of his  expertise  include all phases of the  petroleum and real
estate industries. Mr. Farris holds a Bachelor of Business Administration degree
in  Accounting  from the  University  of Texas at Austin and a Master of Science
degree in  Accounting  from  Texas Tech  University.  He is a  Certified  Public
Accountant and a member of the American  Institute,  Texas  Society,  and Dallas
Chapter  of  CPAs,  and  a  member  of  the  Dallas  Chapter  of  the  Petroleum
Accountants' Society.


     Cindy  Skelton  currently  serves as the  Secretary  of our Company and she
manages the benefit  plans and employee  relations for us. She has served as our
Secretary  since November 27, 2000.  Ms. Skelton is primarily  employed by Eland
and since 1986 has served as Eland's  Accounting  Manager and Controller.  Since
1994, she has held the position of Director of Human  Resources with Eland.  She
received a BBA degree  from Texas Tech  University  in 1981.  She will devote as
much of her time as  necessary  to  fulfill  her  duties  as an  officer  of our
Company.


     Committees of the Board of Directors


     The  Company  has  an  Audit  Committee.   The  Company  does  not  have  a
Compensation  Committee  or a  Nominating  Committee.  In the  absence  of  such
committees, the Board as a whole establishes the compensation of officers of the
Company,  administers the 2000 Stock Compensation Plan, prepares recommendations
to the Board on the  adoption of stock  option and other  incentive  plans,  and
grants stock options.  The Board also considers  individuals to recommend to the
Board  for  inclusion  among  management's   nominees  and  considers  corporate
governance  issues. The Board will consider director  candidates  recommended by
shareholders if the name and  qualifications  of candidates are timely presented
to the Board.


     Audit Committee


     The Audit Committee's functions include evaluating, and recommending to the
Board the engagement of the Company's  registered  independent public accounting
firm,  reviewing the results of their  auditing  findings,  and  monitoring on a
periodic basis the internal  controls of the Company.  The Audit  Committee does
not have a formally  approved  written  charter.  The Audit Committee  currently
consists of Charles  Timothy Allen and Stephen A. Komlosy.  The Audit  Committee
currently does not have a financial  expert as defined under the  Sarbanes-Oxley
Act of 2002. The Audit Committee held three meetings during 2004.


     Code of Ethics


     The Company does not have a formally  approved written code of ethics.  The
Company is in the  process of drafting a code of ethics to be  presented  to the
board for approval.


     Section 16(a) Beneficial Ownership Reporting Compliance


     Section  16(a) of the  Securities  and  Exchange  Act of 1934  requires the
Company's  officers  and  directors,  and  persons who own more than ten percent
(10%) of a registered class of the Company's equity securities,  to file certain
reports regarding  ownership of, and transactions in, the Company's  securities,
with the Securities and Exchange  Commission.  Such officers,  directors and 10%
stockholders are also required to furnish the Company with copies of all Section
16(a) forms that they file.


     Based  solely  on the  Company's  review  of  copies  of Forms 3, 4, 5, and
amendments  thereto  furnished  to the Company  pursuant to Rule  16a-3(e),  the
Company  believes  that,  during the year ended  December 31, 2004,  all Section
16(a) filing requirements applicable to the Company's officers,  directors,  and
10% stockholders were met.


Item 10. Executive Compensation


     Executive Officers

     Our Board appoints the executive officers to serve at the discretion of the
Board until the next annual meeting of the Board of Directors. Robert C. Shreve,
Jr. President, Chief Financial Officer and a director of the Company is the only
officer to receive  $100,000 or more in annual  compensation.  Directors who are
also  employees   receive  no  compensation   for  serving  on  the  Board.  Our
non-employee  directors  receive no  compensation  for serving on the Board.  We
intend to  reimburse  non-employee  directors  for  travel  and  other  expenses
incurred in connection with attending the Board meetings.


     Employment Agreements


     We have entered into a management agreement with Robert C. Shreve, Jr., our
President  and Chief  Executive  Officer  and  Chief  Financial  Officer,  which
terminates on July 10, 2005. The  management  agreement  shall be  automatically
extended  for an  additional  one-year  period  after the initial term unless at
least 30 days prior to the termination date either Mr. Shreve or we give written
notice to the other  that the  management  agreement  will not be  renewed.  Mr.
Shreve will receive an annual base salary of $125,000, which may be increased at
the discretion of our Board. Additionally, Mr. Shreve may be eligible to receive
an annual bonus based on our financial  performance in the form of stock options
and cash not to exceed 15% of his base salary. Upon agreeing to the terms of the
management  agreement,  we issued to Mr. Shreve a five-year  warrant to purchase
1.6 million  shares of our common stock at an exercise price of $1.00 per share.
On December 10, 2004, Mr. Shreve's  warrants were exchanged for 40,000 shares of
the  Company's  common  stock.  See "Part III,  Item 11-  Security  Ownership of
Certain Beneficial Owners and Management."


     Key Man Insurance


     We currently pay an annual  premium of $2,118 for a life  insurance  policy
for  $1,000,000  on the life of Robert C.  Shreve,  Jr.,  our  President,  Chief
Executive  Officer and Chief Financial  Officer.  The proceeds of the policy are
payable to us.


     Stock Option Plan


     On November 14, 2000, our shareholders approved our 2000 Stock Compensation
Plan.  The number of shares of common  stock which may be issued  under the 2000
Plan shall  initially be 400,000  shares which amount may, at the  discretion of
the Board,  be increased from time to time to a number of shares of common stock
equal to 5% of the total outstanding  shares of common stock,  provided that the
aggregate  number of shares of common stock which may be granted  under the 2000
Plan shall not exceed  1,500,000  shares.  We may also  utilize the  granting of
options  under the 2000 Plan to  attract  qualified  individuals  to become  our
employees  and  non-employee  directors,  as well as to ensure the  retention of
management of any acquired business operations. Under the 2000 Plan, we may also
grant  restricted stock awards.  Restricted  stock  represents  shares of common
stock  issued  to  eligible  participants  under the 2000  Plan  subject  to the
satisfaction  by the  recipient  of certain  conditions  and  enumerated  in the
specific restricted stock grant. Conditions,  which may be imposed, include, but
are not limited to,  specified  periods of  employment,  attainment  of personal
performance  standards  or our overall  financial  performance.  The granting of
restricted  stock represents an additional  incentive for eligible  participants
under the 2000 Plan to promote our  development  and growth,  and may be used by
our  management  as  another  means  of  attracting   and  retaining   qualified
individuals  to serve as our  employees  and  directors.  Currently,  options to
purchase  56,808  shares of our common  stock at an exercise  price of $1.25 per
share are  outstanding  to nine  employees.  Such options  expire on January 10,
2011. No options have been granted to our officers or directors.

<PAGE>
<TABLE>
<CAPTION>

-------------------------------------------------------------------------------------------------------
                                          (a)                   (b)                       (c)
-------------------------------------------------------------------------------------------------------
          Plan Category        Number of securities to    Weighted-average       Number of securities
                               be issued upon exercise   exercise price of     remaining available for
                               of outstanding options,      outstanding         future issuance under
                                 warrants and rights     options, warrants    equity compensation plans
                                                             and rights        (excluding securities in
                                                                                     column (a))
-------------------------------------------------------------------------------------------------------
<S>                                     <C>                    <C>                     <C>
Equity compensation plans
approved by security holders            56,808                 1.25                    1,443,192
-------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders               -                     -                          -
-------------------------------------------------------------------------------------------------------
Total
                                        56,808                  1.25                    1,443,192
-------------------------------------------------------------------------------------------------------
</TABLE>


Compensation Table

         The  information  set  forth  below  concerns  the  cash  and  non-cash
compensation to executive officers for each of the past three fiscal years ended
December 31, 2004, 2003 and 2002. In each case, the compensation listed was paid
by our Company or Avatar  Systems,  Ltd.,  our  predecessor  entity.  Except for
Robert C.  Shreve,  Jr.,  our  President,  Chief  Executive  Officer,  and Chief
Financial Officer, no executive officer has an employment  agreement with us and
all executive officers serve at the discretion of the Board.
<TABLE>
<CAPTION>

          Summary Compensation Table

                                                                                 Long-Term Compensation
                Name/Title                           Annual Compensation                Awards
----------------------------------------------------------------------------------------------------------
                                                                                               Securities
                                                                                               Underlying
                                                                 Other Annual   Restricted   Options/SARs/
                                            Year   Salary/Bonus  Compensation  Stock Awards    Warrants
                                            -----  ------------  ------------  ------------  -------------
<S>                                         <C>    <C>            <C>          <C>           <C>
Robert C. Shreve, Jr., President, Chief     2004     $125,000       $7,211         None           None
   Executive Officer, Chief Financial       2003     $125,000       $7,211         None           None
   Officer and Director                     2002     $125,000       $5,208         None           None
</TABLE>

Item 11. Security Ownership Of Certain Beneficial Owners And Management


         The table below sets forth, as of March 14, 2005,  certain  information
with respect to the  beneficial  ownership of the common stock of our Company by
each person who we know to be a beneficial owner of more than 5% of any class or
series of our  capital  stock,  each of the  directors  and  executive  officers
individually, and all directors and executive officers as a group.
<TABLE>
<CAPTION>

                                                Shares Beneficially  Percentage of Shares
                       Name(1)                         Owned          Beneficially Owed
-----------------------------------------       -------------------  --------------------
<S>                                             <C>                  <C>
Robert C. Shreve, Jr...................              1,641,200               18.6
Charles Timothy Allen..................              2,449,973               27.7
Orville Gregory Allen..................              2,406,250               27.2
London & Boston Investments, Plc.......              1,679,002               19.0
Stephen A. Komlosy (2).................              1,695,002               19.2
Allen D. Farris (3)....................                    -0-                -0-
Cindy Skelton(4).......................                    -0-                -0-
Officers and directors as a group (4 persons) (5)     8,192,425              92.7
</TABLE>
---------------

(1)  Unless otherwise indicated, each person named in this table has sole voting
     and  investment  power with respect to the shares  beneficially  owned.  In
     addition,  unless otherwise indicated, the address of each beneficial owner
     identified below is c/o Avatar Systems,  Inc., 5728 LBJ Freeway, Suite 270,
     Dallas, Texas 75240.
(2)  Includes  1,679,002 shares owned by London & Boston.  Stephen A. Komlosy is
     the  Managing  Director of London & Boston and is  authorized  to vote such
     shares on behalf of London & Boston.  Also  includes  1,000 shares owned by
     General Trading  Corporation,  Ltd., a Komlosy family company.  Mr. Komlosy
     has the authority to vote such shares on behalf of General Trading Company.
     Mr.  Komlosy is a director of Avatar.  Mr.  Komlosy's  address is 133 Ebury
     Street, London SW1W9QU, England.


<PAGE>

(3)  Mr. Farris is a director of Avatar.
(4)  Ms. Skelton is the Secretary of Avatar.
(5)  See preceding  notes for an  explanation  of the ownership of the 8,192,425
     shares.

         We currently have 8,838,152 outstanding shares of common stock of which
approximately  646,000  shares  are  owned by  approximately  450  persons.  The
remaining  shares are owned by our principal  shareholders as noted in the above
table.


Item 12. Certain Relationships And Related Transactions

The Company sells computer hardware and provides software maintenance, training,
and  consulting/development  services  to a company  that is  controlled  by two
members of the Company's  Board of Directors.  Total  revenues from that company
were  $22,060 and  $211,697 in 2004 and 2003,  respectively.  Revenues  for 2003
included  a hardware  sale of  $188,532.  The  Company  had  $1,861 of  accounts
receivable  at  December  31, 2004 and 2003,  respectively,  related to services
performed for that company.

In connection with the issuance of 1,600,000  shares of common stock on July 10,
2000 to London & Boston Investments,  PLC, the company issued 5,700,000 warrants
at $1.00 per share  expiring  in July  2005 to  London & Boston,  the  Company's
President/CEO,  and certain  members of the board of directors.  On December 10,
2004, the Company completed the exchange of 142,500 of its common shares for the
5,700,000  outstanding  warrants  with  London &  Boston  Investment,  PLC,  the
Company's President/CEO, and certain members of the board of directors.

Item 13. Exhibits


     Statements filed as part of this Report:


         1. Financial Statements


         See "Index to Financial Statements" under Item 7 of this Report.


     Exhibits


         The  following  documents  are  filed  as  exhibits  herewith,   unless
otherwise specified, and are incorporated herein by this reference:


         31.1 Section 302 Certification pursuant to Sarbanes-Oxley Act.


         32.1 Section 906 Certification pursuant to Sarbanes-Oxley Act.

Exhibit
Number          Description of Exhibit
--------------  ----------------------------------------------------------------
2.0*            Joint  Plan of  Reorganization  Proposed  by the  Debtors  dated
                August 21, 2000 as filed with the U.S.  Bankruptcy Court for the
                Northern District of Texas, Dallas Division,  on August 21, 2000
                (without  exhibits which will be supplied to the Commission upon
                request)

2.1*            Modification  to  the  Debtors'  Joint  Plan  of  Reorganization
                Proposed by the Debtors Dated August 21, 2000

2.2*            Order  Confirming  Joint  Plan  of  Reorganization   and  Fixing
                Deadlines  for  Filing  Administrative  Claims,  Fee  Claims and
                Rejection Claims as filed with the U.S. Bankruptcy Court for the
                Northern  District of Texas,  Dallas Division,  on September 29,
                2000

2.3*            Certificate of Compliance with Reverse Acquisition  Requirements
                as  filed  with  the  U.S.  Bankruptcy  Court  for the  Northern
                District of Texas, Dallas Division, on November 20, 2000

2.4*            Motion for Post Confirmation  Technical  Amendment as filed with
                the U.S.  Bankruptcy  Court for the Northern  District of Texas,
                Dallas Division, on November 30, 2000


<PAGE>

Exhibit
Number          Description of Exhibit
--------------  ----------------------------------------------------------------
2.5*            Order Granting Debtors' Motion for  Post-Confirmation  Technical
                Amendment  as  filed  with  the U.S.  Bankruptcy  Court  for the
                Northern District of Texas, Dallas Division, on January 18, 2001

2.6*            Order Supplementing Order of Confirmation as filed with the U.S.
                Bankruptcy  Court for the  Northern  District  of Texas,  Dallas
                Division, on January 18, 2001

2.7*            Agreement  and  Plan of  Merger  dated  October  9,  2000 by and
                between Avatar Systems,  Inc. and HCI Acquisition  1998-2,  Inc.
                d/b/a Precision Stainless Fabricators whereby Avatar on November
                14, 2000 merged with and into HCI Acquisition  1998-2, Inc. with
                HCI  Acquisition  1998-2,  Inc. being the surviving  corporation
                (without  exhibits and  schedules  which will be supplied to the
                Commission upon request)

2.8*            Certificate  of  Merger  of  Avatar   Systems,   Inc.  with  HCI
                Acquisition  1998-2, Inc. as filed on November 14, 2000 with the
                Secretary  of State of Texas  (please see  Exhibit 3.2  attached
                hereto for a copy of Exhibit "A" to this Certificate of Merger)

3.0*            Articles of  Incorporation of HCI Acquisition  1998-2,  Inc., as
                filed with the Secretary of State of Texas on August 7, 1998

3.1*            Articles  of  Amendment  to  Articles  of  Incorporation  of HCI
                Acquisition 1998-2, Inc. as filed with the Secretary of State of
                Texas on October 23, 2000

3.2*            Certificate  of  Restated  Articles of  Incorporation  of Avatar
                Systems,  Inc. as filed with the  Secretary of State of Texas on
                November 14, 2000

3.3*            Amended and Restated Bylaws of Avatar Systems, Inc.

4.0*            Common Stock Specimen - Avatar Systems, Inc.

9.0*            Shareholders'  Agreement by and between  Avatar  Systems,  Inc.,
                Cybertec Holdings, Plc., Robert C. Shreve, Jr., Tim Allen, Gregg
                Allen, Stephen A. Komlosy and Merchant Capital Holdings, Ltd. as
                of July 10, 2000

10.0*           Stock Purchase Agreement by and between Avatar Systems, Inc. and
                Cybertec  Holdings,  Plc. dated July 10, 2000 (without  exhibits
                and  schedules  which will be  supplied to the  Commission  upon
                request)  providing  for the  issuance  of  1,600,000  shares of
                Avatar's Common Stock to Cybertec for $1.6 million

10.1*           Management  Agreement by and between  Avatar  Systems,  Inc. and
                Robert C. Shreve, Jr. as of July 10, 2000

10.2*           Consulting Agreement by and among Avatar Systems, Inc., Merchant
                Capital  Holdings,  Ltd.  and  its  affiliate,  First  Merchants
                Capital Limited, as of July 10, 2000

10.3*           Investors'  Rights Agreement by and among Avatar Systems,  Inc.,
                Cybertec  Holdings,  Plc.,  Merchants  Capital  Holdings,  Ltd.,
                Robert C.  Shreve,  Jr.,  Tim Allen,  Gregg Allen and Stephen A.
                Komlosy as of July 10, 2000

10.4*           Warrant to Purchase Common Stock of Avatar Systems,  Inc. issued
                to Cybertec Holdings Plc. as of July 10, 2000

10.5*           Warrant to Purchase Common Stock of Avatar Systems,  Inc. issued
                to Robert C. Shreve, Jr. as of July 10, 2000

10.6*           Warrant to Purchase Common Stock of Avatar Systems,  Inc. issued
                to Merchants Capital Holdings, Ltd. as of July 10, 2000

10.7*           Warrant to Purchase Common Stock of Avatar Systems,  Inc. issued
                to Stephen A. Komlosy as of July 10, 2000

10.8*           Warrant to Purchase Common Stock of Avatar Systems,  Inc. issued
                to Tim Allen as of July 10, 2000

10.9*           Warrant to Purchase Common Stock of Avatar Systems,  Inc. issued
                to Gregg Allen as of July 10, 2000

10.10*          2000  Stock  Compensation  Plan of Avatar  Systems,  Inc.  dated
                October 9, 2000

10.11*          Amended and Restated Loan Agreement  dated July 10, 2000 between
                Avatar Systems, Inc. and Bank One, Texas, N.A.

10.12*          Amended and Restated  Term Loan  Promissory  Note dated July 10,
                2000 in the principal amount of $288,888.96

10.13*          Security  Agreement  dated July 10, 2000 between Avatar Systems,
                Inc. and Bank One, Texas, N.A.


<PAGE>

Exhibit
Number          Description of Exhibit
--------------  ----------------------------------------------------------------

10.14*          Copyright  Security Agreement dated July 10, 2000 between Avatar
                Systems, Inc. and Bank One, Texas, N.A.

10.15*          Trademark  Security Agreement dated July 10, 2000 between Avatar
                Systems, Inc. and Bank One, Texas, N.A.

10.16*          Uniform  Commercial  Code  Financial  Statement  between  Avatar
                Systems, Inc. and Bank One, Texas, N.A.

10.17*          Guaranty  of Charles T. Allen dated July 10, 2000 for benefit of
                Bank One, Texas, N.A.

10.18*          Guaranty of Orville G. Allen dated July 10, 2000 for the benefit
                of Bank One, Texas, N.A.

10.19*          Limited  Guaranty of Robert C.  Shreve,  Jr. dated July 10, 2000
                for the benefit of Bank One, Texas, N.A.

10.20*          Executive  Employment  Agreement dated November 23, 2000 between
                Talon Global Solutions, Inc. and Chad P. Statham

10.21*          Executive  Employment  Agreement dated November 23, 2000 between
                Talon Global Solutions, Inc. and Carla Rogers

22.0*           Subsidiaries of the Registrant
-----------------
* Previously filed as exhibits to the Company's  Registration  Statement on Form
10-SB as filed on June 25,  2001  with the  Commission  which  are  incorporated
herein by reference.

Item 14. Principal Accountant Fees And Services

     Audit Fees

         The aggregate fees for professional  services rendered for the audit of
the Company's  financial  statements for the fiscal year ended December 31, 2004
and 2003 were $18,135 and $16,708 respectively.  The fees for the reviews of the
financial  statements  included  in the  Company's  Form  10-QSB were $9,522 and
$9,291 for the fiscal year ended December 31, 2004 and 2003, respectively.

     All Other Fees

         There were no other fees for  services  rendered to the  Company  other
than those services covered in the section captioned "Audit Fees" for the fiscal
years ended December 31, 2004 and 2003.


Signatures


         Pursuant to the  requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                             AVATAR SYSTEMS, INC.

Dated: March 31, 2005                        By: /s/ ROBERT C. SHREVE, JR.
                                                --------------------------------
                                                Robert C. Shreve, Jr., President
                                                     Chief Executive Officer
                                                     Chief Financial Officer


         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
registrant and in the capacities and on the dates indicated.

Dated: March 31, 2005                        By: /s/ ROBERT C. SHREVE, JR.
                                                --------------------------------
                                                     Robert C. Shreve, Jr.
                                                    Chief Executive Officer
                                                    Chief Financial Officer
                                                           Director

Dated: March 31, 2005                        By:  /s/ CHARLES TIMOTHY ALLEN.
                                                --------------------------------
                                                    Charles Timothy Allen
                                                          Director

Dated: March 31, 2005                        By: /s/ ALLEN.D. FARRIS
                                                --------------------------------
                                                       Allen D. Farris
                                                           Director

Dated: March 31, 2005                        By: /s/ STEPHEN A. KOMLOSY
                                                --------------------------------
                                                      Stephen A. Komlosy
                                                           Director


Dated: March 31, 2005                        By: /s/ JOHN J. MAY
                                                --------------------------------
                                                       John J. May
                                                         Director