**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 2054 9





**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, 2007**
              **COMMISSION
                FILE NUMBER**:**000-32925**





**AVATAR
      SYSTEMS, INC** .


(Name
      of
      Small Business Issuer Specified in Its Charter)





**Texas**
            **75-2796037**(State
                or other jurisdiction of incorporation or organization)
            (IRS
                Employer Identification Number)**2801
                Network Blvd., Suite 210, Frisco, Texas**
            **75034**(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 is not required to file reports pursuant to Section 13 or
      15(d) of the Exchange Act.


o





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 o No





Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this form, and no disclosure will be contained,
      to
      the best of registrant’s knowledge, in definitive proxy or information
      statements incorporated by reference in Part III of this Form 10-KSB or any
      amendment to this Form 10-KSB.


x





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


o Yes x No





The
      Issuer’s revenue for its most recent fiscal year was $4,918,980





The
      aggregate market value of the shares held by non-affiliates was approximately
      $473,607 based upon the last trade price of $.56 per share of Common Stock
      on
      the OTC Pink Sheets as of January 17, 2008.





As
      of
      March 25, 2008, 9,038,152 shares of the Issuer’s $0.001 par value common stock
      were outstanding.





The
      following documents are incorporated by reference: None





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





**TABLE
      OF CONTENTS**





**PART
                I**
            
            **2**Item
                1. Description of Business
            
            2Item
                2. Description of Properties
            
            10Item
                3. Legal Proceedings
            
            10Item
                4. Submission of Matters to a Vote of Security Holders
            
            10**PART
                II**
            
            **11**Item
                5. Market for Common Equity and Related Shareholder
                Matters
            
            11Item
                6. Management's Discussion and Analysis of Financial Condition or
                Plan of
                Operations
            
            12Item
                7. Financial Statements
            
            28Item
                8. Changes In and Disagreements with Accountants on Accounting and
                Financial Disclosure
            
            30Item
                8A(T). Controls and Procedures
            
            30Item
                8B. Other Information
            
            30**PART
                III**
            
            **31**Item
                9. Directors, Executive Officers, Promoters, Control Persons and
                Corporate
                Governance; Compliance with Section 16(A) of the Exchange
                Act
            
            31Item
                10. Executive Compensation
            
            32Item
                11. Security Ownership of Certain Beneficial Owners and Management
                and
                Related Stockholder Matters
            
            34Item
                12. Certain Relationships and Related Transactions, and Director
                Independence
            
            35Item
                13. Exhibits
            
            36Item
                14. Principal Accountant Fees and Services
            
            37Signatures
            
            38


i


**PART
      I**




**Item
      1. Description of 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.(“HCI”) 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
      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.




On
      August
      18, 2006, the Company acquired all the outstanding common stock of Questa
      Software Systems, Inc. (“Questa”) pursuant to a Stock Purchase Agreement.
      Questa, located in Midland, Texas, was engaged in the development of accounting
      software for the petroleum production industry. The purchase price was
      approximately $2.24 million, subject to certain post-closing adjustments based
      on Questa’s actual working capital as of the closing date.




The
      acquisition of Questa provides for economies of scale to be achieved by
      eliminating redundant expense items including major development costs,
      solidifies our recurring maintenance revenue stream, and increases the
      professional capacity of our human resources.




Operating
      results of Questa have been included in the Company’s financial statements since
      August 1, 2006, when the Company assumed the risk of loss for Questa’s
      operations, by recording the transaction from that date directly in the accounts
      of the Company.




Avatar’s
      stock symbol is AVSY.PK. Our common stock began trading on the Over-the-Counter
      Pink Sheets on April 2, 2001.




On
      our
      investor relations web site, which is accessible through www.avatarsystems.net,
      we post the following filings as soon as reasonably practicable af ter
      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 inform ation
      statements, and other information regarding issuers that is filed electronically
      with the SEC.


-2-




Our
      principal executive offices are located at 2801 Network Boulevard, Suite 210,
      Frisco, Texas 75034, and our telephone number is (972) 720-1800.




**Industry
      Background**




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




·
            Upstream
                activities include exploration, producing and selling crude oil,
                natural
                gas and gas liquids.




·
            Midstream
                activities typically include the gathering, transportation, and storage
                of
                petroleum products.




·
            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 continually
      need to 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:




·
            Data-Intensive,
                Paper-Based Processes. 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.




·
            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.




·
            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”). These
      ASP’s will offer enhanced outsourcing capabilities including not only
      applications, but through professional services including consulting,
      implementation, integration, software and industry training.


-3-




**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).




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, resource management, and document management
      software for the petroleum industry through our Avatar400, Petroware2000,
      Integra Energy and ISYNERGY product lines. Our products offer a variety of
      applications specific to the accounting, billing, financial analysis, document
      management and land, royalty and production management functions of a petroleum
      company.




**Petroware2000**




Petroware2000
      runs on all major operating systems and hardware types, including
      Mic rosoft
      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.




**Integra
      Energy**




The
      Integra Energy Management Software System provides accounting, land, production,
      field capture and drilling operations software for domestic oil & gas
      operators, investors, and drilling companies. The 32-bit Microsoft Windows
      compliant product utilizes industry standard high performance relational
      database technology to bring companies flexible, fully integrated solutions
      that
      adapt and improve with advances in technology. Comprehensive support for EDI,
      eCommerce and EFT are incorporated into the products via uploads, downloads
      and
      support for industry standard data exchange and interfaces for CDEX, JIBE,
      CODE,
      GRADE, IHS/PI/Dwights, Aries, GeoGraphix, Federal and State electronic
      filing .
      Integra’s extended database technology supports multiple database platforms
      including but not limited to the following: Microsoft SQL Server, Oracle and
      IBM
      DB2.




**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.




**ASP
      Products**




Our Petroware,
      Integra, and RAPID, or Remote Access Private Integrated Datalink 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 expensive in-house information technology
      personnel.


-4-




**iSYNERGY**




iSYNERGY
      is an enterprise class, integrated information management software. It combines
      document and data capture, process automation, workflow, imaging, enterprise
      report management, and secured access in a single, browser-based application.
      iSYNERGY provides the capability to dynamically organize and control the
      delivery of documents and data to increase productivity and share information
      among employees, partners, and customers. iSYNERGY integrates with CRM, ERP,
      accounting and other enterprise applications providing a scalable framework
      for
      functional expansion and for managing the entire enterprise document
      infrastructure. iSYNERGY eliminates unnecessary manual processes and time
      consuming searches for paper documents and files which in turn reduces costs
      and
      increases productivity.




**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 600
      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.




**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 2008, our product
      development efforts will include rollout of production /land modules for our
      Petroware2000 product, DASHBOARD, and further integration of imaging
      functionality in our Petroware2000, Integra, and AS400 products.




**Pursuing
      Acquisitions and Strategic Alliances**




We
      have
      successfully completed three
      acquisitions since 1996. We will continue to evaluate potential acquisitions
      of
      other companies or technologies to 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.


-5-




**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 revenue. 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**




O ur
      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
      Frisco.




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 promotes our products and services over the
      Internet. Our web site is also used to provide current customers information
      on
      new products and services, 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 .




**Customers**




The Company
      had one customer that accounted for more than 10% of revenue during the year
      ended December 31, 2007. In 2006, no single customer accounted for 10% or more
      of the Company’s revenues.




**Suppliers**




Our
      primary supplier is IBM. We purchase most of our equipment for internal use
      and
      resale purposes from IBM. 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 and trademarks to all of our products including, Avatar400, RAPID,
      Petroware2000, Integra, 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.


-6-




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 revenue 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. 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.




**Product
      Developmen** **t**




Our
      capitalized software development costs have been focused on the development
      of
      our Avatar400, Petroware2000 and Integra products. We capitalize software
      development costs applicable to each product after technological feasibility
      has
      been established until the product is released to the market. In
      200 7
      and
      2006, our product development expenditures were $978,611 and $754,852,
      respectively.




**Employees**




As
      of
      December 31, 200 7,
      we had
      29 employees, of which, 15 were engaged in product development and customer
      support, 5 in finance and administration, 3 in management, 4 in sales and
      marketing, 1 in professional services and 1 in information technology. 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.


-7-


**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 integrate any acquired
      companies.




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




·
            diversion
                of management's attention from our existing
                business;


·
            increased
                fixed costs, which could cause profits to
                decrease;


·
            assumption
                of unknown material liabilities of acquired
                companies;


·
            large
                write-offs and amortization expenses related to goodwill and other
                intangible assets;


·
            difficulty
                in integrating an acquired company's personnel and culture with our
                personnel and culture;


·
            difficulty
                in integrating an acquired company's accounting and information systems
                with our accounting and information
                systems;


·
            difficulty
                in maintaining standards, controls, procedures and policies across
                the
                combined companies;


·
            issuances
                of equity securities that may dilute your interest in our
                company;


·
            incurring
                additional debt; and


·
            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.





**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 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.




**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 revenue. 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.


-8-


**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 customer’s 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. This is particularly true when the software is 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.


-9-


**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.




**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.




**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. Description of Properties**




The
      Company leases its 6,192 square foot facility at 2801 Network Boulevard, Suite
      210, Frisco, Texas, 75034. The lease for the corporate office was entered into
      on July 29, 2005 for a one hundred twenty-month lease term commencing on
      November 1, 2005 and expiring on October 31, 2015.




As
      part
      of the acquisition of Questa, the Company assumed the lease of a 7,197 square
      foot facility at 10 Desta Drive, Suite 250 West, Midland, Texas 79705. The
      original lease for the Midland facility was entered into on November 14, 2005
      for a seventy-five month lease term commencing on January 1, 2006 and expiring
      on March 31, 2012.




**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 harm our business.




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




None.


-10-


**PART
      II**




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




Our
      common stock is
      traded
      on the Over-the-Counter Pink Sheets. Our trading symbol is AVSY.PK. There was
      only nominal trading in the shares of our common stock in 2007. No assurance
      can
      be given that an active market will exist for our common stock in the future.
      On
      March 25, 2008, the closing bid price was $0.41 and the closing ask price was
      $0.90.




The
      table
      below summarizes the range of high and low reported sales prices for our common
      stock for the periods indicated:




2007
            
            2006Quarter
                ended
            
            High
            
            Low
            
            High
            
            LowMarch
                31
            
            $
            1.05
            
            $
            0.79
            
            $
            1.01
            
            $
            0.41June
                30
            
            $
            1.10
            
            $
            0.90
            
            $
            0.85
            
            $
            0.41September
                30
            
            $
            1.05
            
            $
            0.80
            
            $
            0.80
            
            $
            0.41December
                31
            
            $
            1.01
            
            $
            0.40
            
            $
            0.95
            
            $
            0.64




**Holders**




As
      of March
      25,
      2008, the Company had approximately 450 shareholders
      of record, its common stock had a closing bid price of $0.41 per share, and
      a
      closing ask price of $0.90 per share.




**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.




**Securities
      Authorized for Issuance under Equity Compensation Plans**




Plan category
            
            Number of securities
              to be issued upon
              exercise of
              outstanding options,
              warrants and rights
            
            Weighted-
              average
              exercise price
              of outstanding
              options,
              warrants and
              rights
            
            Number of
              securities
              remaining available
              for future issuance
              under equity
              compensation plans
              (excluding
              securities reflected
              in column (a))(a)
            
            (b)
            
            (c)Equity
                compensation plans approved by security holders
            
            
            -
            
            $
            -
            
            
            -Equity
                compensation plans not approved by security holders
            
            
            1,258,477
            
            $
            0.528
            
            
            1,241,523Total
            
            
            1,258,477
            
            $
            0.528
            
            
            1,241,523


-11-




See
      Note
      5 in the accompanying notes to the financial statements for a description of
      the
      2000 Stock Compensation Plan and other Non-Qualified Stock Options.




**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.




**1.** **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 these estimates.
      Significant assumptions and estimates are required in the capitalization and
      amortization of software development costs. It is at least reasonably possible
      these estimates could be revised in the near term and the 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 expenses
      approximate their carrying amounts due to the relatively short maturity of
      these
      instruments. The carrying value of short and long-term debt and capital lease
      obligations also approximates fair value since these instruments bear market
      rates of interest. None of these instruments are held for trading
      purposes.


-12-




**Marketable
      Securities**




Marketable securities at December 31, 2007 and 2006 consisted of corporate equities. 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 securities
      is
      determined at the time of purchase and re-evaluated at each balance sheet date.
      As of December 31, 2007 and 2006, 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 or loss
      within the stockholders' equity section of the accompanying balance sheets.
      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 $978,611 and $754,852 of software development costs
      during the years ended December 31, 2007 and 2006, respectively. Capitalized
      software development costs are amortized using the straight-line method over
      a
      period that 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. No charge was recorded in 2007 or 2006 for unamortized
      software costs that exceeded the net realizable value. Amortization of
      capitalized developed software charged to expense was $457,134 and $406,049
      for
      the years ended December 31, 2007 and 2006, respectively.




**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 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,
      200 7
      and
      2006, the Company recorded no impairment charges.




**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.


-13-




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.




Hardware
      sales are recorded as revenue in accordance with SEC Staff Accounting Bulletin
      (“SAB”) 104, *Revenue
      Recognition* .
      Revenue
      is recognized when title and/or risk of loss have passed to the customer, there
      is persuasive evidence of an arrangement, delivery has occurred or services
      have
      been rendered, the sales price is fixed or determinable, and collectability
      is
      reasonably assured. Revenue is recognized under the gross method in accordance
      with Emerging Issues Task Force (“EITF”) 99-19, *Reporting
      Revenue Gross as a Principle vs. Net as an Agent* .
      As
      such, revenue includes the value of the product sold.




**Stock-based
      Compensation**




On
      January 1, 2006, the Company adopted SFAS No. 123(R), *Share-Based
      Payment* ,
      and has
      elected to use the modified prospective method, which requires the application
      of the accounting standard to all share-based awards issued on or after January
      1, 2006 and any outstanding share-based awards that were issued but not vested
      as of January 1, 2006. The adoption of SFAS No. 123(R) resulted in incremental
      stock-based compensation expense for the years ended December 31, 2007 and
      2006
      of $83,943 and $7,341, respectively.




Prior
      to
      the adoption of SFAS 123(R), the Company applied Accounting Principles Board
      (“APB”) No. 25 to account for its stock-based awards.




**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.




As
      of
      January 1, 2007, the Company adopted the FASB Interpretation No. 48 (“FIN 48”),
*Accounting for Uncertainty in Income Taxes — an Interpretation of FASB
      Statement No. 109 Accounting for Income Taxes*. The current Company policy
      classifies any interest recognized on an underpayment of income taxes as
      interest expense and classifies any statutory penalties recognized on a tax
      position taken as selling, general and administrative expense. There was an
      insignificant amount of interest expense accrued or recognized related to income
      taxes for the twelve months ended December 31, 2007. There was an insignificant
      amount of selling, general and administrative expense recognized for the same
      period. The Company has not taken a tax position that, if challenged, would
      have
      a material effect on the financial statements or the effective tax rate for
      the
      twelve-months ended December 31, 2007, or during the prior three years
      applicable under FIN 48. The Company has determined it is not reasonably
      possible for the amounts of unrecognized tax benefits to significantly increase
      or decrease within twelve months of the adoption of FIN 48. The Company is
      currently subject to a three-year statute of limitations.




**2.
      Acquisition**




On
      August
      18, 2006, the Company acquired all the outstanding common stock of Questa
      Software Systems, Inc. (“Questa”) pursuant to a Stock Purchase Agreement.
      Questa, located in Midland, Texas, was engaged in the development of accounting
      software for the petroleum production industry. The purchase price was
      approximately $2.24 million, subject to certain post-closing adjustments based
      on Questa’s actual working capital as of the closing date. The $2.24 million
      purchase price consisted of:




·  cash
      paid
      to the Sellers in the aggregate amount of $1,790,634;


·  convertible
      promissory notes issued to the Sellers in the aggregate amount of $280,000;


-14-


·  an
      aggregate of 200,000 shares of common stock of the Company issued to the
      Sellers, valued at $0.505 per share in accordance with EITF 99-12, *Determination
      of the Measurement Date for the Market Price of Acquirer Securities Issued
      in a
      Purchase Business Combination* ;
      and


·  transaction
      costs of $67,789.




In
      connection with the execution of the Stock Purchase Agreement, the Company
      entered into a Stock Buyback Agreement with the sellers on August 18, 2006.
      Pursuant to the Stock Buyback Agreement, the Company granted the sellers the
      right and option to sell to the Company all or any portion of the shares on
      the
      first business day five years from the closing date of the acquisition at a
      price of $1.00 per share. As a result, these shares have been classified as
      temporary equity on the balance sheet.




The
      acquisition was financed with a term loan from a financial institution in the
      amount of $476,500, the promissory note to two stockholders in the amount of
      $823,500, the convertible promissory notes issued to the seller’s in the amount
      of $280,000 and the issuance of 200,000 shares of common stock of the
      Company.




The
      acquisition of Questa provides for economies of scale to be achieved by
      eliminating redundant expense items including major development costs,
      solidifies our recurring maintenance revenue stream, and increases the
      professional capacity of our human resources.




Operating
      results of Questa have been included in the Company’s financial statements since
      August 1, 2006, when the Company assumed the risk of loss for Questa’s
      operations, by recording the transaction from that date directly in the accounts
      of the Company.




The
      following table summarizes the initial fair values of the assets acquired and
      liabilities assumed at the date of acquisition based on a preliminary valuation.
      Subsequent adjustments may be recorded upon the completion of the valuation
      and
      the final determination of the purchase price allocation.




Current
                assets
            
            $
            138,116Computers
                and software
            
            
            27,370Furniture
                and fixtures
            
            
            14,379Purchased
                software
            
            
            2,141,702Current
                liabilities
            
            
            (82,144
            )$
            2,239,423




**3.
      Long-term Debt**




**Long-term
      Debt to Financial Institution**




On August
      16, 2006, the Company entered into a Bank Loan Agreement (Loan Agreement) with
      a
      financial institution to provide a promissory note term credit facility (Term
      Loan) for $476,500.




The
      Term
      Loan is payable in 53 monthly principal payments of $7,942 beginning on March
      5,
      2007 and a final payment of the outstanding principal balance on August 5,
      2011.
      Interest on the outstanding principal balance of the note is payable monthly,
      with a final payment on the term maturity date. The note bears interest at
      the
      greater of the prime rate plus three quarters of one percent (0.75%), or nine
      percent (9.0%).




The
      Term
      Loan is collateralized by substantially all of the Company’s assets. The Term
      Loan may be prepaid or terminated at the Company's option at anytime without
      penalty. The Loan Agreement contains certain financial covenants and customary
      default provisions (with grace periods where customary), including, among other
      things, failure to pay any principal or interest when due; any materially false
      or misleading representation, warranty, or financial statement; failure to
      comply with or to perform any provision of the agreement; and default on any
      debt in excess of $500,000.


-15-




In
      connection with the Loan Agreement, Robert C. Shreve, the Company’s Chairman,
      President, Chief Executive Officer and Chief Financial Officer, provided a
      guaranty in favor of the financial institution, pursuant to which Mr. Shreve
      guaranteed up to $676,500 of the Company’s obligations under the Term Loan and
      the Revolving Loan. As consideration for providing this guaranty, the Company
      issued common stock options to purchase 451,000 shares of common stock of the
      Company to Mr. Shreve at an exercise price of $0.505 per share. The options
      were
      fully vested on the date of issuance. The value of the options, using the
      Black-Scholes option pricing model was determined to be $171,018 and was
      recorded as debt issuance costs included in other assets in the accompanying
      balance sheets, and will be amortized as interest expense over the life of
      the
      loan. For the years ended December 31, 2007 and 2006, $53,924 and $19,462
      respectively, were recorded as interest expense in the accompanying statements
      of income and comprehensive income.




At
      December 31, 2007 and 2006, the Company was not in compliance with certain
      financial covenants of the Loan Agreement. The Company has received a waiver
      of
      the requirements at December 31, 2007 and 2006. The Company expects to be in
      compliance with the financial covenants as additional profits are realized
      in
      the future as a result of the acquisition.




**Note
      Payable-Stockholders**




On August
      16, 2006, the Company entered into a loan agreement and promissory note with
      two
      stockholders to provide a promissory note for $823,500. The stockholders own
      approximately 27.1% and 26.6%, respectively, of the outstanding common stock
      of
      the Company.




The
      promissory note is payable in 53 monthly principal payments of $13,725 beginning
      on March 5, 2007 and a final payment of the outstanding principal balance on
      the
      August 5, 2011. Interest on the outstanding principal balance of the note is
      payable monthly, with a final payment on the term maturity date. The note bears
      interest at the greater of the prime rate plus three quarters of one percent
      (0.75%), or nine percent (9.0%).




The
      promissory note is collateralized by substantially all of the Company’s assets
      and is subordinated to the Term Loan from the financial institution. The
      stockholder note payable may be prepaid or terminated at the Company's option
      at
      anytime without penalty. The loan agreement contains certain financial covenants
      and customary default provisions (with grace periods where customary),
      including, among other things, failure to pay any principal or interest when
      due; any materially false or misleading representation, warranty, or financial
      statement; failure to comply with or to perform any provision of the agreement;
      and default on any debt in excess of $500,000.




As
      consideration for providing the loan agreement and the promissory note, the
      Company issued common stock options to purchase 274,500 shares of common stock
      of the Company to the each of the stockholders at an exercise price of $0.505
      per share. The options were fully vested on the date of issuance . The
      value
      of the options, using the Black-Scholes option pricing model was determined
      to
      be $208,179 and was recorded as a discount to the related debt and will be
      amortized as interest expense over the life of the loan. For the years ended
      December 31, 2007 and 2006, $65,643 and $23,690, respectively, were recorded
      as
      interest expense in the accompanying statement of income and comprehensive
      income.




At
      December 31, 2007 and 2006, the Company was not in compliance with certain
      financial covenants of the loan agreement. The Company has received a waiver
      of
      the requirements at December 31, 2007 and 2006. The Company expects to be in
      compliance with the financial covenants as additional profits are realized
      in
      the future as a result of the acquisition.




**Convertible
      Notes Payable-Stockholders**




On
      August
      18, 2006, as
      partial consideration for the acquisition, the Company issued convertible
      promissory notes to the sellers of Questa (the “Seller Promissory Notes”) in the
      amounts of $120,000 and $160,000. Accrued and unpaid interest on the Seller
      Promissory Notes is payable for a period of five years following the date of
      the
      note in twenty quarterly installments commencing on September 30, 2006 and
      continuing on the last day of each third calendar month. Thereafter, principal
      and accrued interest on the notes is payable in twelve equal quarterly
      installments commencing on the fifth anniversary of the notes, and continuing
      thereafter on the last day of each third calendar month, with the final
      installment of the unpaid principal balance and all accrued and unpaid interest
      due eight years from the date of the notes.


-16-




The
      outstanding principal balances of the Seller Promissory Notes are convertible,
      at the option of the holders, in whole or in part and at any time or from time
      to time, into shares of common stock of the Company at a conversion price of
      $3.50 per share, as adjusted from time to time for stock splits, combinations,
      stock dividends and other similar events.




The
      Seller Promissory Notes is unsecured and may be prepaid at the Company's option
      at anytime without penalty, provided that, after the Company notifies the
      holders that the outstanding principal balance will be repaid and the date
      of
      such prepayment fifteen days in advance. The holders have the option during
      the
      fifteen days to convert all or any portion of the outstanding principal balance
      of the Seller Promissory Notes in accordance with the conversion features of
      the
      notes.




**4.
      Temporary Equity**




On
      August
      18, 2006, the Company issued 200,000 shares of its common stock to the sellers
      of Questa, in connection with the execution of a Stock Purchase Agreement to
      acquire Questa. The Company entered into a Stock Buyback Agreement with the
      sellers on August 18, 2006. Pursuant to the Stock Buyback Agreement, the Company
      granted the sellers the right and option to sell to the Company all or any
      portion of the shares on the first business day five years from the closing
      date
      of the acquisition at a price of $1.00 per share. The shares were valued at
      $0.505 per share in accordance with EITF 99-12, and because of the potential
      obligation to repurchase the shares on August 18, 2011; the shares were recorded
      as temporary equity in accordance with EITF Topic No. 98, *Classification
      and Measurement of Redeemable Securities*


-17-




**5.
      Stock Options**




**2000
      Stock Compensation Plan**




The
      2000
      Stock Compensation Plan authorizes the grant of up to 1,500,000 shares of the
      Company’s common stock in the form of incentive stock options (“ISOs”), and, the
      plan provides that: (i) the exercise price of an ISO must be no less than the
      fair value of the stock at the date of grant and (ii) the exercise price of
      an
      ISO held by an optionee who possesses more than 10% of the total combined voting
      power of all classes of stock must be no less than 110% of the fair market
      value
      of the stock at the time of grant. The Compensation Committee of the Board
      of
      Directors has the authority to set expiration dates no later than ten years
      from
      the date of grant (or five years for an optionee who meets the 10% criteria),
      payment terms and other provisions for each grant. Shares associated with
      unexercised options or reacquired shares of common stock become available for
      options or issuances. The Compensation Committee of the Board of Directors
      may,
      at its sole discretion, accelerate or extend the date or dates on which all
      or
      any particular award or awards granted under the plan may vest or be exercised.
      In the event of a merger, liquidation or sale of substantially all of the assets
      of the Company, the Board of Directors has the discretion to accelerate the
      vesting of the options granted under the plan. At the discretion of the
      Compensation Committee, any option may include a “reload” feature. Such feature
      allows an optionee exercising an option to receive, in addition to the number
      of
      shares of common stock due on the exercise, an additional option with an
      exercise price equal to the fair market value of the common stock on the date
      such additional option is granted.




The
      fair
      value of each option grant is estimated on the date of grant using the
      Black-Scholes Option Pricing Model (“BSOPM”) which was developed for use in
      estimating the fair value of traded options that have no vesting restrictions
      and are fully transferable. The Company’s options have characteristics
      significantly different from those of traded options, and changes in input
      assumptions can materially affect the fair value estimates. The
      Company’s determination of fair value of share-based payment awards on the date
      of grant using an option-pricing model is affected by the Company’s stock price
      as well as assumptions regarding a number of highly complex and subjective
      variables.




The
      fair
      value of options that were granted under the 2000 Stock Compensation Plan during
      the year ended December 31, 2006 was $0.47 per share. The fair values of options
      granted were estimated using the Black-Scholes pricing model with a weighted
      average risk-free interest rate of 4.75%. The following assumptions were also
      used to determine the fair value of each option grant: dividend yields of 0%;
      weighted average expected volatility of 137.3 %, a weighted average expected
      term of 6.5 years, and an expected forfeiture rate of 67% based on the Company’s
      historical experience. The volatility was determined based on the historic
      volatility of the Company’s stock for the length of the expected term of the
      options.




At
      December 31, 2007, total unrecognized estimated compensation cost related to
      non-vested stock options granted prior to that date was $21,202, which will
      be
      recognized during 2008. There were no 2000 Stock Compensation Plan options
      exercised during the year ended December 31, 2007.




Information
      regarding the 2000 Stock Compensation Plan option transactions for the year
      ended December 31, 2007 is summarized below:




Options
            
            Weighted
              Average
              Exercise
              Price
            
            Weighted
              Average
              Remaining
              Contractual Term
              (years)Options
                outstanding at beginning of year
            
            
            276,477
            
            $
            0.611
            
            
            -Options
                granted
            
            
            -
            
            
            -
            
            
            -Options
                exercised
            
            
            -
            
            
            -
            
            
            -Options
                forfeited
            
            
            (18,000
            )
            $
            0.505
            
            
            -Options
                outstanding at December 31, 2007
            
            
            258,477
            
            $
            0.619
            
            
            7.74Options
                exercisable at December 31, 2007
            
            
            185,477
            
            $
            0.664
            
            
            7.39


-18-




Information
      regarding the 2000 Stock Compensation Plan options outstanding as of December
      31, 2007 is summarized below:




Options
                Outstanding
            
            Options
                ExercisableExercisePrice
            
            Options
            
            Weighted
              Average
              Remaining
              Contractual
              Life
              (years)
            
            Weighted
              Average
              Exercise
              Price
            
            Aggregate
              Intrinsic
              Value
            
            Options
            
            Weighted
              Average
              Exercise
              Price
            
            Aggregate
              Intrinsic
              Value$ 1.250
            
            
            39,477
            
            
            2.78
            
            $
            1.250
            
            $
            -
            
            
            39,477
            
            $
            1.250
            
            $
            -$ 0.505
            
            
            219,000
            
            
            8.64
            
            $
            0.505
            
            $
            9,855
            
            
            146,000
            
            $
            0.505
            
            $
            6,570




**Nonqualified
      Stock Options**




As
      previously indicated under Note H, Robert C. Shreve, Jr., the Company’s
      Chairman, President, Chief Executive Officer and Chief Financial Officer,
      provided a guaranty in favor of a financial institution, pursuant up to $676,500
      of the Company’s obligations under the Term Loan and the Revolving Loan for the
      Questa acquisition. As consideration for providing this guaranty, the Company
      issued common stock options to purchase 451,000 shares of common stock of the
      Company to Mr. Shreve at an exercise price of $0.505 per share. The options
      were
      fully vested on the date of issuance.




The
      Company also issued, as consideration for providing a loan agreement and
      promissory note in connection with the Questa acquisition, common stock options
      to purchase 274,500 shares of common stock of the Company to two
      stockholders at an exercise price of $0.505 per share. The options were fully
      vested on the date of issuance.




The
      Nonqualified Stock Option Agreement provides that the option price is $0.505,
      and the optioned shares are fully vested and fully exercisable. The option
      period commences on August 16, 2006 and expires on August 16, 2013, unless
      earlier terminated by the grantee’s termination of service, death, disability,
      failure to pay the exercise price, or makes an assignment of the option without
      written consent of the Company. In the event of a merger, liquidation or sale
      of
      substantially all of the assets of the Company, the option shall pertain to
      and
      apply to the securities or rights to which a holder of the number of shares
      of
      common stock subject to this option would have been entitled. The option may
      be
      canceled by the Company, in its sole discretion, as of the effective date of
      any
      change of control, merger, consolidation or share exchange, or any issuance
      of
      bonds, debentures, preferred or preference stocks ranking prior to or otherwise
      affecting the common stock, or the rights thereof, or of any proposed sale
      of
      all or substantially all of the assets of the Company, or of any dissolution
      or
      liquidation of the Company, by either: (i) giving notice to grantee of its
      intention to cancel the optioned shares for which the issuance of shares of
      common stock involved payment by grantee for such shares and, permitting the
      purchase during the 30 day period next preceding such effective date of any
      or
      all of the shares of common stock subject to this option; or (ii) paying grantee
      an amount equal to a reasonable estimate of the difference between the net
      amount per share payable in such transaction or as a result of such
      transaction.




The
      fair
      value of each option grant is estimated on the date of grant using the
      Black-Scholes Option Pricing Model (“BSOPM”) which was developed for use in
      estimating the fair value of traded options that have no vesting restrictions
      and are fully transferable. The Company’s options have characteristics
      significantly different from those of traded options, and changes in input
      assumptions can materially affect the fair value estimates. The Company’s
      determination of fair value of share-based payment awards on the date of grant
      using an option-pricing model is affected by the Company’s stock price as well
      as assumptions regarding a number of highly complex and subjective
      variables.




The
      fair
      value of non-qualified stock options that were granted during the year ended
      December 31, 2006 was $0.38 per share. The fair values of options granted were
      estimated using the Black-Scholes pricing model with a risk-free interest rate
      of 4.75%. The following assumptions were also used to determine the fair value
      of each option grant: dividend yields of 0%; expected volatility of 117.7%,
      and
      an expected term of 3.5 years. The volatility was determined based on the
      historic volatility of the Company’s stock for the length of the expected term
      of the options.


-19-




Information
      regarding non-qualified stock option transactions for the year ended December
      31, 2007 is summarized below:




Options
            
            Weighted
              Average
              Exercise
              Price
            
            Weighted
              Average
              Remaining
              Contractual Term
              (years)Options
                outstanding at beginning of year
            
            
            1,000,000
            
            $
            0.505
            
            
            -Options
                granted
            
            
            -
            
            
            -
            
            
            -Options
                exercised
            
            
            -
            
            
            -
            
            
            -Options
                forfeited
            
            
            -
            
            
            -
            
            
            -Options
                outstanding at December 31, 2007
            
            
            1,000,000
            
            $
            0.505
            
            
            5.63Options
                exercisable at December 31, 2007
            
            
            1,000,000
            
            $
            0.505
            
            
            5.63




Information
      regarding non-qualified stock options outstanding as of December 31, 2007 is
      summarized below:




Options
                Outstanding
            
            Options
                ExercisableExercise Price
            
            Options
            
            Weighted
              Average
              Remaining
              Contractual
              Life
              (years)
            
            Weighted
              Average
              Exercise
              Price
            
            Aggregate
              Intrinsic
              Value
            
            Options
            
            Weighted
              Average
              Exercise
              Price
            
            Aggregate
              Intrinsic
              Value$ 0.505
            
            
            1,000,000
            
            
            5.63
            
            $
            0.505
            
            $
            45,000
            
            
            1,000,000
            
            $
            0.505
            
            $
            45,000




**6.
      Stock Based Compensation**




Effective
      January 1, 2006, the Company adopted SFAS 123R for stock-based compensation
      plans. Under SFAS 123R, all stock-based compensation is measured at the grant
      date, based on the fair value of the award, and is recognized as an expense
      in
      the statements of income and
      other
      comprehensive incomeover the requisite service period.




The
      Company adopted SFAS 123R using a modified prospective application in compliance
      with the revised implementation date on January 1, 2006. Under the modified
      prospective application, prior periods are not revised for comparative purposes.
      The valuation provisions of SFAS 123R apply to new awards and to awards that
      were outstanding at the effective date and subsequently modified or
      cancelled.




The
      fair
      value of each option grant is estimated on the date of grant using the BSOPM,
      which was developed for use in estimating the fair value of traded options
      that
      have no vesting restrictions and are fully transferable. The weighted-average
      fair value of options that were granted during the year ended December 31,
      2006
      was $0.40 per share. The Company’s options have characteristics significantly
      different from those of traded options, and changes in input assumptions can
      materially affect the fair value estimates. The fair values of options granted
      were estimated using the Black-Scholes pricing model with a weighted average
      risk-free interest rate of 4.75%. The following assumptions were also used
      to
      determine the fair value of each option grant: dividend yields of 0%; weighted
      average expected volatility of 122.1%, a weighted average expected term of
      4.18
      years, and an expected forfeiture rate of 67% based on the Company’s historical
      experience. The volatility was determined based on the historic volatility
      of
      the Company’s stock for the length of the expected term of the options.




Share-based
      compensation expense included in general and administrative expenses and
      share-based interest expense for options issued in connection with the
      stockholder debt and debt issuance costs recognized for the year ended December
      31, 2007 and 2006 were as follows:


-20-




December
                31,2007
            
            2006Operating
                expenses:General
                and administrative (employee related options)
            
            $
            83,943
            
            $
            7,341Other
                income (expense):Interest
                expense
            
            
            119,567
            
            
            43,152Share-based
                expense before taxes
            
            
            203,510
            
            
            50,493Related
                income tax benefits
            
            
            (69,194
            )
            
            (17,168
            )Share-based
                expense, net of taxes
            
            $
            134,316
            
            $
            33,325




In
      the
      fourth quarter of 2007, the Company recorded a total of $69,000 in adjustments
      to stock compensation expense, which consisted principally of a prior-period
      adjustment of $53,000. The prior period adjustment related to options that
      were
      vested on the grant date. The Company determined that the adjustment would
      have
      an immaterial effect to the Company’s financial statements for the respective
      twelve-month periods ended December 31, 2006 and 2007, based upon management’s
      qualitative and quantitative analysis relative to its materiality consistent
      with the appropriate accounting guidance. The remaining adjustments related
      primarily to an interim period change in forfeiture rates.




Robert
      C.
      Shreve, Jr., the Company’s Chairman, President, Chief Executive Officer and
      Chief Financial Officer, provided a guaranty in favor of a financial
      institution, pursuant to which Mr. Shreve guaranteed up to $676,500 of the
      Company’s obligations under the Term Loan and the Line-of-Credit. As
      consideration for providing this guaranty, the Company issued common stock
      options to purchase 451,000 shares of common stock of the Company to Mr. Shreve
      at an exercise price of $0.505 per share. The options were fully vested on
      the
      date of issuance. The value of the options, using the BSOPM model was determined
      to be $171,018 and was recorded as debt issuance costs included in other assets
      in the accompanying balance sheets, and will be amortized as interest expense
      over the life of the loan. The Company recorded $53,924 and $19,462 as interest
      expense to reflect the amortization of the debt issuance costs for the period
      ended December 31, 2007 and 2006, respectively.




The Company
      entered into a loan agreement and promissory note with two stockholders to
      provide a promissory note for $823,500. The stockholders own approximately
      27.1%
      and 26.6%, respectively, of the outstanding common stock of the Company. As
      consideration for providing the loan agreement and the promissory note, the
      Company issued common stock options to purchase 274,500 shares of common stock
      of the Company to the each of the stockholders at an exercise price of $0.505
      per share. The options were fully vested on the date of issuance. The value
      of
      the options, using the Black-Scholes option pricing model was determined to
      be
      $208,179 and was recorded as a discount to the related debt and will be
      amortized as interest expense over the life of the loan. The Company recorded
      $65,643 and $23,690 as interest expense to reflect the amortization of the
      debt
      issuance costs for the period ended December 31, 2007 and 2006,
      respectively.




**Results
      of Operations**




**Revenue**




Year
                ended December 31,
            
            Change2007
            
            2006
            
            Amount
            
            %Software
            
            $
            843,920
            
            $
            816,688
            
            $
            27,232
            
            
            3.3Maintenance
            
            
            2,639,498
            
            
            1,825,639
            
            
            813,859
            
            
            44.6Professional
                services
            
            
            618,154
            
            
            686,547
            
            
            (68,393
            )
            
            (10.0
            )Hardware
            
            
            817,408
            
            
            326,579
            
            
            490,829
            
            
            150.3Total
                revenue
            
            $
            4,918,980
            
            $
            3,655,453
            
            $
            1,263,527
            
            
            34.6




Our
      revenue includes four components: software licensing fees, maintenance,
      professional services, and hardware. Our
      revenues for the year ended December 31, 2007 increased 34.6% to $4,918,980
      compared with revenues of $3,655,453 for the year ended December 31, 2006.
      Our
      overall revenues were primarily affected by the additional maintenance revenue
      related to the acquisition of Questa, increases in our ASP revenues, and a
      large
      hardware sale in December.


-21-




**Software**




·
            Software
                sales for the year ended December 31, 2006 increased 3.3% to $843,920
                from
                $816,688 in 2006.




·
            Sales
                of our Integra and AS400 products increased $126,132 and $29,725,
                respectively, but were offset by decreases of $81,319 and $23,848
                in our
                Petroware2000 and iSynergy
                products.




·
            Petroware2000
                and iSynergy licensed products sales were unusually strong in 2006.
                Demand
                was higher for our Petroware2000 ASP services in
                2007.




**Maintenance**




·
            Maintenance
                revenue for the year ended December 31, 2007 increased 44.6% to $2,639,498
                compared with maintenance revenue of $1,825,639 in
                2006.




·
            Maintenance
                revenue was primarily impacted by the addition of Questa revenue
                of
                $551,475 followed by an increase in Petroware of $118,858, which
                was
                driven by higher Petroware ASP revenue, and a CPI increase provided
                for in
                our maintenance contracts.




·
            Maintenance
                revenue increased $55,148 as result of a price increase on the database
                component of our Petroware2000
                product.




·
            AS400
                maintenance increased $25,029 due to the CPI price increase provided
                for
                in our maintenance contracts. AS400 maintenance should increase in
                2008
                because of a contract that was closed in December of
                2007.




**Professional
      services**




·
            Professional
                service revenue for the year ended December 31, 2007 decreased 10.0%
                to
                $618,154 compared to $686,547 in
                2006.




·
            The
                decrease in professional services revenue of $68,393 was due primarily
                to
                lower demand for custom programming
                services.




·
            Custom
                programming services related to Integra and Petroware products decreased
                $30,712 and $25,877, respectively.




**Hardware**




·
            Hardware
                sales for the year ended December 31, 2007 increased 150.3% to $817,408
                compared with hardware sales of $326,579 in
                2006.




·
            The
                increase in hardware sales of $490,829 was primarily the result of
                a large
                sale completed to one customer during December of
                2007.




·
            Hardware
                sales related to our document imaging product decreased $43,548 after
                unusually strong sales in 2006.




**Cost
      of Revenue**




Year
                ended December 31,
            
            Change2007
            
            2006
            
            Amount
            
            %Software
            
            $
            167,827
            
            $
            324,008
            
            $
            (156,181
            )
            
            (48.2
            )Maintenance
            
            
            504,782
            
            
            388,277
            
            
            116,505
            
            
            30.0Professional
                services
            
            
            213,790
            
            
            161,546
            
            
            52,244
            
            
            32.3Hardware
            
            
            595,154
            
            
            266,655
            
            
            328,499
            
            
            123.2Total
                cost of revenue
            
            $
            1,481,553
            
            $
            1,140,486
            
            $
            341,067
            
            
            29.9


-22-




Our
      cost
      of revenue includes four components: cost of software, cost of maintenance
      revenue, cost of professional services, and cost of hardware sales. Our cost
      of
      revenue for the year ended December 31, 2007 increased 29.9% to $1,481,553
      compared with $1,140,486 in 2006. Cost of revenue as a percentage of total
      revenue decreased to 30.1% for the year ended December 31, 2007 from 31.2%
      in
      2006. The overall increase in cost of revenue was directly related to the
      increase in hardware sales.




**Software**




·
            Cost
                of software sales for the year ended December 31, 2007 decreased
                48.2% to
                $167,827 from $324,008 in 2006.




·
            Cost
                of software sales was lower primarily due to lower commissions in
                relation
                to Petroware2000 licensed software sales of
                $83,514.




·
            The
                primary supplier of our database component has changed their pricing
                structure so that the database is now available for distribution
                to us at
                no cost.




·
            Sales
                commissions on our AS400 software were $20,997
                lower.




·
            Our
                cost of providing document imaging services was $18,038 lower due
                to lower
                software sales.




·
            Cost
                of software as a percentage of the related revenue decreased to 19.9%
                for
                the year ended December 31, 2007 from 39.7% in
                2006.




**Maintenance**




·
            Cost
                of maintenance revenue for the year ended December 31, 2007 increased
                30.0% to $504,782 compared with $388,277 in
                2006.




·
            Cost
                of maintenance revenue increased due to higher personnel costs of
                $77,206,
                commission on ASP sales of $36,268, and data center utilities of
                $12,956
                offset by a reduction in ASP hardware rental of $9,491. These costs
                increased in relation to higher revenues from ASP
                services.




·
            Cost
                of maintenance as a percentage of the related revenue decreased to
                19.1%
                for the year ended December 31, 2007 from 21.3% in 2006.




**Professional
      Services**




·
            Cost
                of professional services for the year ended December 31, 2007 increased
                32.3% to $213,790 compared with $161,546 in
                2006.




·
            Cost
                of professional services increased due to higher salaries of $39,116
                and
                commissions of $30,610 offset by lower outsourced services of
                $18,240.




·
            Cost
                of professional services as a percentage of the related revenue increased
                to 34.6% for 2007 and 23.5% in
                2006.




**Hardware**




·
            Cost
                of hardware sales for the year ended December 31, 2007 increased
                123.2% to
                $595,154 compared with $266,655 in
                2006.




·
            The
                increase in cost of hardware sales is directly attributable to the
                increase in hardware sales.




·
            Cost
                of hardware as a percentage of the related revenue decreased to 72.8%
                for
                2007 compared to 81.7% 2006 due to better
                margins.




-23-




**Operating
      Expenses**




Year
                ended December 31,
            
            Change2007
            
            2006
            
            Amount
            
            %Sales
                and marketing
            
            $
            474,398
            
            $
            453,411
            
            $
            20,987
            
            
            4.6General
                and administrative
            
            
            1,204,569
            
            
            765,484
            
            
            439,085
            
            
            57.4Amortization
            
            
            763,091
            
            
            536,057
            
            
            227,034
            
            
            42.4Depreciation
            
            
            206,622
            
            
            223,661
            
            
            (17,039
            )
            
            (7.6
            )Total
                operating expenses
            
            $
            2,648,680
            
            $
            1,978,613
            
            $
            670,067
            
            
            33.9




Sales
      and
      Marketing




·
            Our
                sales and marketing expenses for the year ended December 31, 2007
                increased 4.6% to $474,398 compared with $453,411 in
                2006.




·
            The
                increase in sales and marketing expenses was related primarily an
                increase
                in marketing salaries of $18,985.




·
            Sales
                and marketing expenses as a percentage of total revenues decreased
                to 9.6%
                for 2007 compared with 12.4% for
                2006.




**General
      and Administrative**




·
            Our
                general and administrative expenses for the year ended December 31,
                2007
                increased 57.4% to $1,204,569 compared with $765,484 in 2006.




·
            General
                and administrative costs increased due to higher salaries of $205,880;
                an
                increase in bad debts of $73,789; $63,376 in accounting and auditing
                costs; $40,176 in healthcare insurance costs; $37,082 in telephone
                expense; and net costs incurred of $22,559 for an annual user
                conference.




·
            General
                and administrative expenses as a percentage of total revenues increased
                to
                24.5% for the year ended December 31, 2007 compared with 20.9% in
                2006.




**Amortization**




·
            Amortization
                expense increased 42.4% to $763,091 for the year ended December 31,
                2007
                from $536,057 in 2006.




·
            The
                increase in amortization expense of $227,034 included an additional
                $178,475 for a full year of amortization related to the Questa
                purchase.




·
            Amortization
                expense as a percentage of total revenue increased to 15.5% in 2007
                compared with 14.7% in 2006.




**Depreciation**




·
            Depreciation
                expense decreased 7.6% to $206,622 for the year ended December 31,
                2007
                from $223,661 in 2006.




·
            Depreciation
                expense as a percentage of total revenues decreased to 4.2% in 2007
                compared with 6.1% in 2006.




-24-






**Other
      Income (Expense)**




Year ended December 31,
            
            Change2007
            
            2006
            
            Amount
            
            %Investment
                income
            
            $
            19,061
            
            $
            22,768
            
            $
            (3,707
            )
            
            (16.3
            )Gain
                (loss) on sales of marketable securities
            
            
            (546
            )
            
            18,022
            
            
            (18,568
            )
            
            (103.0
            )Interest
                expense
            
            
            (269,592
            )
            
            (113,876
            )
            
            (155,716
            )
            
            136.7Total
                other expense
            
            $
            (251,077
            )
            $
            (73,086
            )
            $
            (177,991
            )
            
            243.5




**Investment
      Income**






·
            Investment
                income was $19,061 for the year ended December 31, 2007 compared
                to
                $22,768 in 2006.




**Gain
      (loss) on sales of marketable securities**




·
            We
                realized a gain on investments of $18,022 during the year ended December
                31, 2006. The gain was realized when we liquidated investments that
                we had
                earmarked for acquisitions. We sold the investments to complete the
                Questa
                acquisition.




**Interest
      Expense**




December
      31, 2007 interest expense was as follows:




Stated
              Interest on
              Notes
            
            Discount
              Amortization
            
            Financing
              Cost
              Amortization
            
            Total
              Interest
              ExpenseLine
                of credit
            
            $
            13,274
            
            $
            -
            
            $
            -
            
            $
            13,274Capital
                lease obligations
            
            
            9,720
            
            
            -
            
            
            -
            
            
            9,720Long-term
                promissory notes
            
            
            40,306
            
            
            -
            
            
            57,389
            
            
            97,695Notes
                payable-stockholders
            
            
            68,453
            
            
            65,643
            
            
            -
            
            
            134,096Convertible
                notes payable-stockholders
            
            
            11,356
            
            
            -
            
            
            -
            
            
            11,356Other
            
            
            3,451
            
            
            -
            
            
            -
            
            
            3,451Total
                interest expense
            
            $
            146,560
            
            $
            65,643
            
            $
            57,389
            
            $
            269,592




December
      31, 2006 interest expense was as follows:




Stated
              Interest on
              Notes
            
            Discount
              Amortization
            
            Financing
              Cost
              Amortization
            
            Total
              Interest
              ExpenseLine
                of credit
            
            $
            5,077
            
            $
            -
            
            $
            -
            
            $
            5,077Capital
                lease obligations
            
            
            9,949
            
            
            -
            
            
            -
            
            
            9,949Long-term
                promissory notes
            
            
            18,661
            
            
            -
            
            
            19,462
            
            
            38,123Notes
                payable-stockholders
            
            
            28,411
            
            
            23,690
            
            
            -
            
            
            52,101Convertible
                notes payable-stockholders
            
            
            4,200
            
            
            -
            
            
            -
            
            
            4,200Other
            
            
            4,426
            
            
            -
            
            
            -
            
            
            4,426Total
                interest expense
            
            $
            70,724
            
            $
            23,690
            
            $
            19,462
            
            $
            113,876




-25-




**Provision
      for Income Taxes**




·
            For
                the years ended December 31, 2007 and 2006, we recorded income tax
                expense
                of 182,808 and $157,511 based on our pretax income of $537,670 and
                $463,268, respectively using an effective tax rate of 34%, which
                was our
                anticipated effective tax rate. The actual effective tax rate for
                the
                entire fiscal year could vary substantially depending on actual results
                achieved.




**Liquidity
      and Capital Resources**




Our
      cash
      and cash equivalents and marketable securities at December
      31, 2007 were $1,083,625 compared with $717,162 at December 31, 2006. Cash
      flows
      for the year ended December 31, 2007 were impacted positively by cash we
      collected from recurring maintenance agreements, software, and hardware sales.
      These cash flows were offset by additions to software development costs,
      purchases of computer equipment, and principal payments on debt.




**Cash
      flows from Operating Activities**




Our
      cash
      flows from operating activities represent the most significant source of funding
      for our operations. Operating activities provided cash flows of $1,688,093
      and
      $1,324,891 for the years ended December 31, 2007 and 2006,
      respectively.




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 primarily to the stability of our recurring maintenance revenues,
      but it will be impacted by fluctuations in software sales, hardware sales,
      and
      debt service requirements.




**Cash
      Flows from Investing Activities**




Net
      cash
      used in investing activities for year ended December 31, 2007 of $1,030,950
      included $978,611 in capitalized software development costs, purchases of
      computer equipment of $70,533, and net marketable securities sold of
      $18,194.




Net
      cash
      used in investing activities for the year ended December 31, 2006 of $2,652,837
      consisted of capitalized software development costs of $754,852, purchases
      of
      property and equipment of $153,693 and $1,810,548 for the acquisition of Questa,
      less net marketable securities sold of $66,256.




**Cash
      Flows from Financing Activities**




Net
      cash
      used in financing activities for the year ended December 31, 2007 of $272,418
      was for principal payments on capital lease obligations of $32,645, principal
      payments on long-term debt of $102,523, and principal payments on notes payable
      - stockholders of $137,250.




Net
      cash
      provided from financing activities for the year ended December 31, 2006 was
      $1,392,937. Cash was provided by a line-of-credit for $145,067, issuance of
      long-term debt of $476,500 to a financial institution, and issuance of notes
      payable to stockholders of $823,500. Cash was applied to capital lease
      obligations and long-term debt totaling $52,130.




**Working
      Capital**




At
      December 31, 2007, we had a working capital surplus of $126,743 up from a
      deficit working capital position of $16,877 at December 31, 2006. The increase
      in working capital is attributable primarily to net income of $354,862 offset
      by
      a decrease in long-term debt of $233,657. We currently have no significant
      capital commitments other than commitments under our capital lease obligations,
      notes payable and operating leases.




-26-




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
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* (“SFAS
      157”). SFAS 157 defines fair value, establishes a market-based framework or
      hierarchy for measuring fair value, and expands disclosures about fair value
      measurements. SFAS 157 is applicable whenever another accounting pronouncement
      requires or permits assets and liabilities to be measured at fair value. SFAS
      157 does not expand or require any new fair value measures; however, the
      application of this statement may change current practice. The requirements
      of
      SFAS 157 are first effective for the Company’s fiscal year beginning January 1,
      2008. However, in February 2008 the FASB decided that an entity need not apply
      this standard to nonfinancial assets and liabilities that are recognized or
      disclosed at fair value in the financial statements on a nonrecurring basis
      until the subsequent year. Accordingly, the Company’s adoption of this standard
      on January 1, 2008, is limited to financial assets and liabilities. The Company
      does not believe the initial adoption of SFAS 157 will have a material effect
      on
      its financial condition or results of operations. However, the Company is still
      in the process of evaluating this standard with respect to its effect on
      nonfinancial assets and liabilities and therefore has not yet determined the
      impact that it will have on the Company’s financial statements upon full
      adoption




In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities Including
      an
      Amendment of FASB Statement No. 115* .
      The
      fair value option permits entities to choose to measure eligible financial
      instruments at fair value at specified election dates. The entity will report
      unrealized gains and losses on the items on which it has elected the fair value
      option in earnings. SFAS 159 is effective beginning in fiscal year 2008. The
      Company is currently evaluating the effect of adopting SFAS 159, but does not
      expect it to have a material impact on its results of operations or financial
      condition.




In
      December 2007, the SEC issued Staff Accounting Bulletin (“SAB”) 110, *Share-Based
      Payment* .
      SAB 110
      amends and replaces Question 6 of Section D.2 of Topic 14, “Share-Based
      Payment,” of the Staff Accounting Bulletin series. Question 6 of Section D.2 of
      Topic 14 expresses the views of the staff regarding the use of the “simplified”
method in developing an estimate of the expected term of “plain vanilla” share
      options and allows usage of the “simplified” method for share option grants
      prior to December 31, 2007. SAB 110 allows public companies which do not have
      historically sufficient experience to provide a reasonable estimate to continue
      use of the “simplified” method for estimating the expected term of “plain
      vanilla” share option grants after December 31, 2007. SAB 110 is effective
      January 1, 2008. The Company currently uses the “simplified” method to estimate
      the expected term for share option grants, as it does not have enough historical
      experience to provide a reasonable estimate. The Company will continue to use
      the “simplified” method until it has enough historical experience to provide a
      reasonable estimate of expected term in accordance with SAB 110. The Company
      does not expect SAB 110 will have a material impact on its balance sheets,
      statements of income and comprehensive income and cash flows.




In
      December 2007, the FASB issued Statement No. 141R, *Business
      Combinations* ,
      and
      Statement No. 160, *Non-controlling
      Interests in Consolidated Financial Statements, an amendment of ARB No.
      51* .
      Statement No. 141R modifies the accounting and disclosure requirements for
      business combinations and broadens the scope of the previous standard to apply
      to all transactions in which one entity obtains control over another business.
      Statement No. 160 establishes new accounting and reporting standards for
      non-controlling interests in subsidiaries. The Company will be required to
      apply
      the provisions of the new standards in the first quarter of 2009. Early adoption
      is not permitted for these new standards.




-27-




**Item
      7. Financial Statements**




Avatar
      Systems, Inc.


Index
      to
      Financial Statements





Report
                of Independent Registered Public Accounting Firm
            
            
            F-1Financial
                StatementsBalance
                Sheets as of December 31, 2007 and 2006
            
            
            F-2Statements
                of Income and Comprehensive Income for the years ended December 31,
                2007
                and 2006
            
            
            F-3Statements
                of Changes in Stockholders’ Equity for the years ended December 31, 2007
                and 2006
            
            
            F-4Statements
                of Cash Flows for the years ended December 31, 2007 and
                2006
            
            
            F-5Notes
                to Financial Statements
            
            
            F-6
                to F-34


-28-


Financial
      Statements and Report of Independent Registered Public Accounting
      Firm




Avatar
      Systems, Inc.




December
      31, 2007 and 2006




-29-





REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To
      the
      Board of Directors and Stockholders of


Avatar
      Systems, Inc.





We
      have
      audited the accompanying balance sheets of Avatar Systems, Inc., as of December
      31, 2007 and 2006 and the related statements of income and comprehensive income,
      changes in stockholders’ equity, and cash flows for the years 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 audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. The Company is not required to
      have, nor were we engaged to perform, an audit of its internal control over
      financial reporting. An audit includes consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company's internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements, assessing the accounting principles used and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of Avatar Systems, Inc. as of December
      31, 2007 and 2006, and the results of its operations and its cash flows for
      the
      years then ended, in conformity with accounting principles generally accepted
      in
      the United States of America.




/s/
      Whitley Penn LLP




Dallas,
      Texas


April
      4,
      2008




F-1





Avatar
      Systems, Inc.


**BALANCE
      SHEETS**




December
                312007
            
            2006**ASSETS****CURRENT
                ASSETS**Cash
                and cash equivalents
            
            $
            706,772
            
            $
            322,047Marketable
                securities
            
            
            376,853
            
            
            395,115Accounts
                receivable
            
            
            518,376
            
            
            351,570Prepaid
                expenses and other current assets
            
            
            39,421
            
            
            31,499Deferred
                income taxes
            
            
            -
            
            
            16,853**Total
                current assets**
            
            
            1,641,422
            
            
            1,117,084**PROPERTY
                AND EQUIPMENT**,
                net of accumulated depreciation****of
                $695,626 and $489,004, respectively
            
            
            330,925
            
            
            456,514**PURCHASED
                SOFTWARE,**net
                of accumulated amortization****of
                $1,295,101 and $989,144, respectively
            
            
            1,708,262
            
            
            2,014,219**SOFTWARE
                DEVELOPMENT COSTS,**net of accumulated amortization****of
                $2,236,256 and $1,779,122, respectively
            
            
            3,273,894
            
            
            2,752,417**OTHER
                ASSETS, net**
            
            
            116,486
            
            
            173,876**Total
                assets**
            
            $
            7,070,989
            
            $
            6,514,110**LIABILITIES,
                TEMPORARY EQUITY AND****PERMANENT
                STOCKHOLDERS' EQUITY****CURRENT
                LIABILITIES**Accounts
                payable
            
            $
            200,637
            
            $
            273,504Accrued
                expenses
            
            
            203,101
            
            
            161,678Line-of-credit
            
            
            145,067
            
            
            145,067Federal
                income taxes payable
            
            
            162,385
            
            
            -Current
                maturities of capital lease obligations
            
            
            21,016
            
            
            32,335Current
                maturities of long-term debt
            
            
            95,300
            
            
            88,165Current
                maturities of notes payable-stockholders
            
            
            113,174
            
            
            71,608Deferred
                revenue
            
            
            568,562
            
            
            361,604Deferred
                income taxes
            
            
            5,437
            
            
            -**Total
                current liabilities**
            
            
            1,514,679
            
            
            1,133,961**DEFERRED
                INCOME TAXES**
            
            
            569,035
            
            
            587,684**OTHER
                LONG-TERM LIABILITIES**
            
            
            82,792
            
            
            93,361**LONG-TERM
                DEBT**Long-term
                capital lease obligations
            
            
            23,723
            
            
            34,549Long-term
                debt
            
            
            302,586
            
            
            412,244Note
                payable-stockholders
            
            
            454,230
            
            
            567,403Convertible
                notes payable-stockholders
            
            
            280,000
            
            
            280,000**Total
                long-term debt**
            
            
            1,060,539
            
            
            1,294,196**Total
                liabilities**
            
            
            3,227,045
            
            
            3,109,202**COMMITMENTS
                AND CONTINGENCIES**
            
            
            -
            
            
            -**TEMPORARY
                EQUITY**Common
                stock, subject to put rights, 200,000 shares issued and
                outstanding
            
            
            101,000
            
            
            101,000**PERMANENT
                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
                shares
                issued and outstanding
            
            
            8,838
            
            
            8,838Paid-in
                capital
            
            
            2,238,684
            
            
            2,154,741Retained
                earnings
            
            
            1,484,868
            
            
            1,130,006Accumulated
                other comprehensive income
            
            
            10,554
            
            
            10,323**Total
                stockholders' equity**
            
            
            3,742,944
            
            
            3,303,908**Total
                liabilities, temporary equity and permanent stockholders'
                equity**
            
            $
            7,070,989
            
            $
            6,514,110




See
      accompanying notes to financial statements.




F-2




Avatar
      Systems, Inc.


**STATEMENTS
      OF INCOME AND COMPREHENSIVE INCOME**




Year ended December 31,2007
            
            2006**Revenue:**Software
            
            $
            843,920
            
            $
            816,688Maintenance
            
            
            2,639,498
            
            
            1,825,639Professional
                services
            
            
            618,154
            
            
            686,547Hardware
            
            
            817,408
            
            
            326,579**Total
                revenue**
            
            
            4,918,980
            
            
            3,655,453**Cost
                of revenue:**Software
            
            
            167,827
            
            
            324,008Maintenance
            
            
            504,782
            
            
            388,277Professional
                services
            
            
            213,790
            
            
            161,546Hardware
            
            
            595,154
            
            
            266,655**Total
                cost of revenue**
            
            
            1,481,553
            
            
            1,140,486**Gross
                profit**
            
            
            3,437,427
            
            
            2,514,967**Operating
                expenses:**Sales
                and marketing
            
            
            474,398
            
            
            453,411General
                and administrative
            
            
            1,204,569
            
            
            765,484Amortization
            
            
            763,091
            
            
            536,057Depreciation
            
            
            206,622
            
            
            223,661**Total
                operating expenses**
            
            
            2,648,680
            
            
            1,978,613**Operating
                income**
            
            
            788,747
            
            
            536,354**Other
                income (expense):**Investment
                income
            
            
            19,061
            
            
            22,768Gain
                (loss) on sales of marketable securities
            
            
            (546
            )
            
            18,022Interest
                expense
            
            
            (269,592
            )
            
            (113,876
            )**Total
                other expense**
            
            
            (251,077
            )
            
            (73,086
            )**Income
                before income taxes**
            
            
            537,670
            
            
            463,268Income
                tax expense
            
            
            182,808
            
            
            157,511**NET
                INCOME**
            
            $
            354,862
            
            $
            305,757**Other
                comprehensive income, net of tax:**Unrealized
                gain on marketable securities
            
            
            726
            
            
            12,349Deferred
                income tax expense
            
            
            247
            
            
            4,199Reclassification
                adjustment, net of tax
            
            
            (248
            )
            
            (6,282
            )**Other
                comprehensive income**
            
            
            231
            
            
            1,868**Total
                comprehensive income**
            
            $
            355,093
            
            $
            307,625**Net
                income per share:****Basic
                and diluted**
            
            $
            0.04
            
            $
            0.03**Weighted
                average common shares outstanding:****Basic**
            
            
            9,038,152
            
            
            8,912,065**Diluted**
            
            
            9,702,094
            
            
            9,252,552




See
      accompanying notes to financial statements.




F-3




Avatar
      Systems, Inc.


**STATEMENTS
      OF CHANGES IN STOCKHOLDERS' EQUITY**





Years
      ended December 31, 2007 and 2006




Common
                  stock
              
              Paid-in
              
              Retained
              
              Accumulated
                other
                ComprehensiveShares
              
              Amount
              
              capital
              
              earnings
              
              Income
              
              TotalBalance
                  at December 31, 2005
              
              
              8,838,152
              
              $
              8,838
              
              $
              1,768,203
              
              $
              824,249
              
              $
              8,455
              
              $
              2,609,745Shares
                  issued
              
              
              200,000
              
              
              200
              
              
              100,800
              
              
              -
              
              
              -
              
              
              101,000Reclassification
                  of temporary equity-common stock subject to put rights
              
              
              (200,000
              )
              
              (200
              )
              
              (100,800
              )
              
              -
              
              
              -
              
              
              (101,000
              )Stock
                  options issued related to debt issuance
              
              
              -
              
              
              -
              
              
              379,197
              
              
              -
              
              
              -
              
              
              379,197Employee
                  stock option compensation expense
              
              
              -
              
              
              -
              
              
              7,341
              
              
              -
              
              
              -
              
              
              7,341Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              305,757
              
              
              -
              
              
              305,757Change
                  in unrealized gain on marketable securities, net of tax
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              8,150
              
              
              8,150Reclassification
                  adjustment, net of tax
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (6,282
              )
              
              (6,282
              )Comprehensive
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              307,625Balance
                  at December 31, 2006
              
              
              8,838,152
              
              
              8,838
              
              
              2,154,741
              
              
              1,130,006
              
              
              10,323
              
              
              3,303,908Employee
                  stock option compensation expense
              
              
              -
              
              
              -
              
              
              83,943
              
              
              -
              
              
              -
              
              
              83,943Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              354,862
              
              
              -
              
              
              354,862Change
                  in unrealized gain on marketable securities, net of tax
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              479
              
              
              479Reclassification
                  adjustment, net of tax
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (248
              )
              
              (248
              )Comprehensive
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              355,093Balance
                  at December 31, 2007
              
              
              8,838,152
              
              $
              8,838
              
              $
              2,238,684
              
              $
              1,484,868
              
              $
              10,554
              
              $
              3,742,944





See
      accompanying notes to financial statements.




F-4





Avatar
      Systems, Inc.


**STATEMENTS
      OF CASH FLOWS**





Year ended December 31,2007
            
            2006**Cash
                flows from operating activities**Net
                income
            
            $
            354,862
            
            $
            305,757Adjustments
                to reconcile net income to net cash provided by operating
                activities:Amortization
                of software costs
            
            
            763,091
            
            
            536,057Non-cash
                interest expense
            
            
            123,033
            
            
            44,307Depreciation
            
            
            206,622
            
            
            223,661(Gain)
                loss on sale of marketable securities
            
            
            546
            
            
            (18,022
            )Stock
                compensation expense
            
            
            83,943
            
            
            7,341Deferred
                income tax expense
            
            
            3,394
            
            
            157,511Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (166,806
            )
            
            (180,150
            )Prepaid
                expenses and other current assets
            
            
            (7,922
            )
            
            3,284Other
                assets
            
            
            -
            
            
            (12,905
            )Accounts
                payable
            
            
            (72,867
            )
            
            77,452Accrued
                expenses
            
            
            41,423
            
            
            44,362Federal
                income taxes payable
            
            
            162,385
            
            
            -Deferred
                revenue
            
            
            206,958
            
            
            62,252Other
                long-term liabilities
            
            
            (10,569
            )
            
            73,984Net
                cash provided by operating activities
            
            
            1,688,093
            
            
            1,324,891**Cash
                flows from investing activities**Software
                development costs capitalized
            
            
            (978,611
            )
            
            (754,852
            )Purchases
                of property and equipment
            
            
            (70,533
            )
            
            (153,693
            )Acquisition
                of Questa Software Systems, Inc., net of cash acquired
            
            
            -
            
            
            (1,810,548
            )Purchases
                of marketable securities
            
            
            (556,591
            )
            
            (758,234
            )Proceeds
                from sale of marketable securities
            
            
            574,785
            
            
            824,490Net
                cash used in investing activities
            
            
            (1,030,950
            )
            
            (2,652,837
            )**Cash
                flows from financing activities**Principal
                payments on capital lease obligations
            
            
            (32,645
            )
            
            (36,829
            )Principal
                payments on long-term debt
            
            
            (102,523
            )
            
            (15,301
            )Principal
                payments on long-term debt-stockholders
            
            
            (137,250
            )
            
            -Proceeds
                from line-of-credit
            
            
            -
            
            
            145,067Proceeds
                from long-term debt
            
            
            -
            
            
            476,500Proceeds
                from notes payable-stockholders
            
            
            -
            
            
            823,500Net
                cash provided by (used in) financing activities
            
            
            (272,418
            )
            
            1,392,937Net
                increase in cash and cash equivalents
            
            
            384,725
            
            
            64,991Cash
                and cash equivalents at beginning of year
            
            
            322,047
            
            
            257,056Cash
                and cash equivalents at end of year
            
            $
            706,772
            
            $
            322,047Supplemental
                disclosure of cash paid for:Income
                tax
            
            $
            19,419
            
            $
            -Interest
            
            $
            146,560
            
            $
            52,723Supplemental
                disclosure of noncash investing and financing activities:Change
                in unrealized gain on marketable securities, net of tax
            
            $
            479
            
            $
            8,150Purchase
                of equipment under capital lease obligation
            
            $
            10,500
            
            $
            46,600Stock
                issued in connection with acquisition
            
            $
            -
            
            $
            101,000Debt
                issued in connnection with acquisition
            
            $
            -
            
            $
            280,000Stock
                options issued related to debt
            
            $
            -
            
            $
            379,197




F-5





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





**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 toprovide Enterprise Resource Planning (“ERP”)
      accounting software for small to medium-sized oil and gas producerslocated
      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 UnitedStates of America requires management to make
      estimates and assumptions that affect the reported amounts ofassets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and thereported amounts of revenues and expenses during
      the reporting period. Actual results could differ from theseestimates.
      Significant assumptions and estimates are required in the capitalization and
      amortization of softwaredevelopment costs. It is at least reasonably possible
      those estimates could be revised in the near term and thoserevisions could
      be
      material.





Concentrations
      of Credit Risk





Financial
      instruments that potentially subject the Company to concentrations of credit
      risk consist primarily of tradeaccounts receivable. Products are sold to
      customers located principally in the United States. The Companycontinually
      evaluates the creditworthiness of its customers' financial condition and
      generally does not requirecollateral. 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, theCompany records a specific reserve for bad debts
      against amounts due. The Company has not experiencedsignificant 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 andliabilities which qualify
      as
      financial instruments under this statement and includes this additional
      information in thenotes 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 expenses approximate their
      carryingamounts due to the relatively short maturity of these instruments.
      The
      carrying value of short and long-term debtand capital lease obligations also
      approximates fair value since these instruments bear market rates of interest.
      Noneof 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 becash equivalents. The Company maintains deposits
      primarily in one financial institution, which may at times exceedamounts covered
      by insurance provided by the U.S. Federal Deposit Insurance Corporation. At
      December 31, 2007and 2006, the uninsured portion of these deposits was
      approximately $511,000 and $271,000 respectively. TheCompany has not incurred
      any losses related to its uninsured deposits with financial
      institutions.




F-6





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





Marketable
      Securities





Marketable
      securities at December 31, 2007 and 2006 consisted of corporate equities. SFAS
      No. 115, *Accountingfor
      Certain Investments in Debt and Equity Securities* ,
      requires certain investments be recorded at fair value oramortized cost. The
      appropriate classification of the investments in marketable equity securitiesis determined at the time ofpurchase and re-evaluated at each balance
      sheet date. As of December 31, 2007 and 2006, the Company'smarketable securities
      were classified as available-for-sale, which are carried at fair value, with
      unrealized gains andlosses reported as other comprehensive income or loss within
      the stockholders' equity section of the accompanyingbalance sheets. The cost
      of
      marketable equity securities sold is determined on a specific identification
      basis. Thefair value of marketable equity securities is based on quoted market
      prices. The Company had realized losses of$546 and gains of $18,022 related
      to
      marketable securities for the years ended December 31, 2007 and
      2006,respectively. Marketable securities held at December 31, 2007 and 2006
      have
      a cost basis of $360,862 and$379,475, respectively.





Software
      Development Costs





The
      Company capitalizes the costs of developing and testing new or significantly
      enhanced software products inaccordance with the provisions of SFAS No. 86, *Accounting
      for the Costs of Computer Software to be Sold, Leasedor Otherwise
      Marketed* .
      Under
      SFAS No. 86, all costs incurred to establish technological feasibility of a
      computerproduct are charged to operations as incurred. After technological
      feasibility is established, costs of developing thecomputer software product
      are
      capitalized until the product is available for general release to customers.
      TheCompany capitalized $978,611 and $754,852 of software development costs
      during the years ended December 31,2007 and 2006, respectively. Capitalized
      software development costs are amortized using the straight-line methodover
      a
      period that 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 periodthe
      excess is determined. No charge was recorded in 2007 or 2006 for unamortized
      software costs that exceeded thenet realizable value. Amortization of
      capitalized developed software charged to expense was $457,134 and$406,049
      for
      the years ended December 31, 2007 and 2006, 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 usefullives ranging
      from 3 to 7 years. Amortization of leasehold improvements is provided on the
      straight-line methodover 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 orchanges in circumstances indicate that the carrying
      amount of the assets may not be recoverable. Recoverability ofassets to be
      held
      and used is measured by a comparison of the carrying amounts of the assets
      to
      future net cash flowsexpected to be generated by the assets. If such assets
      are
      considered impaired, the impairment to be recognized ismeasured by the amount
      by
      which the carrying amount of the assets exceed the fair value of the assets
      based onestimated future cash flows. During the years ended December 31, 2007
      and 2006, the Company recorded noimpairment charges.




F-7


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





Revenue
      Recognition





The
      Company’s revenue recognition policies are in accordance with Statement of
      Position (“SOP”) 97-2, *SoftwareRevenue
      Recognition* ,
      as
      amended by SOP 98-9, *Modification
      of SOP 97-2* , *Software
      Revenue Recognition withRespect to Certain Transactions* ,
      Staff
      Accounting Bulletin (“SAB”) No. 104, *Revenue
      Recognition* ,
      and
      EmergingIssues 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 arrangementexists, the product has been delivered, the fee is
      fixed and determinable, and collection of the resulting receivable isreasonably
      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. Maintenancefees are charged in the initial
      licensing year and for renewals of annual maintenance in subsequent years.
      Revenueis recognized for maintenance ratably over the contract
      term.





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





Professional
      services including implementation, data conversion, integration, custom report
      writing and training aregenerally 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.





Hardware
      sales are recorded as revenue in accordance with SEC Staff Accounting Bulletin
      (“SAB”) 104, *RevenueRecognition* .
      Revenue
      is recognized when title and/or risk of loss have passed to the customer, there
      is persuasiveevidence of an arrangement, delivery has occurred or services
      have
      been rendered, the sales price is fixed ordeterminable, and collectability
      is
      reasonably assured. Revenue is recognized under the gross method in
      accordancewith Emerging Issues Task Force (“EITF”) 99-19, *Reporting
      Revenue Gross as a Principle vs. Net as an Agent* .
      Assuch,
      revenue includes the value of the product sold.





Stock-based
      Compensation





On
      January 1, 2006, the Company adopted SFAS No. 123(R), *Share-Based
      Payment* ,
      and has
      elected to use themodified prospective method, which requires the application
      of
      the accounting standard to all share-based awardsissued on or after January
      1,
      2006 and any outstanding share-based awards that were issued but not vested
      as
      ofJanuary 1, 2006. The adoption of SFAS No. 123(R) resulted in incremental
      stock-based compensation expense forthe years ended December 31, 2007 and 2006
      of $83,943 and $7,341, respectively. See Note R for additionaldisclosures
      relating to stock based compensation.




F-8





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





Income
      Taxes





Deferred
      income taxes are determined using the liability method in accordance with SFAS
      No. 109, *Accounting
      forIncome Taxes* .
      Deferred tax assets and liabilities are recognized for the future tax
      consequences attributable todifferences between the financial statement carrying
      amounts of existing assets and liabilities and their respectivetax bases.
      Deferred tax assets and liabilities are measured using enacted tax rates
      expected to apply to taxableincome in the years in which those temporary
      differences are expected to be recovered or settled. The effect ondeferred
      tax
      assets and liabilities of a change in tax rates is recognized in income in
      the
      period that includes theenactment date. In addition, a valuation allowance
      is
      established to reduce any deferred tax asset for which it isdetermined that
      it
      is more likely than not that some portion of the deferred tax asset will not
      be
      realized.





As
      of
      January 1, 2007, the Company adopted the FASB Interpretation No. 48 (“FIN 48”),
*Accounting forUncertainty in Income Taxes — an Interpretation of FASB
      Statement No. 109 Accounting for Income Taxes.* Thecurrent Company policy
      classifies any interest recognized on an underpayment of income taxes as
      interest expenseand classifies any statutory penalties recognized on a tax
      position taken as selling, general and administrativeexpense. There was an
      insignificant amount of interest expense accrued or recognized related to income
      taxes forthe twelve months ended December 31, 2007. There was an insignificant
      amount of selling, general andadministrative expense recognized for the same
      period. The Company has not taken a tax position that, ifchallenged, would
      have
      a material effect on the financial statements or the effective tax rate for
      the
      twelve-monthsended December 31, 2007, or during the prior three years applicable
      under FIN 48. The Company has determined itis not reasonably possible for the
      amounts of unrecognized tax benefits to significantly increase or decrease
      withintwelve months of the adoption of FIN 48. The Company is currently subject
      to a three-year statute of limitations.





Comprehensive
      Income





The
      Company reports comprehensive income in accordance with the provisions of SFAS
      No. 130, *ReportingComprehensive
      Income* .
      Comprehensive income consists of net income and gains (losses) on
      available-for-salemarketable securities and is presented in the statements
      of
      changes in stockholders’ equity and the statement ofincome and comprehensive
      income.





Earnings
      Per Share





The
      Company computes earnings per share in accordance with SFAS No. 128, *Earnings
      Per Share* .
      SFAS
      No. 128provides for the calculation of basic and diluted earnings per share.
      Basic earnings per share includes no dilutionand is computed by dividing income
      available to common stockholders by the weighted average number of commonshares
      outstanding for the period. Diluted earnings per share reflect the potential
      dilution of securities that couldshare in the earnings of the Company. Common
      stock equivalents, representing convertible debt and stock optionstotaling
      approximately 119,477 shares at December 31, 2007 and 2006 are not included
      in
      the dilutive earnings pershare as they would be antidilutive.




F-9





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





Recent
      Accounting Pronouncements





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* (“SFAS
      157”). SFAS 157 definesfair value, establishes a market-based framework or
      hierarchy for measuring fair value, and expands disclosuresabout fair value
      measurements. SFAS 157 is applicable whenever another accounting pronouncement
      requires orpermits assets and liabilities to be measured at fair value. SFAS
      157
      does not expand or require any new fair valuemeasures; however, the application
      of this statement may change current practice. The requirements of SFAS 157are
      first effective for the Company’s fiscal year beginning January 1, 2008.
      However, in February 2008 the FASBdecided that an entity need not apply this
      standard to nonfinancial assets and liabilities that are recognized ordisclosed
      at fair value in the financial statements on a nonrecurring basis until the
      subsequent year. Accordingly, theCompany’s adoption of this standard on January
      1, 2008, is limited to financial assets and liabilities. The Companydoes not
      believe the initial adoption of SFAS 157 will have a material effect on its
      financial condition or results ofoperations. However, the Company is still
      in
      the process of evaluating this standard with respect to its effect
      onnonfinancial assets and liabilities and therefore has not yet determined
      the
      impact that it will have on the Company’sfinancial statements upon full
      adoption.





In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and FinancialLiabilities* Including
      an *Amendment
      of FASB Statement No. 115* .
      The
      fair value option permits entities to choose tomeasure eligible financial
      instruments at fair value at specified election dates. The entity will report
      unrealizedgains and losses on the items on which it has elected the fair value
      option in earnings. SFAS 159 is effectivebeginning in fiscal year 2008. The
      Company is currently evaluating the effect of adopting SFAS 159, but does
      notexpect it to have a material impact on its results of operations or financial
      condition.





In
      December 2007, the SEC issued Staff Accounting Bulletin (“SAB”) 110, *Share-Based
      Payment* .
      SAB
      110amends and replaces Question 6 of Section D.2 of Topic 14, “Share-Based
      Payment,” of the Staff AccountingBulletin series. Question 6 of Section D.2 of
      Topic 14 expresses the views of the staff regarding the use of the“simplified”
method in developing an estimate of the expected term of “plain vanilla” share
      options and allowsusage of the “simplified” method for share option grants prior
      to December 31, 2007. SAB 110 allows publiccompanies which do not have
      historically sufficient experience to provide a reasonable estimate to continue
      use ofthe “simplified” method for estimating the expected term of “plain
      vanilla” share option grants after December 31,2007. SAB 110 is effective
      January 1, 2008. The Company currently uses the “simplified” method to estimate
      theexpected term for share option grants, as it does not have enough historical
      experience to provide a reasonableestimate. The Company will continue to use
      the
“simplified” method until it has enough historical experience toprovide a
      reasonable estimate of expected term in accordance with SAB 110. The Company
      does not expect SAB110 will have a material impact on its balance sheets,
      statements of income and comprehensive income and cashflows.





In
      December 2007, the FASB issued Statement No. 141R, *Business
      Combinations* ,
      and
      Statement No. 160, *Noncontrolling
      Interests in Consolidated Financial Statements, an amendment of ARB No.
      51* .
      Statement No. 141Rmodifies the accounting and disclosure requirements for
      business combinations and broadens the scope of theprevious standard to apply
      to
      all transactions in which one entity obtains control over another business.
      StatementNo. 160 establishes new accounting and reporting standards for
      non-controlling interests in subsidiaries. TheCompany will be required to apply
      the provisions of the new standards in the first quarter of 2009. Early adoption
      isnot permitted for these new standards.




F-10


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





**NOTE
      B – ACQUISITION**





On
      August
      18, 2006, the Company acquired all the outstanding common stock of Questa
      Software Systems, Inc.(“Questa”) pursuant to a Stock Purchase Agreement. Questa,
      located in Midland, Texas, was engaged in thedevelopment of accounting software
      for the petroleum production industry. The purchase price was approximately$2.24
      million, subject to certain post-closing adjustments based on Questa’s actual
      working capital as of the closingdate. The $2.24 million purchase price
      consisted of:





·
            cash
                paid to the Sellers in the aggregate amount of
                $1,790,634;


·
            convertible
                promissory notes issued to the Sellers in the aggregate amount of
                $280,000;


·
            an
                aggregate of 200,000 shares of common stock of the Company issued
                to the
                Sellers, valued at $0.505 pershare in accordance with EITF 99-12,*Determination
                of the Measurement Date for the Market Price ofAcquirer Securities
                Issued
                in a Purchase Business Combination*;
                and


·
            transaction
                costs of $67,789.





In
      connection with the execution of the Stock Purchase Agreement, the Company
      entered into a Stock BuybackAgreement with the sellers on August 18, 2006.
      Pursuant to the Stock Buyback Agreement, the Company grantedthe sellers the
      right and option to sell to the Company all or any portion of the shares on
      the
      first business day fiveyears from the closing date of the acquisition at a
      price
      of $1.00 per share.





The
      acquisition was financed with a term loan from a financial institution in the
      amount of $476,500, the PromissoryNote to two stockholders in the amount of
      $823,500, the convertible promissory notes issued to the seller’s in theamount
      of $280,000 and the issuance of 200,000 shares of common stock of the
      Company.The acquisition of Questa provides for economies of scale to be achieved
      by eliminating redundant expense itemsincluding major development costs,
      solidifies our recurring maintenance revenue stream, and increases
      theprofessional capacity of our human resources.





Operating
      results of Questa have been included in the Company’s financial statements since
      August 1, 2006, whenthe Company assumed the risk of loss for Questa’s
      operations, by recording the transaction from that date directly inthe accounts
      of the Company.





The
      following table summarizes the initial fair values of the assets acquired and
      liabilities assumed at the date ofacquisition based on a preliminary valuation.
      Subsequent adjustments may be recorded upon the completion of thevaluation
      and
      the final determination of the purchase price allocation.





Current
                assets
            
            $
            138,116Computers
                and software
            
            
            27,370Furniture
                and fixtures
            
            
            14,379Purchased
                software
            
            
            2,141,702Current
                liabilities
            
            
            (82,144
            )$
            2,239,423


F-11





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





The
      following unaudited pro forma information presents the 2006 results of
      operations of the Company as if theacquisition had occurred at the beginning
      of
      the year. The unaudited pro forma results are not necessarily indicativeof
      results that would have occurred had the acquisition been in effect for the
      periods presented, nor are theynecessarily indicative of future
      results.





Year
                ended
              December
                31,2006(unaudited)Total
                revenue
            
            $
            4,721,785Net
                income
            
            $
            618,452Net
                income per share:Basic
                and diluted
            
            $
            0.07Weighted
                average common shares outstanding:Basic
            
            
            9,038,152Diluted
            
            
            9,278,639




F-12





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





**NOTE
      C – MARKETABLE SECURITIES**





At
      December 31, 2007, marketable securities were summarized in the following
      table:




Cost
            
            Gross
              Unrealized
              Gains
            
            Gross
              Unrealized
              Losses
            
            Aggregate
              FairValueCorporate
                equities mutual fund
            
            $
            85,862
            
            $
            15,991
            
            $
            -
            
            $
            101,853Corporate
                equities preferred stock
            
            
            275,000
            
            
            -
            
            
            -
            
            
            275,000$
            360,862
            
            $
            15,991
            
            $
            -
            
            $
            376,853





At
      December 31, 2006, marketable securities were summarized in the following
      table:




Cost
            
            Gross
              Unrealized
              Gains
            
            Gross
              Unrealized
              Losses
            
            Aggregate
              FairValueCorporate
                equities mutual fund
            
            $
            54,475
            
            $
            15,640
            
            $
            -
            
            $
            70,115Corporate
                equities preferred stock
            
            
            325,000
            
            
            -
            
            
            -
            
            
            325,000$
            379,475
            
            $
            15,640
            
            $
            -
            
            $
            395,115





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 within the normal operating cycle. Accordingly,
      all marketable securities are classified as current assets. Gross realized
      (losses) and gains on sales of marketable securities were $(546) and $18,022
      in
      2007 and 2006, respectively.




F-13





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





**NOTE
      D – PROPERTY AND EQUIPMENT**





Property
      and equipment are summarized as follows:


December
                    31,2007
                
                2006Computer
                    equipment and software
                
                $
                636,800
                
                $
                577,804Furniture
                    and fixtures
                
                
                106,618
                
                
                104,358Leasehold
                    improvements
                
                
                72,422
                
                
                69,457Transportation
                
                
                33,716
                
                
                33,716Telecommunication
                    equipment
                
                
                23,277
                
                
                16,965Assets
                    under capital lease
                
                
                153,718
                
                
                143,2181,026,551
                
                
                945,518Less
                    accumulated depreciation
                
                
                695,626
                
                
                489,004Property
                    and equipment, net
                
                $
                330,925
                
                $
                456,514





During
      the years ended December 31, 2007 and 2006, the Company recorded depreciation
      expense of $206,622 and $223,661, respectively. Depreciation expense in 2007
      and
      2006 also included the depreciation expense on assets recorded under capital
      leases. As of December 31, 2007 and 2006, the Company had $115,218 and $84,640,
      respectively, of accumulated depreciation recorded for assets under capital
      lease.




F-14





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





**NOTE
      E – PURCHASED SOFTWARE**





Purchased
      software is summarized as follows:





December
                31,2007
            
            2006Purchased
                software
            
            $
            3,003,363
            
            $
            3,003,363Less
                accumulated amortization
            
            
            1,295,101
            
            
            989,144Purchased
                software, net
            
            $
            1,708,262
            
            $
            2,014,219





Purchased
      software is recorded at cost. Amortization of purchased software is provided
      on
      the straight-line methodover 7 years. During the years ended December 31, 2007
      and 2006, the Company recorded amortization expense of$305,957 and $130,008,
      respectively.





As
      of
      December 31, 2007, future purchased software amortization expense is as
      follows:





Year endingDecember
                31,2008
            
            $
            305,9572009
            
            
            305,9572010
            
            
            305,9572011
            
            
            305,9572012
            
            
            305,957Thereafter
            
            
            178,477Total
                future purchased software amortization
            
            
            
            
            $
            1,708,262




F-15





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006





**NOTE
      F – DEVELOPED SOFTWARE**





Developed
      software is summarized as follows:





December
                31,2007
            
            2006Software
                development costs
            
            $
            5,510,150
            
            $
            4,531,539Less
                accumulated amortization
            
            
            2,236,256
            
            
            1,779,122Software
                development costs, net
            
            $
            3,273,894
            
            $
            2,752,417





Developed
      software is recorded at cost. Amortization of developed software is provided
      on
      the straight-line methodover 7 years. During the years ended December 31, 2007
      and 2006, the Company recorded amortization expense of$457,134 and $406,049,
      respectively.





As
      of
      December 31, 2007, future developed software amortization expense is summarized
      as follows:





Year
                endingDecember
                31,2008
            
            $
            386,9552009
            
            
            325,5692010
            
            
            263,8772011
            
            
            190,5142012
            
            
            136,344Thereafter
            
            
            145,737Total
                future developed software amortization
            
            
            
            
            $
            1,448,996





Software
      development costs in process at December 31, 2007 and 2006 were $1,824,898
      and
      $1,351,924, respectively.


F-16





**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      G - LINE OF CREDIT**





On
      August
      16, 2006, the Company entered into a Bank Loan Agreement (“Loan Agreement”) with
      a financialinstitution to provide a Line-Of-Credit facility (“Line-Of-Credit”)
      for $200,000.





The
      Line-Of-Credit outstanding principal balance is payable in full in a single
      payment August 5, 2008. Interest onthe outstanding principal balance of the
      note
      is payable monthly. The note bears interest at the greater of the primerate
      (7.25%
      at
      December 31, 2007)plus three quarters of one percent (0.75%), or nine
      percent (9.0%).





The
      Line-Of-Credit is collateralized by substantially all of the Company’s assets.
      The Line-Of-Credit may beprepaid or terminated at the Company's option at
      anytime without penalty. The Loan Agreement contains certain financial covenants
      and customary default provisions (with grace periods where customary),
      including, among otherthings, failure to pay any principal or interest when
      due;
      any materially false or misleading representation, warranty,or financial
      statement; failure to comply with or to perform any provision of the agreement;
      and default on any debtin excess of $500,000.





The
      outstanding principal balance of the Line-Of-Credit as of December 31, 2007
      and
      2006 was $145,067 with theremainder available for future borrowing.





At
      December 31, 2007 and 2006, the Company was not in compliance with certain
      financial covenants of the LoanAgreement. The Company has received a waiver
      of
      the requirements at December 31, 2007 and 2006. TheCompany expects to be in
      compliance with the financial covenants as additional profits are realized
      in
      the future as aresult of the acquisition.




F-17




**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      H - LONG-TERM DEBT**




On
      August
      16, 2006, the Company entered into a Bank Loan Agreement (Loan Agreement) with
      a
      financial institution to provide a promissory note term credit facility (Term
      Loan) for $476,500.




The
      Term
      Loan is payable in 53 monthly principal payments of $7,942 beginning on March
      5,
      2007 and a final payment of the outstanding principal balance on August 5,
      2011.
      Interest on the outstanding principal balance of the note is payable monthly,
      with a final payment on the term maturity date. The note bears interest at
      the
      greater of the prime rate (7.25%
      at
      December 31, 2007)plus three quarters of one percent (0.75%), or nine
      percent (9.0%).




The
      Term
      Loan is collateralized by substantially all of the Company’s assets. The Term
      Loan may be prepaid or terminated at the Company's option at anytime without
      penalty. The Loan Agreement contains certain financial covenants and customary
      default provisions (with grace periods where customary), including, among other
      things, failure to pay any principal or interest when due; any materially false
      or misleading representation, warranty, or financial statement; failure to
      comply with or to perform any provision of the agreement; and default on any
      debt in excess of $500,000.




In
      connection with the Loan Agreement, Robert C. Shreve, Jr., the Company’s
      Chairman, President, Chief Executive Officer and Chief Financial Officer,
      provided a guaranty in favor of the financial institution, pursuant to which
      Mr.
      Shreve guaranteed up to $676,500 of the Company’s obligations under the Term
      Loan and the Revolving Loan. As consideration for providing this guaranty,
      the
      Company issued common stock options to purchase 451,000 shares of common stock
      of the Company to Mr. Shreve at an exercise price of $0.505 per share. The
      options were fully vested on the date of issuance. The value of the options,
      using the Black-Scholes option pricing model was determined to be $171,018
      and
      was recorded as debt issuance costs included in other assets in the accompanying
      balance sheets, and will be amortized as interest expense over the life of
      the
      loan. For the years ended December 31, 2007 and 2006, $53,924 and $19,462
      respectively, were recorded as interest expense in the accompanying statements
      of income and comprehensive income.




At
      December 31, 2006, long-term debt included a note payable to GMAC, collaterized
      by an automobile, bearing interest at 6.99% per annum, payable in forty-eight
      monthly principal payments of $845. The note was fully paid as of December
      31,
      2007.




Total
      notes payable at December 31, 2007 and 2006 were as follows:




December
                31,2007
            
            2006Current
                portion - auto
            
            $
            -
            
            $
            8,748Current
                portion - term note payable
            
            
            95,300
            
            
            79,41795,300
            
            
            88,165Term
                note payable - auto
            
            
            -
            
            
            15,161Term
                note payable
            
            
            302,586
            
            
            397,083302,586
            
            
            412,244Total
                long-term notes payable
            
            $
            397,886
            
            $
            500,409




F-18


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




Future
      principal payment requirements on the long-term notes payable at December 31,
      2007 were as follows:




Year
                ending
              December 31,2008
            
            $
            95,3002009
            
            
            95,3002010
            
            
            95,3002011
            
            
            111,986Total
                future principal payment requirements
            
            $
            397,886





At
      December 31, 2007 and 2006, the Company was not in compliance with certain
      financial covenants of the Loan Agreement. The Company has received a waiver
      of
      the requirements at December 31, 2007 and 2006. The Company expects to be in
      compliance with the financial covenants as additional profits are realized
      in
      the future as a result of the acquisition.




F-19


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      I – NOTE PAYABLE - STOCKHOLDERS**




On
      August
      16, 2006, the Company entered into a loan agreement and promissory note with
      two
      stockholders to provide a promissory note for $823,500. The stockholders own
      approximately 27.1% and 26.6%, respectively, of the outstanding common stock
      of
      the Company.




The
      promissory note is payable in 53 monthly principal payments of $13,725 beginning
      on March 5, 2007 and a final payment of the outstanding principal balance on
      the
      August 5, 2011. Interest on the outstanding principal balance of the note is
      payable monthly, with a final payment on the term maturity date. The note bears
      interest at the greater of the prime rate (7.25%
      at
      December 31, 2007) plus three quarters of one percent (0.75%), or nine
      percent (9.0%).




The
      promissory note is collateralized by substantially all of the Company’s assets
      and is subordinated to the Term Loan from the financial institution. The
      stockholder note payable may be prepaid or terminated at the Company's option
      at
      anytime without penalty. The loan agreement contains certain financial covenants
      and customary default provisions (with grace periods where customary),
      including, among other things, failure to pay any principal or interest when
      due; any materially false or misleading representation, warranty, or financial
      statement; failure to comply with or to perform any provision of the agreement;
      and default on any debt in excess of $500,000.




As
      consideration for providing the loan agreement and the promissory note, the
      Company issued common stock options to purchase 274,500 shares of common stock
      of the Company to the each of the stockholders at an exercise price of $0.505
      per share. The options were fully vested on the date of issuance. The value
      of
      the options, using the Black-Scholes option pricing model was determined to
      be
      $208,179 and was recorded as a discount to the related debt and will be
      amortized as interest expense over the life of the loan. For the years ended
      December 31, 2007 and 2006, $65,643 and $23,690, respectively, were recorded
      as
      interest expense in the accompanying statements of income and comprehensive
      income.




Note
                  FaceValue
            
            Unamortized Discount
                Debt Issuance Costs
            
            DiscountedFace
                ValueDecember
                31,
            
            December
                31,
            
            December
                31,2007
            
            2007
            
            2007Current
                portion - note payable stockholders
            
            $
            164,700
            
            $
            51,526
            
            $
            113,174Note
                payable - stockholders
            
            
            521,550
            
            
            67,320
            
            
            454,230Total
                notes payable - stockholders
            
            $
            686,250
            
            $
            118,846
            
            $
            567,404




F-20


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




Future
      principal payment requirements on the notes payable - stockholders at December
      31, 2007 were as follows:




Year ending
              December 31,2008
            
            $
            164,7002009
            
            
            164,7002010
            
            
            164,7002011
            
            
            192,150Total
                future principal payment requirements
            
            $
            686,250





At
      December 31, 2007, the Company was not in compliance with certain financial
      covenants of the loan agreement. The Company has received a waiver of the
      requirements at December 31, 2007 and 2006. The Company expects to be in
      compliance with the financial covenants as additional profits are realized
      in
      the future as a result of the acquisition.




F-21


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      J – CONVERTIBLE NOTES PAYABLE-STOCKHOLDERS**




On
      August
      18, 2006, as partial consideration for the acquisition, the Company issued
      convertible promissory notes to the sellers of Questa (the “Seller Promissory
      Notes”) in the amounts of $120,000 and $160,000. Accrued and unpaid interest on
      the Seller Promissory Notes is payable for a period of five years following
      the
      date of the note in twenty quarterly installments commencing on September 30,
      2006 and continuing on the last day of each third calendar month. Thereafter,
      principal and accrued interest on the notes is payable in twelve equal quarterly
      installments commencing on the fifth anniversary of the notes, and continuing
      thereafter on the last day of each third calendar month, with the final
      installment of the unpaid principal balance and all accrued and unpaid interest
      due eight years from the date of the notes.




The
      outstanding principal balances of the Seller Promissory Notes are convertible,
      at the option of the holders, in whole or in part and at any time or from time
      to time, into shares of common stock of the Company at a conversion price of
      $3.50 per share, as adjusted from time to time for stock splits, combinations,
      stock dividends and other similar events.




The
      Seller Promissory Notes is unsecured and may be prepaid at the Company's option
      at anytime without penalty, provided that, after the Company notifies the
      holders that the outstanding principal balance will be repaid and the date
      of
      such prepayment fifteen days in advance. The holders have the option during
      the
      fifteen days to convert all or any portion of the outstanding principal balance
      of the Seller Promissory Notes in accordance with the conversion features of
      the
      notes.




The
      principal balance outstanding at December 31, 2007 and 2006 was $280,000.




Future
      principal payment requirements on the convertible notes payable - stockholders
      at December 31, 2007 were as follows:




Year ending
              December 31,2008
            
            $
            -2009
            
            
            -2010
            
            
            -2011
            
            
            44,3082012
            
            
            91,416Thereafter
            
            
            144,276Total
                future principal payment requirements
            
            $
            280,000





F-22


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      K – CAPITAL LEASE OBLIGATIONS**




The
      Company entered into a capital lease arrangement for the rental of computer
      equipment in its ASP hosting facility for $10,500 on September 14, 2007. The
      lease agreement requires monthly payments of principal and interest of
      approximately $287 at 15.5% and matures forty-eight months from the date of
      the
      lease in 2011.




During
      2006, the Company entered into various capital lease arrangements for the rental
      of computer equipment in its ASP hosting facility in the aggregate amount of
      $46,600. The lease agreements require monthly payments of principal and interest
      of approximately $1,370 at interest rates of approximately 14% and mature
      thirty-six and forty-eight months from the date of the lease in 2009.




Capital
      lease obligations at December 31, 2007 and 2006 are summarized as follows:




December
                31,2007
            
            2006Current
                portion of capital lease obligations
            
            $
            21,016
            
            $
            32,335Long-term
                portion of capital lease obligations
            
            
            23,723
            
            
            34,549Total
                capital lease obligations
            
            $
            44,739
            
            $
            66,884




Future
      minimum capital lease obligations in effect at December 31, 2007 were as
      follows:




Year ending
              December 31,2008
            
            $
            26,3432009
            
            
            18,7382010
            
            
            5,8192011
            
            
            2,012Less
                interest
            
            
            (8,173
            )Total
                future minimum capital lease obligations
            
            $
            44,739




F-23




**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      L – LEASE OBLIGATIONS**




The
      Company leases its 6,192 square foot facility at 2801 Network Boulevard, Suite
      210, Frisco, Texas, 75034. The lease for the corporate office was entered into
      on July 29, 2005 for a one hundred twenty-month lease term commencing on
      November 1, 2005 and expiring on October 31, 2015.




As
      part
      of the acquisition of Questa, the Company assumed the lease of a 7,197 square
      foot facility at 10 Desta Drive, Suite 250 West, Midland, Texas 79705. The
      original lease for the Midland facility was entered into on November 14, 2005
      for a seventy-five month lease term commencing on January 1, 2006 and expiring
      on March 31, 2012.




Future
      minimum payments are as follows:





Year ending
              December 31,2008
            
            $
            204,8092009
            
            
            204,8092010
            
            
            204,8452011
            
            
            205,0232012
            
            
            153,744Thereafter
            
            
            387,178Minimum
                future lease payments
            
            $
            1,360,408





Rent
      expense under the operating leases was $204,814 and $167,994 for the years
      ended
      December 31, 2007 and 2006, respectively.




F-24




**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      M – TEMPORARY EQUITY**




On
      August
      18, 2006, the Company issued 200,000 shares of its common stock to the sellers
      of Questa, in connection with the execution of a Stock Purchase Agreement to
      acquire Questa. The Company entered into a Stock Buyback Agreement with the
      sellers on August 18, 2006. Pursuant to the Stock Buyback Agreement, the Company
      granted the sellers the right and option to sell to the Company all or any
      portion of the shares on the first business day five years from the closing
      date
      of the acquisition at a price of $1.00 per share. The shares were valued at
      $0.505 per share in accordance with EITF 99-12, and because of the potential
      obligation to repurchase the shares on August 18, 2011, the shares were recorded
      as temporary equity in accordance with EITF Topic No. 98, *Classification
      and Measurement of Redeemable Securities.*




**NOTE
      N – EARNINGS PER SHARE**




Basic
      earnings per share are computed by dividing earnings available to common
      stockholders by the weighted average number of common shares outstanding during
      the period. Diluted earnings per share reflect per share amounts that would
      have
      resulted if dilutive potential common stock had been converted to common stock.




The
      following reconciles amounts reported in the financial statements:




December
                31,2007
            
            2006Numerator:Net
                income
            
            $
            354,862
            
            $
            305,757Denominator:Weighted-average
                shares outstanding:Basic
            
            
            9,038,152
            
            
            8,912,065Options
                issued to employees and debtholders
            
            
            663,942
            
            
            340,487Diluted
            
            
            9,702,094
            
            
            9,252,552Earnings
                per common share:Basic
            
            $
            0.04
            
            $
            0.03Diluted
            
            $
            0.04
            
            $
            0.03





F-25


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      O – INCOME TAXES**




The
      tax
      effects of temporary differences that gave rise to significant portions of
      the
      deferred tax assets and liabilities were as follows:




Deferred
      assets and liabilities consist of the following:





December
                31,2007
            
            2006Deferred
                tax assetsNet
                operating loss carryforwards
            
            $
            -
            
            $
            46,497Purchased
                software amortization
            
            
            209,601
            
            
            100,435Incentive
                stock option amortization
            
            
            31,037
            
            
            -Nonqualified
                stock option amortization
            
            
            55,324
            
            
            -Accrued
                expenses
            
            
            -
            
            
            22,171295,962
            
            
            169,103Deferred
                tax liabilitiesCapitalized
                software
            
            
            823,551
            
            
            662,373Property
                and equipment
            
            
            41,446
            
            
            72,243Unrealized
                gain on marketable securities
            
            
            5,437
            
            
            5,318870,434
            
            
            739,934Net
                deferred tax liability
            
            $
            (574,472
            )
            $
            (570,831
            )Net
                deferred tax asset (liability) - current
            
            $
            (5,437
            )
            $
            16,853Net
                deferred tax liability - long term
            
            
            (569,035
            )
            
            (587,684
            )Net
                deferred tax liability
            
            $
            (574,472
            )
            $
            (570,831
            )




The
      components of income before income taxes were as follows:




December
                31,2007
            
            2006U.S.
                Income
            
            $
            537,670
            
            $
            463,268





The
      components of the provision for income taxes included the following:





2007
            
            2006CurrentFederal
            
            $
            162,385
            
            $
            -DeferredFederal
            
            
            20,423
            
            
            157,511$
            182,808
            
            $
            157,511





F-26


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




A
      reconciliation of the expected U.S. income taxes related to continuing
      operations is as follows:





2007
            
            2006Computed
                expected tax expense
            
            $
            162,385
            
            $
            17,048Permanent
                differences
            
            
            11,244
            
            
            3,994Temporary
                differences:Net
                operating loss
            
            
            -
            
            
            47,458Purchases
                software amortization
            
            
            (84,494
            )
            
            (27,105
            )Software
                development costs
            
            
            177,302
            
            
            118,992Share-based
                expense
            
            
            (69,194
            )
            
            (19,826
            )Fixed
                assets
            
            
            (14,435
            )
            
            16,950Total
                income tax expense
            
            $
            182,808
            
            $
            157,511





At
      December 31, 2006, the Company had federal net operating loss carryforwards
      of
      approximately $137,000, which were fully utilized in 2007.




As
      of
      January 1, 2007, the Company adopted the FASB Interpretation No. 48 (“FIN 48”),
“Accounting for Uncertainty in Income Taxes — an Interpretation of FASB
      Statement No. 109 Accounting for Income Taxes.” The current Company policy
      classifies any interest recognized on an underpayment of income taxes as
      interest expense and classifies any statutory penalties recognized on a tax
      position taken as selling, general and administrative expense. There was an
      insignificant amount of interest expense accrued or recognized related to income
      taxes for the twelve months ended December 31, 2007. There was an insignificant
      amount of selling, general and administrative expense recognized for the same
      period. The Company has not taken a tax position that, if challenged, would
      have
      a material effect on the financial statements or the effective tax rate for
      the
      twelve-months ended December 31, 2007, or during the prior three years
      applicable under FIN 48. The Company has determined it is not reasonably
      possible for the amounts of unrecognized tax benefits to significantly increase
      or decrease within twelve months of the adoption of FIN 48. The Company is
      currently subject to a three-year statute of limitations.




F-27


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      P - RELATED PARTY 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
      $41,750 and $84,774 in 2007 and 2006, respectively. The Company had $4,447
      of
      accounts receivable at December 31, 2006 related to services performed for
      that
      company.




As
      disclosed in Note I, the Company entered into a loan agreement and promissory
      note with two stockholders to provide a promissory note for $823,500. The
      stockholders own approximately 27.1% and 26.6%, respectively, of the outstanding
      common stock of the Company.




Total
      interest expense on the promissory note recorded by the Company for the period
      ended December 31, 2007 and 2006 was $134,096 and $52,101, respectively.




As
      disclosed in Note J, the Company issued convertible promissory notes to the
      sellers of Questa in the amounts of $120,000 and $160,000. The Company also
      issued 200,000 shares of its common stock to the sellers of Questa in connection
      with the execution of a Stock Purchase Agreement to acquire Questa.




Total
      interest expense on the convertible promissory notes recorded by the Company
      for
      the period ended December 31, 2007 and 2006 was $11,356 and $4,200,
      respectively.




Robert
      C.
      Shreve, Jr., the Company’s Chairman, President, Chief Executive Officer and
      Chief Financial Officer, provided a guaranty in favor of a financial
      institution, pursuant to which Mr. Shreve guaranteed up to $676,500 of the
      Company’s obligations under the Term Loan and the Revolving Loan. As
      consideration for providing this guaranty, the Company issued common stock
      options to purchase 451,000 shares of common stock of the Company to Mr. Shreve
      at an exercise price of $0.505 per share. The options were fully vested on
      the
      date of issuance. The value of the options, using the Black-Scholes option
      pricing model was determined to be $171,018 and was recorded as debt issuance
      costs included in other assets in the accompanying balance sheets, and will
      be
      amortized as interest expense over the life of the loan.




The
      Company recorded $53,924 and $19,462 as interest expense to reflect the
      amortization of the debt issuance costs for the years ended December 31, 2007
      and 2006, respectively.




F-28


**Avatar
      Systems, Inc.**




NOTES
      TO
      FINANCIAL STATEMENTS




December
      31, 2007 and 2006




**NOTE
      Q- STOCK OPTIONS**




2000
      Stock Compensation Plan




The
      2000
      Stock Compensation Plan authorizes the grant of up to
      1,500,000 shares of the Company’s common stock in the form of
      incentive stock options (“ISOs”), and, the plan provides that: (i) the exercise
      price of an ISO must be no less than the fair value of the stock at the date
      of
      grant and (ii) the exercise price of an ISO held by an optionee who possesses
      more than 10% of the total combined voting power of all classes of stock must
      be
      no less than 110% of the fair market value of the stock at the time of grant.
      The Compensation Committee of the Board of Directors has the authority to set
      expiration dates no later than ten years from the date of grant (or five years
      for an optionee who meets the 10% criteria), payment terms and other provisions
      for each grant. Shares associated with unexercised options or reacquired shares
      of common stock become available for options or issuances. The Compensation
      Committee of the Board of Directors may, at its sole discretion, accelerate
      or
      extend the date or dates on which all or any particular award or awards granted
      under the plan may vest or be exercised. In the event of a merger, liquidation
      or sale of substantially all of the assets of the Company, the Board of
      Directors has the discretion to accelerate the vesting of the options granted
      under the plan. At the discretion of the Compensation Committee, any option
      may
      include a “reload” feature. Such feature allows an optionee exercising an option
      to receive, in addition to the number of shares of common stock due on the
      exercise, an additional option with an exercise price equal to the fair market
      value of the common stock on the date such additional option is granted.




The
      fair
      value of each option grant is estimated on the date of grant using the
      Black-Scholes Option Pricing Model (“BSOPM”) which was developed for use in
      estimating the fair value of traded options that have no vesting restrictions
      and are fully transferable. The Company’s options have characteristics
      significantly different from those of traded options, and changes in input
      assumptions can materially affect the fair value estimates. The Company’s
      determination of fair value of share-based payment awards on the date of grant
      using an option-pricing model is affected by the Company’s stock price as well
      as assumptions regarding a number of highly complex and subjective variables.




The
      fair
      value of options that were granted under the 2000 Stock Compensation Plan during
      the year ended December 31, 2006 was $0.47 per share. The fair values of options
      granted were estimated using the Black-Scholes pricing model with a weighted
      average risk-free interest rate of 4.75%. The following assumptions were also
      used to determine the fair value of each option grant: dividend yields of 0%;
      weighted average expected volatility of 137.3%, a weighted average expected
      term
      of 6.5 years, and an expected forfeiture rate of 67% based on the Company’s
      historical experience. The volatility was determined based on the historic
      volatility of the Company’s stock for the length of the expected term of the
      options.




At
      December 31, 2007, total unrecognized estimated compensation cost related to
      non-vested stock options granted prior to that date was $21,202 which will
      be
      recognized during 2008. There were no 2000 Stock Compensation Plan options
      exercised during the year ended December 31, 2007.




F-29




**Avatar
        Systems, Inc.**
  NOTES
        TO
        FINANCIAL STATEMENTS
  December
        31, 2007 and 2006
 
 Information
        regarding the 2000 Stock Compensation Plan option transactions for the year
        ended December 31, 2007 is summarized below:
  Weighted
              
              Weighted AverageAverage
              
              RemainingExercise
              
              Contractual TermOptions
              
              Price
              
              (years)Options
                  outstanding at beginning of year
              
              
              276,477
              
              $
              0.611
              
              
              -Options
                  granted
              
              
              -
              
              
              -
              
              
              -Options
                  exercised
              
              
              -
              
              
              -
              
              
              -Options
                  forfeited
              
              
              (18,000
              )
              $
              0.505
              
              
              -Options
                  outstanding at December 31, 2007
              
              
              258,477
              
              $
              0.619
              
              
              7.74Options
                  exercisable at December 31, 2007
              
              
              185,477
              
              $
              0.664
              
              
              7.39
  Information
        regarding the 2000 Stock Compensation Plan options outstanding as of December
        31, 2007 is summarized below:
 
 Options Outstanding
              
              Options ExercisableExercise
                  Price
              
              Options
              
              Weighted
                Average
                Remaining
                Contractual
                Life (years)
              
              Weighted
                Average
                Exercise
                Price
              
              Aggregate
                Intrinsic
                Value
              
              Options
              
              Weighted
                Average
                Exercise
                Price
              
              Aggregate
                Intrinsic
                Value$
                  1.250
              
              
              39,477
              
              
              2.78
              
              $
              1.250
              
              $
              -
              
              
              39,477
              
              $
              1.250
              
              $
              -$
                  0.505
              
              
              219,000
              
              
              8.64
              
              $
              0.505
              
              $
              9,855
              
              
              146,000
              
              $
              0.505
              
              $
              6,570
  F-30
  **Avatar
        Systems, Inc.**
  NOTES
        TO
        FINANCIAL STATEMENTS
  December
        31, 2007 and 2006
  Nonqualified
        Stock Options
  As
        previously indicated under Note H, Robert C. Shreve, Jr., the Company’s
        Chairman, President, Chief Executive Officer and Chief Financial Officer,
        provided a guaranty in favor of a financial institution, pursuant up to $676,500
        of the Company’s obligations under the Term Loan and the Revolving Loan for the
        Questa acquisition. As consideration for providing this guaranty, the Company
        issued common stock options to purchase 451,000 shares of common stock of
        the
        Company to Mr. Shreve at an exercise price of $0.505 per share. The options
        were
        fully vested on the date of issuance.
  The
        Company also issued, as consideration for providing a loan agreement and
        promissory note in connection with the Questa acquisition, common stock options
        to purchase 274,500 shares of common stock of the Company to two stockholders
        at
        an exercise price of $0.505 per share. The options were fully vested on the
        date
        of issuance.
  The
        Nonqualified Stock Option Agreement provides that the option price is $0.505,
        and the optioned shares are fully vested and fully exercisable. The option
        period commences on August 16, 2006 and expires on August 16, 2013, unless
        earlier terminated by the grantee’s termination of service, death, disability,
        failure to pay the exercise price, or makes an assignment of the option without
        written consent of the Company. In the event of a merger, liquidation or
        sale of
        substantially all of the assets of the Company, the option shall pertain
        to and
        apply to the securities or rights to which a holder of the number of shares
        of
        common stock subject to this option would have been entitled. The option
        may be
        canceled by the Company, in its sole discretion, as of the effective date
        of any
        change of control, merger, consolidation or share exchange, or any issuance
        of
        bonds, debentures, preferred or preference stocks ranking prior to or otherwise
        affecting the common stock, or the rights thereof, or of any proposed sale
        of
        all or substantially all of the assets of the Company, or of any dissolution
        or
        liquidation of the Company, by either: (i) giving notice to grantee of its
        intention to cancel the optioned shares for which the issuance of shares
        of
        common stock involved payment by grantee for such shares and, permitting
        the
        purchase during the 30 day period next preceding such effective date of any
        or
        all of the shares of common stock subject to this option; or (ii) paying
        grantee
        an amount equal to a reasonable estimate of the difference between the net
        amount per share payable in such transaction or as a result of such transaction.
  The
        fair
        value of each option grant is estimated on the date of grant using the BSOPM
        which was developed for use in estimating the fair value of traded options
        that
        have no vesting restrictions and are fully transferable. The Company’s options
        have characteristics significantly different from those of traded options,
        and
        changes in input assumptions can materially affect the fair value estimates.
        The
        Company’s determination of fair value of share-based payment awards on the date
        of grant using an option-pricing model is affected by the Company’s stock price
        as well as assumptions regarding a number of highly complex and subjective
        variables.
  The
        fair
        value of non-qualified stock options that were granted during the year ended
        December 31, 2006 was $0.38 per share. The fair values of options granted
        were
        estimated using the Black-Scholes pricing model with a risk-free interest
        rate
        of 4.75%. The following assumptions were also used to determine the fair
        value
        of each option grant: dividend yields of 0%; expected volatility of 117.7%,
        and
        an expected term of 3.5 years. The volatility was determined based on the
        historic volatility of the Company’s stock for the length of the expected term
        of the options.
  F-31
  **Avatar
        Systems, Inc.**
  NOTES
        TO
        FINANCIAL STATEMENTS
  December
        31, 2007 and 2006
  Information
        regarding non-qualified stock option transactions for the year ended December
        31, 2007 is summarized below:
  Options
              
              Weighted
                Average
                Exercise
                Price
              
              Weighted Average
                Remaining
                Contractual Term
                (years)Options
                  outstanding at beginning of year
              
              
              1,000,000
              
              $
              0.505
              
              
              -Options
                  granted
              
              
              -
              
              
              -
              
              
              -Options
                  exercised
              
              
              -
              
              
              -
              
              
              -Options
                  forfeited
              
              
              -
              
              
              -
              
              
              -Options
                  outstanding at December 31, 2007
              
              
              1,000,000
              
              $
              0.505
              
              
              5.63Options
                  exercisable at December 31, 2007
              
              
              1,000,000
              
              $
              0.505
              
              
              5.63
 
 Information
        regarding non-qualified stock options outstanding as of December 31, 2007
        is
        summarized below:
 
 Options Outstanding
              
              Options ExercisableExercisePrice
              
              
              Options
              
              
              Weighted
                Average
                Remaining
                Contractual
                Life (years)
              
              
              Weighted
                Average
                Exercise
                Price
              
              
              Aggregate
                Intrinsic
                Value
              
              
              Options
              
              
              Weighted
                  Average ExercisePrice
              
              
              Aggregate
                  IntrinsicValue$
                  0.505
              
              
              1,000,000
              
              
              5.63
              
              $
              0.505
              
              $
              45,000
              
              
              1,000,000
              
              $
              0.505
              
              $
              45,000
  F-32
  **Avatar
        Systems, Inc.**
  NOTES
        TO
        FINANCIAL STATEMENTS
  December
        31, 2007 and 2006
  **NOTE
        R – STOCK BASED COMPENSATION**
  Effective
        January 1, 2006, the Company adopted SFAS No. 123(R) for stock-based
        compensation plans. Under SFAS No. 123(R) , all stock-based compensation
        is
        measured at the grant date, based on the fair value of the award, and is
        recognized as an expense in the statements of income and
        comprehensive incomeover the requisite service period.
  The
        Company adopted SFAS No. 123(R) using a modified prospective application
        in
        compliance with the revised implementation date on January 1, 2006. Under
        the
        modified prospective application, prior periods are not revised for comparative
        purposes. The valuation provisions of SFAS No. 123(R) apply to new awards
        and to
        awards that were outstanding at the effective date and subsequently modified
        or
        cancelled.
  The
        fair
        value of each option grant is estimated on the date of grant using the BSOPM,
        which was developed for use in estimating the fair value of traded options
        that
        have no vesting restrictions and are fully transferable. The weighted-average
        fair value of options that were granted during the year ended December 31,
        2006
        was $0.40 per share. The Company’s options have characteristics significantly
        different from those of traded options, and changes in input assumptions
        can
        materially affect the fair value estimates. The fair values of options granted
        were estimated using the Black-Scholes pricing model with a weighted average
        risk-free interest rate of 4.75%. The following assumptions were also used
        to
        determine the fair value of each option grant: dividend yields of 0%; weighted
        average expected volatility of 122.1%, a weighted average expected term of
        4.18
        years, and an expected forfeiture rate of 18% based on the Company’s historical
        experience. The volatility was determined based on the historic volatility
        of
        the Company’s stock for the length of the expected term of the options. There
        were no options granted during the year ended December 31, 2007.
  Share-based
        compensation expense included in general and administrative expenses and
        share-based interest expense for options issued in connection with the
        stockholder debt and debt issuance costs recognized for the years ended December
        31, 2007 and 2006 were as follows:
  December
                  31,2007
              
              2006Operating
                  expenses:General
                  and administrative (employee related options)
              
              $
              83,943
              
              $
              7,341Other
                  income (expense):Interest
                  expense
              
              
              119,567
              
              
              43,152Share-based
                  expense before taxes
              
              
              203,510
              
              
              50,493Related
                  income tax benefits
              
              
              (69,194
              )
              
              (17,168
              )Share-based
                  expense, net of taxes
              
              $
              134,316
              
              $
              33,325
 
 In
        the
        fourth quarter of 2007, the Company recorded a total of $69,000 in adjustments
        to stock compensation expense, which consisted principally of a prior-period
        adjustment of $53,000. The prior period adjustment related to options that
        were
        vested on the grant date. The Company determined that the adjustment would
        have
        an immaterial effect to the Company’s financial statements for the respective
        twelve-month periods ended December 31, 2006 and 2007, based upon management’s
        qualitative and quantitative analysis relative to its materiality consistent
        with the appropriate accounting guidance. The remaining adjustments related
        primarily to an interim period change in forfeiture rates.
  F-33
  **Avatar
        Systems, Inc.**
  NOTES
        TO
        FINANCIAL STATEMENTS
  December
        31, 2007 and 2006
  Robert
        C.
        Shreve, Jr., the Company’s Chairman, President, Chief Executive Officer and
        Chief Financial Officer, provided a guaranty in favor of a financial
        institution, pursuant to which Mr. Shreve guaranteed up to $676,500 of the
        Company’s obligations under the Term Loan and the Line-of-Credit. As
        consideration for providing this guaranty, the Company issued common stock
        options to purchase 451,000 shares of common stock of the Company to Mr.
        Shreve
        at an exercise price of $0.505 per share. The options were fully vested on
        the
        date of issuance. The value of the options, using the BSOPM model was determined
        to be $171,018 and was recorded as debt issuance costs included in other
        assets
        in the accompanying balance sheets, and will be amortized as interest expense
        over the life of the loan. The Company recorded $53,924 and $19,462 as interest
        expense to reflect the amortization of the debt issuance costs for the years
        ended December 31, 2007 and 2006, respectively.
  The
        Company entered into a loan agreement and promissory note with two stockholders
        to provide a promissory note for $823,500. The stockholders own approximately
        27.1% and 26.6%, respectively, of the outstanding common stock of the Company.
        As consideration for providing the loan agreement and the promissory note,
        the
        Company issued common stock options to purchase 274,500 shares of common
        stock
        of the Company to the each of the stockholders at an exercise price of $0.505
        per share. The options were fully vested on the date of issuance. The value
        of
        the options, using the Black-Scholes option pricing model was determined to be
        $208,179 and was recorded as a discount to the related debt and will be
        amortized as interest expense over the life of the loan. The Company recorded
        $65,643 and $23,690 as interest expense to reflect the amortization of the
        debt
        issuance costs for the years ended December 31, 2007 and 2006, respectively.
  **NOTE
        S - EMPLOYEE RETIREMENT PLAN**
  The
        Company sponsors an IRC 401(k) Profit Sharing Plan (the "Plan"), which covers
        all the Company's corporate employees. The Plan allows the corporate 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 $46,713 and $26,032 for the years
        ended
        December 31, 2007 and 2006, respectively.
  F-34
  **Item
        8. Changes In and Disagreements with Accountants on Accounting and Financial
        Disclosure**
  None.
  **Item
        8A(T). Controls and Procedures**
  **Evaluation
        of Disclosure Controls and Procedure**
  **Management’s
        Report on Internal Control Over Financial Reporting**
  The
        Company’s management is responsible for establishing and maintaining adequate
        internal control over financial reporting, as such term is defined in Exchange
        Act Rule 13a-15(f). Because of its inherent limitations, internal control
        over
        financial reporting may not prevent or detect misstatements. Also, projections
        of any evaluation of effectiveness to future periods are subject to risk
        that
        controls may become inadequate because of changes in conditions, or that
        the
        degree of compliance with the policies or procedures may deteriorate.
  Management
        assessed the effectiveness of the Company’s internal control over financial
        reporting as of December 31, 2007. In making this assessment, management
        used
        the criteria set forth by the Committee of Sponsoring Organizations of the
        Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on
        this assessment, we believe that, as of December 31, 2007, our internal control
        over financial reporting was effective based on those criteria.
  This
        annual report does not include an attestation report of the Company's registered
        public accounting firm regarding internal control over financial reporting.
        Management's report was not subject to attestation by the Company's registered
        public accounting firm pursuant to temporary rules of the Securities and
        Exchange Commission that permit the Company to provide only management's
        report
        in this annual report.
  **Changes
        in Internal Controls over Financial Reporting**
  During
        the three months ended December 31, 2007, there have been no changes in the
        Company’s internal control over financial reporting that have materially
        affected or are reasonably likely to materially affect the Company’s internal
        control over financial reporting.
  **Item
        8B. Other Information**
  Not
        applicable.
  -30-
  **PART
        III**
  **Item
        9. Directors, Executive Officers, Promoters, Control Persons and Corporate
        Governance; 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 AvatarRobert
                  C. Shreve, Jr.
              
              45
              
              President,
                  Chief Executive Officer,Chief
                  Financial Officer, Chairman of the Board and DirectorAllen
                  D. Farris
              
              56
              
              DirectorStephen
                  A. Komlosy
              
              67
              
              DirectorJohn
                  J. May
              
              59
              
              DirectorCindy
                  Skelton
              
              49
              
              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.
  **Stephen
        A. Komlosy** ,
        a
        member of MENSA, has over 45 years experience in business as a proprietor
        and
        has been a director of a number of public companies operating in the UK and
        the
        USA, and was until October 2005 chairman of AIM listed London and Boston
        Investments Plc (now PSG Solutions Plc), moving the company to OFEX and then
        to
        AIM. Previously, he was instrumental in the flotation of PremiSys Plc, the
        Laurie March Group and, on NASDAQ, Avatar Systems Inc., of which he remains
        a
        director. Mr. Komlosy has been a director of a number of publicly listed
        companies, including LPO, Pavilion Leisure Plc and Branon Plc, a supplier
        to
        North Sea Oil Companies and Ministry of Defence supplier, which he co-founded
        and where he was the director in charge of the launch of Cavendish Petroleum
        Plc, an Ohio, USA gas producer. Additionally, since 1964, he has built up
        three
        private property companies, two of which have been amalgamated with public
        companies.
  **John
        J. May** is a
        Fellow of the Institute of Chartered Accountants in England and Wales. He
        is
        policy director of the Small Business Bureau Limited and deputy chairman
        of The
        Genesis Initiative Limited, a lobby group for small business to the UK
        Parliament. Mr. May is the principal of his own London-based chartered
        accountancy practice. He was finance director of AIM listed PSG Solutions
        PLC,
        formerly London & Boston Investments Plc, until December 2005, and was
        previously finance director of Healthcare Enterprise Group Plc (formerly
        Interactivity Plc) and non-executive director of Croma Group Plc, both of
        which
        are listed on AIM. From 1977 to 1994 Mr. May was a senior partner with Horwath
        Clark Whitehill, where he served for eight years on the managing board and
        for
        nine years as chairman of its Thames Valley offices. In his capacity as UK
        national marketing partner and head of its property consultancy division,
        he was
        a director of its UK and international associations. He is currently a
        non-executive director of Platinum Diversified Mining Inc. listed on AIM,
        NASDAQ-listed Avatar Systems Inc. and non-executive chairman of Southbank
        UK
        Plc, listed on the Channel Islands Stock Exchange.
  -31-
  **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 is not a listed company on a national stock exchange and is therefore,
        not required to have an Audit Committee, a Compensation Committee, or a
        Nominating Committee. In the absence of such committees, the Board as a whole
        evaluates and recommends the engagement of the Company’s independent registered
        public accounting firm, reviews the results of their audit findings, and
        monitors on a periodic basis the internal controls of the Company, 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.
  **Code
        of Ethics**
  The
        Company has not formally approved a written code of ethics because it is
        impractical and cost prohibitive for the Company to implement due to its
        size.
  **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, 2007, 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
  -32-
  **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, 2008. 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 receives an
        annual
        base salary of $170,000, 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.
  **Key
        Man Insurance**
  We
        currently pay an annual premium of $3,467 for a life insurance policy for
        $2,550,000 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
        the Company.
  **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,
        2007, 2006 and 2005. In each case, the compensation listed was paid by our
        Company. 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.
  **Summary
        Compensation Table**
  Name
                and
                Principal
                Position
              
              Year
              
              Salary
              
              All
                Other
                Compensation
              
              TotalRobert
                  C. Shreve, Jr.
              
              
              2007
              
              $
              156,667
              
              $
              13,077
              
              $
              169,744Chief
                  Executive Officer
              
              
              2006
              
              $
              150,000
              
              $
              8,654
              
              $
              158,6542005
              
              $
              133,333
              
              $
              7,211
              
              $
              140,544
  -33-
  **Outstanding
        Equity Awards at Fiscal Year End**
  Option
                  AwardsName
              
              Number
                of
                Securities
                  Underlying
                Unexercised
                Options
                (#)
                Exercisable
              
              Number
                of
                Securities
                  Underlying Unexercised Options
                (#)
                Unexercisable
              
              Equity
                Incentive
                Plan
                Awards
                Number
                of
                Securities
                  Underlying Unexercised Unearned
                Options
                (#)
              
              Option
                Exercise
                Price
              
              Option
                Expiration
                DateRobert
                  C. Shreve, Jr.
              
              
              451,000
              
              
              -
              
              
              -
              
              $
              0.505
              
              
              08/16/2013
 
 **Director
        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.
  **Item
        11. Security Ownership of Certain Beneficial Owners and Management and Related
        Stockholder Matters**
  The
        table
        below sets forth, as of March 25, 2008, 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.
  Name(1)
              
              Shares
                Beneficially
                Owned
              
              Percentage of Shares
                Beneficially OwnedRobert
                  C. Shreve, Jr. (8)
              
              
              2,092,200
              
              
              20.8Charles
                  Timothy Allen (6) (9)
              
              
              2,724,473
              
              
              27.1Orville
                  Gregory Allen (6) (10)
              
              
              2,680,750
              
              
              26.7PSG
                  Solutions Plc (2) (6)
              
              
              1,679,002
              
              
              16.7Stephen
                  A. Komlosy (3)
              
              
              16,000
              
              
              0.2Allen
                  D. Farris (4)
              
              
              -
              
              
              -John
                  J. May (4)
              
              
              -
              
              
              -Cindy
                  Skelton (5)
              
              
              -
              
              
              -Officers
                  and directors as a group (5 persons) (11)
              
              
              2,108,200
              
              
              21.0
  
 (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 above is c/o Avatar Systems, Inc., 2801 Network Boulevard,
                  Suite 210, Frisco, Texas 75034.(2)
              The
                  address of PSG Solutions Plc is 133 Ebury Street, London SW1W9QU,
                  England.
  -34-
  (3)
              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 P.O. Box
                  3218 Gerrards Cross Buckinghamshire SL9 7WY, England.(4)
              Mr.
                  Farris and Mr. May are directors of Avatar.(5)
              Ms.
                  Skelton is the Secretary of Avatar.(6)
              Beneficial
                  owner of more than 5%. Neither an officer or director.(7)
              See
                  preceding notes for an explanation of the ownership of the 1,657,200
                  shares.(8)
              Includes
                  451,000 shares of common stock, which may be issued to Mr. Shreve
                  upon
                  exercise of 451,000 stock options at $.505 per share.
                  Such options are currently exercisable and expire August 13, 2013.
                  Mr.
                  Shreve is the President, Chief Executive Officer, Chief
                  Financial Officer and a director of Avatar.(9)
              Includes
                  274,500 shares of common stock, which may be issued to Mr. Allen
                  upon
                  exercise of 274,500 warrants at $0.505 per share.
                  Such warrants are currently exercisable and expire August 13, 2013.(10)
              Includes
                  274,500 shares of common stock, which may be issued to Mr. Allen
                  upon
                  exercise of 274,500 warrants at $0.505 per share.
                  Such warrants are currently exercisable and expire August 13, 2013(11)
              See
                  preceding notes for an explanation of the ownership of the 2,108,200
                  shares.
 
 We
        currently have 9,038,152 outstanding shares of common stock of which
        approximately 450 persons own
        approximately 846,000 shares. Our principal shareholders as noted in the
        above
        table own the remaining shares.
  **Item
        12. Certain Relationships and Related Transactions, and Director Independence**
  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
        $41,750 and $84,774 in 2007 and 2006, respectively. The Company had $4,447
        of
        accounts receivable at December 31, 2006 related to services performed for
        that
        company.
  The
        Company entered into a loan agreement and promissory note with two stockholders
        to provide a promissory note for $823,500. The stockholders own approximately
        27.1% and 26.6%, respectively, of the outstanding common stock of the Company.
  Total
        interest expense on the promissory note recorded by the Company for the period
        ended December 31, 2007 and 2006 was $133,096 and $52,101, respectively.
  On
        August
        18, 2006, as partial consideration for the acquisition, the Company issued
        convertible promissory notes to the sellers of Questa (the “Seller Promissory
        Notes”) in the amounts of $120,000 and $160,000. The Company also issued 200,000
        shares of its common stock to the sellers of Questa in connection with the
        execution of a Stock Purchase Agreement to acquire Questa.
  The
        outstanding principal balances of the Seller Promissory Notes are convertible,
        at the option of the holders, in whole or in part and at any time or from
        time
        to time, into shares of common stock of the Company at a conversion price
        of
        $3.50 per share, as adjusted from time to time for stock splits, combinations,
        stock dividends and other similar events.
  Total
        interest expense on the convertible promissory notes recorded by the Company
        for
        the period ended December 31, 2007 and 2006 was $11,356 and $4,200,
        respectively.
  Robert
        C.
        Shreve, Jr., the Company’s Chairman, President, Chief Executive Officer and
        Chief Financial Officer, provided a guaranty in favor of a financial
        institution, pursuant to which Mr. Shreve guaranteed up to $676,500 of the
        Company’s obligations under the Term Loan and the Revolving Loan. As
        consideration for providing this guaranty, the Company issued common stock
        options to purchase 451,000 shares of common stock of the Company to Mr.
        Shreve
        at an exercise price of $0.505 per share. The options were fully vested on
        the
        date of issuance. The value of the options, using the Black-Scholes option
        pricing model was determined to be $171,018 and was recorded as debt issuance
        costs included in other assets in the accompanying balance sheets, and will
        be
        amortized as interest expense over the life of the loan.
  The
        Company recorded $53,924 and $19,462 as interest expense to reflect the
        amortization of the debt issuance costs for the period ended December 31,
        2007
        and 2006, respectively.
 
 -35-
  **Item
        13. 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 Exhibit2.0*
              
              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, 20002.2*
              
              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, 20002.3*
              
              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, 20002.4*
              
              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, 20002.5*
              
              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, 20012.6*
              
              Order
                  Supplementing Order of Confirmation as filed with the U.S. Bankruptcy
                  Court for the Northern District of Texas, Dallas Division, on January
                  18,
                  20012.7*
              
              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, 19983.1*
              
              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,
                  20003.2*
              
              Certificate
                  of Restated Articles of Incorporation of Avatar Systems, Inc. as
                  filed
                  with the Secretary of State of Texas on November 14,
                  20003.3*
              
              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, 200010.0*
              
              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
                  million10.1*
              
              Management
                  Agreement by and between Avatar Systems, Inc. and Robert C. Shreve,
                  Jr. as
                  of July 10, 200010.2*
              
              Consulting
                  Agreement by and among Avatar Systems, Inc., Merchant Capital Holdings,
                  Ltd. and its affiliate, First Merchants Capital Limited, as of
                  July 10,
                  200010.3*
              
              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 Exhibit
                  Number
                  Description of Exhibit
 
 -36-
  10.4*
              
              Warrant
                  to Purchase Common Stock of Avatar Systems, Inc. issued to Cybertec
                  Holdings Plc. as of July 10, 200010.5*
              
              Warrant
                to Purchase Common Stock of Avatar Systems, Inc. issued to Robert
                C.
                Shreve, Jr. as of July 10, 200010.6*
              
              Warrant
                to Purchase Common Stock of Avatar Systems, Inc. issued to Merchants
                Capital Holdings, Ltd. as of July 10, 200010.7*
              
              Warrant
                  to Purchase Common Stock of Avatar Systems, Inc. issued to Stephen
                  A.
                  Komlosy as of July 10, 200010.8*
              
              Warrant
                  to Purchase Common Stock of Avatar Systems, Inc. issued to Tim
                  Allen as of
                  July 10, 200010.9*
              
              Warrant
                  to Purchase Common Stock of Avatar Systems, Inc. issued to Gregg
                  Allen as
                  of July 10, 200010.10*
              
              2000
                Stock Compensation Plan of Avatar Systems, Inc. dated October 9,
                200010.11*
              
              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 $288,888.9610.13*
              
              Security
                  Agreement dated July 10, 2000 between Avatar Systems, Inc. and
                  Bank One,
                  Texas, N.A.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. Statham10.21*
              
              Executive
                  Employment Agreement dated November 23, 2000 between Talon Global
                  Solutions, Inc. and Carla Rogers22.0*
              
              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 billed for professional services rendered for the audit of
        the
        Company's financial statements for the years ended December 31, 2007 and
        2006
        were $56,750 and $57,780 respectively. The fees for the reviews of the quarterly
        financial statements included in the Company's Form 10-QSB were $15,000 and
        $21,584 for the years ended December 31, 2007 and 2006, respectively.
  **Audit-Related
        Fees**
  The
        aggregate fees billed for professional services rendered for assurance and
        related services for the year ended December 31, 2007 and 1006 were $-0-,
        and
        $11,500, respectively. The fees were paid in 2006 for services related to
        the
        Company’s acquisition of Questa.
  **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, 2007 and 2006.
  -37-
  **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:**April 4, 2008
              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:**April
                  4, 2008
              By:
              /s/
                  ROBERT C. SHREVE, JR.Robert
                  C. Shreve, Jr.
                Chief
                  Executive Officer
                Chief
                  Financial Officer
                Director**Dated:**April 4, 2008
              By:
              /s/
                  ALLEN.D. FARRISAllen
                  D. Farris
                Director**Dated:**April 4, 2008
              By:
              /s/
                  STEPHEN A. KOMLOSYStephen
                  A. Komlosy
                Director**Dated:**April 4, 2008
              By:
              /s/
                  JOHN J. MAYJohn
                  J. May
                Director
  -38-