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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-KSB

|x | ANNUAL REPORT PURSUANT TO   SECTION 13 OR 15(D) OFTHE SECURITIES EXCHANGE ACT OF 1934
|- | -------------------------------------------------------------------------------------
|  |                                                                                      
|  | FOR THE FISCAL YEAR ENDED   DECEMBER 31, 2005
COMMISSION FILE NUMBER: 000-32925      

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

|Texas                                          |  | 75-2796037                            
|---------------------------------------------- |  | --------------------------------------
|(State   of incorporation)                     |  | (IRS   Employer Identification Number)
|                                               |  |                                       
|2801 Network   Drive, 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 (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.

|Yes
x | No
o
|----- | ----

As of March 24, 2006, 8,838,152 shares of the Issuers $0.001 par value common stock were outstanding and the aggregate market value of the share held by non-affiliates was approximately $355,000 based upon a closing bid price of $.55 per share of Common Stock on the OTC Bulletin Board.

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

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

|Yes
o | No
x
|----- | ----

The Issuers revenue for its most recent fiscal year was $2,278,404.

The following documents are incorporated by reference: None

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TABLE OF CONTENTS

|PART I                                                                                                                      | 1 
|--------------------------------------------------------------------------------------------------------------------------- | --
|Item 1. Description of Business                                                                                             | 1 
|Item 2. Description of Properties                                                                                           | 9 
|Item 3. Legal Proceedings                                                                                                   | 10
|Item 4. Submission of Matters To A Vote Of   Security Holders                                                               | 10
|PART II                                                                                                                     | 11
|Item 5. Market For Common Equity And   Related Shareholder Matters                                                          | 11
|Item 6. Managements Discussion And   Analysis Of Financial Condition Or Plan Of Operations                                 | 11
|Item 7. Financial Statements                                                                                                | 16
|Item 8. Changes In And Disagreements With   Accountants On Accounting And Financial Disclosure                              | 18
|Item 8a. Controls And Procedures                                                                                            | 18
|Item 8b. Other Information                                                                                                  | 18
|PART III                                                                                                                    | 18
|Item 9. Directors, Executive Officers,   Promoters and Control Persons; Compliance With Section 16(A) Of The Exchange   Act | 18
|Item 10. Executive Compensation                                                                                             | 20
|Item 11. Security Ownership Of Certain Beneficial   Owners And Management and Related Stockholder Matters                   | 22
|Item 12. Certain Relationships And Related   Transactions                                                                   | 22
|Item 13. Exhibits                                                                                                           | 23
|Item 14. Principal Accountant Fees And   Services                                                                           | 24
|Signatures                                                                                                                  | 25

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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.

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

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

Our principal executive offices are located at 2801 Network Drive, 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.

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

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

| |  | 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.

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 (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, 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.

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Petroware2000

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

Avatar400

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

RAPID and Petroware2000 ASP Products

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

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.

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Growth Strategy

Leveraging Existing Customer Relationships

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

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 2006, our product development efforts will include development of production /land modules for our Petroware2000 product and integration of new imaging functionality in both our AS400 and Petroware2000 products.

Pursuing Acquisitions and Strategic Alliances

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

Expanding ASP Hosting Business

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

Sales and Marketing

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

Competition

The market for
enterprise information solutions is intensely competitive, subject to rapid
change and significantly affected by new product introductions and other market
activities of industry participants. We face direct and indirect competition
from a broad range of competitors, many of whom have greater financial,
technical and marketing resources than we do.

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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

For the year ended December 31, 2005, the Company had no customers that accounted for more than 10% of revenues.

The Company completed a hardware sale with one customer for $739,826 during the year ended December 31, 2004.  In 2004, the Company completed hardware sales with three customers totaling $941,329.  These sales accounted for 86% of hardware revenue and 35% of total revenue for the year ended December 31, 2004.

Suppliers

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

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

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

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

Regulatory and Environmental Matters

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

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

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

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

Product Development

Our capitalized software development costs have been focused on the development of our Avatar400 and Petroware2000 products.  We capitalize software development costs applicable to each product after technological feasibility has been established until the product is released to the market.  It was necessary for us to develop a Windows-based application to gain a competitive edge and have successful sales in the oil and gas market.  In 2005 and 2004, our product development expenditures were $628,644 and $624,948 respectively.

Employees

As of  December 31, 2005, we had 13 employees, of which 1 was engaged in professional services, 6 in product development and customer support, 4 in sales and marketing and 2 in finance and administration.  We believe our future success will depend, in part, on our continued ability to attract and retain highly qualified personnel in a competitive market for experienced and talented software engineers and sales and marketing personnel.  Our success depends, to a significant extent, upon the continued contributions of our senior management and other key personnel, many of whom would be difficult to replace.  None of our employees are represented by a labor union or are subject to a collective bargaining agreement. We believe that our employee relations are strong.

Risk Factors and Other Trends and Uncertainties Affecting Future Operations

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

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

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

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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 effectively manage our present growth or any future expansion, which could cause substantial increases in our operating costs without corresponding increases in our revenue.  To support our growth, we will need to continue to hire qualified employees in all areas of our business. This planned strategy could strain our ability to integrate and properly train our new employees. Inadequate integration and training of our employees may result in an inefficient workforce and may harm our operating results.

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

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

WE MUST CONTINUE TO INTRODUCE NEW PRODUCTS AND PRODUCT ENHANCEMENTS.

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

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

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

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

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

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

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

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

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

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

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

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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.

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

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

AN ACTIVE TRADING MARKET MAY NOT DEVELOP FOR OUR COMMON STOCK

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

Item 2. Description of Properties

The Company leases its 5,765 square foot facility at 2801 Network Drive, 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.

The Company leases a 1,496 square foot facility at 6 Desta Drive, Suite 3350, Midland, Texas 79705.  The lease for the Midland facility was entered into on September 27, 2005 for a twelve-month lease term commencing on October 1, 2005 and expiring on September 30, 2006.

-9-

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The company leases a 250 square foot facility at 1901 Rickety, Suite 216, Tyler, Texas.  The lease for the Tyler facility was entered into on May 5, 2005 for a twelve-month lease term commencing on June 1, 2005 and expiring on May 30, 2006.

Item 3. Legal Proceedings

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

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

None.

-10-

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PART II

Item 5. Market For Common Equity And Related Shareholder Matters

Our common stock began trading on the Over-the-Counter Pink Sheets on April 2, 2001.  On November 5, 2001, our Registration Statement on Form 10-SB became effective and our stock was approved for trading on December 19, 2001, on the NASD OTC Bulletin Board.  During 2005, there was only nominal trading in the shares of our common stock.  As of January 13, 2006, the last reported trade in our stock was at $0.41.  No assurance can be given that an active market will exist for our common stock in the future.  On March 24, 2006, the last date reported for our common stock, the closing bid price was $.55 and the closing ask price was $1.05.  Our trading symbol is AVSY.OB.

Holders

As of March 24, 2006, the Company had approximately 450 shareholders of record, its common stock had a closing bid price of $0.55 per share, and a closing ask price of $1.05 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.

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

Forward Looking Statements

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

Critical Accounting Policies and Estimates

Use of Estimates and Certain Significant Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from 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.

-11-

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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.

Marketable Securities

Marketable securities at December 31, 2005 of consisted of corporate equities and at December 31, 2004 consisted of corporate equities and corporate bond mutual funds.  SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires certain investments be recorded at fair value or amortized cost.  The appropriate classification of the investments in marketable securities is determined at the time of purchase and re-evaluated at each balance sheet date.  As of December 31, 2005 and 2004, the Companys marketable securities were classified as available-for-sale, which are carried at fair value, with unrealized gains and losses reported as other comprehensive income within the stockholders equity section of the accompanying balance sheets, net of the related tax effect.  The cost of marketable equity securities sold is determined on a specific
identification basis.  The fair value of marketable equity securities is based on quoted market prices.

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 $628,644 and $624,948 of software development costs during the years ended December 31, 2005 and 2004, respectively.  Capitalized software development costs are amortized by the straight-line method over a period of seven years.  The amount, by which unamortized software costs exceed the net
realizable value, if any, is recognized in the period the excess is determined.  Amortization of capitalized software charged to expense was $390,120 and $335,952 for the years ended December 31, 2005 and 2004, 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, 2005 and 2004, the Company recorded no impairment charges.

-12-

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Revenue Recognition

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

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

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

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

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

Inflation

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

Results of Operations

Revenues

Our revenues include four components: software licensing fees, maintenance, professional services, and hardware.  Our revenues for the year ended December 31, 2005 decreased 14.4% to $2,278,404 compared with revenues of $2,661,370 for the year ended December 31, 2004.  Our overall revenues were primarily affected by lower hardware sales during 2005 offset by a strong increase in our software and professional services revenues.

Software. Software sales for the year ended December 31, 2005 increased 56.9% to $565,948 compared with software sales of $360,746 in 2004.  Software sales were higher compared to 2004 primarily because of the  strength in the energy sector which is being driven by higher oil prices.  Software sales were also impacted by installations of ISYNERGY, our new document management solution.

Maintenance. Maintenance revenue for the year ended December 31, 2005 increased 14.0% to $1,173,333 compared with maintenance revenue of $1,029,131 in 2004.  The increase in maintenance revenue was related to the higher software sales and an increase in maintenance prices during the third quarter.

Professional services.Professional service revenue for the year ended December 31, 2005 increased 55.3% to $279,865 compared with professional services revenue of $180,234 in 2004.  Professional services increased during 2005 because of higher training and system conversion services related to software sales and installations of our ISYNERGY document management software that require professional implementation services.

Hardware. Hardware
sales for the year ended December 31, 2005 decreased 76.2% to $259,258 compared
with hardware sales of $1,091,259 in 2004.  Hardware sales increased
dramatically during 2004 because of three transactions with our larger customers
that expanded operations during a period of rising petroleum prices.

-13-

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Cost of Revenues

Our cost of revenues includes four components: cost of software, cost of maintenance revenue, cost of professional services, and cost of hardware sales.  Our cost of revenues for the year ended December 31, 2005 decreased 48.2% to $639,449 compared with cost of revenues of $1,235,370 in 2004.  Cost of revenues as a percentage oftotal revenues decreased to 28.1% for the year ended December 31, 2005 from 46.4% in 2004.  The decrease in cost of revenues was primarily impacted by lower hardware sales that have a higher cost component offset by an increase in cost of software relative to higher software sales.

Cost of
software. Cost of software increased 110.3% to $229,458 for the year ended
December 31, 2005 from $109,117 in 2004.  Cost of software as a percentage
of the related revenues increased to 40.5% for the year ended December 31, 2005
compared to 30.2% in 2004. The increase in cost of software was related to an
increase in commissions on higher software sales during the third quarter offset
by a decrease in royalty costs under an expired royalty contract.

Cost of maintenance. Cost of maintenance revenue decreased 8.8% to $138,900 for the year ended December 31, 2005 from $152,309 in 2004.  Cost of maintenance revenue as a percentage of the related revenue decreased to 11.8% for the year ended December 31, 2005, compared to 14.8% for the same period last year.  The decreases in cost of maintenance and percentages of cost of maintenance as a percentage of the related revenues are due to reductions in personnel costs related to maintenance support and higher revenues.

Cost of professional services. Cost of professional services increased 4.9% to $66,320 for the year ended December 31, 2005, compared with $63,252 in 2004.  Cost of professional services as a percentage of the related revenue decreased to 23.7% for the year ended December 31, 2005, compared to 35.1% in 2004.  The increase in cost of professional services was related to increases in demand for training and systems conversions services that have a higher gross margin.

Hardware. Cost of hardware sold decreased 77.5% to $204,771 for year ended December 31, 2005, compared with $910,692 in 2004.  Cost of hardware as a percentage of the related revenue decreased to 79.0% for the year ended December 31, 2005, compared with 83.5% in 2004.  The decrease in cost of hardware is directly related to lower hardware sales.

Operating Expenses

Sales and Marketing.Our sales and marketing expenses for the year ended December 31, 2005 increased 73.3% to $277,161 compared with $159,903 in 2004.  Sales and marketing expenses as a percentage of total revenues increased to 12.2% for the year ended December 31, 2005 from 6.0% in 2004.  The increases in cost and related percentages of revenue were due to the addition of a sales manager to market ISYNERGY, our new document management software, related increases in travel and printing costs and higher trade show expenditures.

General and
Administrative. Our general and administrative expenses for the year ended
December 31, 2005 increased 4.8% to $481,458 compared with $459,466 in 2004.
General and administrative expenses as a percentage oftotal revenues increased
to 21.1% for the year ended December 31, 2005, compared with 17.3% in 2004
primarily as a result of lower revenues.

Depreciation and Amortization. Amortization expense increased 12.7% to $479,465 for the year ended December 31, 2005 from $425,296 in 2004.  Amortization expense as a percentage of total revenue increased to 21.0% in 2005 compared with 16.0% in 2004.  Amortization expense increased during 2005 because of software development projects that were completed in 2004 receiving a full year of amortization during 2005.  Lower total revenues impacted the increase in the percentage of amortization expense to total revenue.

Depreciation expense increased 54.9% to $148,369 for the year ended December 31, 2005 from $95,795.  Depreciation expense as a percentage of total revenues increased to 6.5% in 2005 from 3.6% in 2004.  Depreciation expense was higher in 2005 because of equipment we purchased during 2004 to facilitate the delivery of our Petroware2000 product as an ASP, and for equipment we purchased during 2005 to complete the data center at our new location.  The increase in the percentage of depreciation expense to total revenue was directly related to the higher depreciation expense.

-14-

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Investment
Income. Investment income was $20,259 for the year ended December 31,
2005 compared to $12,493 in 2004.  The increase in investment income was
due to increasing short term interest rates and higher invested
balances.

Loss on
investments. Loss on investments of $10,007 during the year ended December
31, 2005, included losses realized on investments in mutual bond funds with
longer terms of maturity.  Loss on investments of $2,271 were realized in
2004 from the sale of an investment in a mutual fund investing in variable rate
mortgages.

Interest Expense. Interest expense was $8,165 for the year ended December 31, 2005, compared to $5,524 in 2004.  The increase is due primarily to higher average amounts of debt outstanding during 2005 related to the 2004 addition of equipment to expand our ASP hosting capability.

Provision for Income Taxes.For the year ended December 31, 2005, we recorded a deferred tax provision on income before income taxes of $86,459 compared to $98,681 in 2004.  The decrease in deferred tax expense is directly attributable to the decrease in income before income tax.

Liquidity and Capital Resources

Our cash and cash equivalents and marketable securities at December 31, 2005 were $697,576 compared with $617,909 at December 31, 2004.

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 of $1,047,692 and $853,052 in 2005 and 2004, respectively.  Our cash provided by operating activities was impacted primarily by strong software sales and higher maintenance revenue during 2005.

Our accounts receivable balance decreased to $81,179 in 2005 from $145,770 at the end of 2004 primarily due to sales incentives owed to the Company in 2004 from large hardware sales.

The major use of our operating cash is to fund obligations that flow through our accounts payable and accrued expenses, 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 will be impacted by fluctuations in software and hardware sales.

Cash Flows from Investing Activities

Net cash used in investing activities in 2005 of $1,049,789 consisted of software development costs of $628,644, equipment purchases of $292,083, and net marketable securities purchased of $129,062.

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

Cash Flows from Financing Activities

Net cash used in financing activities in 2005 and 2004 was $31,993 and 21,302, respectively, was for principal payments on capital lease obligations and notes payable.

At December 31, 2005, we had $255,446 in working capital, down from $321,491 at December 31, 2004. The decrease in working capital primarily related to equipment purchases for our new data center, new telephone system, and leasehold improvements for our new corporate headquarters.  We currently have no significant capital commitments other than commitments under our capital lease obligations, note payable, and operating leases.

-15-

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

Recent Accounting Pronouncements

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

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

In December 2004, the FASB issued SFAS 123R, Share-Based Payment, which is a revision of SFAS 123 Accounting for Stock-Based Compensation and supersedes APB Opinion 25, Accounting for Stock Issued to Employees.  SFAS 123R focuses primarily on share-based payments for employee services, requiring these payments to be recorded as an expense using a fair-value-based method.  The use of APB 25s intrinsic value method of accounting for employee stock options has been eliminated.  The impact on the results of operations of the Company will be dependent on the number of options granted and the fair value of those options.  For the Company, SFAS 123R will be effective beginning January 1, 2006.

Item 7. Financial Statements

Avatar Systems, Inc.Index to Financial Statements

|Report   of Independent Registered Public   Accounting Firm                                    | F-1        
|---------------------------------------------------------------------------------------------- | -----------
|                                                                                               |            
|Financial   Statements                                                                         |            
|Balance Sheets as of December   31, 2005 and 2004                                              | F-2        
|Statements of Income for the   years ended December 31, 2005 and 2004                          | F-3        
|Statements of Changes in   Stockholders Equity for the years ended December 31, 2005 and 2004 | F-4        
|Statements of Cash Flows for   the years ended December 31, 2005 and 2004                      | F-5        
|Notes to Financial Statements                                                                  | F-6 to F-17

-16-

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Financial Statements and Report of Independent Registered Public Accounting Firm

Avatar Systems, Inc.

December 31, 2005 and 2004

-17-

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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, 2005 and 2004 and the related statements of 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. 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 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, 2005 and 2004, 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       
|February 18,   2006   

F-1

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Avatar Systems, Inc.BALANCE SHEETS

|                                                                                                          |  | December   31, |          
|--------------------------------------------------------------------------------------------------------- |  | -------------- | ---------
|                                                                                                          |  |                |          
|                                                                                                          |  | 2005           |          
|                                                                                                          |  |                |          
|ASSETS                                                                                                    |  |                |          
|CURRENT   ASSETS                                                                                          |  |                |          
|Cash   and cash equivalents                                                                               |  | $              | 257,056  
|Marketable   securities                                                                                   |  |                | 440,520  
|Accounts   receivable, net of allowance of $14,368 in 2004 and none in 2005                               |  |                | 81,179   
|Prepaid   expenses and other current assets                                                               |  |                | 34,783   
|Deferred   income taxes                                                                                   |  |                | 20,347   
|                                                                                                          |  |                |          
|Total current assets                                                                                      |  |                | 833,885  
|PROPERTY   AND EQUIPMENT, net of accumulated depreciation of $265,343 and   $496,920, respectively        |  |                | 438,132  
|PURCHASED   SOFTWARE, net of accumulated amortization of $859,136 and   $769,791, respectively            |  |                | 2,526    
|SOFTWARE   DEVELOPMENT COSTS, net of accumulated amortization of $1,373,073 and   $982,953, respectively  |  |                | 2,403,614
|OTHER   ASSETS                                                                                            |  |                | 10,569   
|                                                                                                          |  |                |          
|Total assets                                                                                              |  | $              | 3,688,726
|                                                                                                          |  |                |          
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                      |  |                |          
|CURRENT   LIABILITIES                                                                                     |  |                |          
|Accounts payable                                                                                          |  | $              | 121,050  
|Accrued   expenses                                                                                        |  |                | 117,316  
|Current   maturities of long-term debt                                                                    |  |                | 8,159    
|Current   maturities of capital lease obligations                                                         |  |                | 32,562   
|Deferred   revenue                                                                                        |  |                | 299,352  
|                                                                                                          |  |                |          
|Total current liabilities                                                                                 |  |                | 578,439  
|DEFERRED   INCOME TAXES                                                                                   |  |                | 432,705  
|OTHER   LONG-TERM LIABILITIES                                                                             |  |                | 19,377   
|LONG-TERM   DEBT                                                                                          |  |                |          
|Long-term   debt                                                                                          |  |                | 23,908   
|Long-term   capital lease obligations                                                                     |  |                | 24,552   
|                                                                                                          |  |                |          
|Total long-term debt                                                                                      |  |                | 48,460   
|                                                                                                          |  |                |          
|Total liabilities                                                                                         |  |                | 1,078,981
|COMMITMENTS   AND CONTINGENCIES                                                                           |  |                |         
|STOCKHOLDERS   EQUITY                                                                                    |  |                |          
|Preferred   stock, $0.001 par value, 10,000,000 shares authorized; none issued                            |  |                |         
|Common   stock, $0.001 par value; 30,000,000 shares authorized; 8,838,152 shares   issued and outstanding |  |                | 8,838    
|Paid-in   capital                                                                                         |  |                | 1,768,203
|Retained   earnings                                                                                       |  |                | 824,249  
|Accumulated   other comprehensive income                                                                  |  |                | 8,455    
|                                                                                                          |  |                |          
|Total stockholders equity                                                                                |  |                | 2,609,745
|                                                                                                          |  |                |          
|Total liabilities and stockholders equity                                                                |  | $              | 3,688,726
|                                                                                                          |  |                |          

See accompanying notes to financial statements.

F-2

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Avatar Systems, Inc.STATEMENTS OF INCOME

|                                                                 |  | Year ended   December 31, |          
|---------------------------------------------------------------- |  | ------------------------- | ---------
|                                                                 |  |                           |          
|                                                                 |  | 2005                      |          
|                                                                 |  |                           |          
|Revenue:                                                         |  |                           |          
|Software                                                         |  | $                         | 565,948  
|Maintenance                                                      |  |                           | 1,173,333
|Professional   services                                          |  |                           | 279,865  
|Hardware                                                         |  |                           | 259,258  
|                                                                 |  |                           |          
|Total revenues                                                   |  |                           | 2,278,404
|Cost of   Sales:                                                 |  |                           |          
|Software                                                         |  |                           | 229,458  
|Maintenance                                                      |  |                           | 138,900  
|Professional   services                                          |  |                           | 66,320   
|Hardware                                                         |  |                           | 204,771  
|                                                                 |  |                           |          
|                                                                 |  |                           | 639,449  
|                                                                 |  |                           |          
|Gross profit                                                     |  |                           | 1,638,955
|Operating   Expenses:                                            |  |                           |          
|Sales   and Marketing                                            |  |                           | 277,161  
|General   and administrative                                     |  |                           | 481,458  
|Depreciation   and amortization                                  |  |                           | 627,834  
|                                                                 |  |                           |          
|                                                                 |  |                           | 1,386,453
|                                                                 |  |                           |          
|Operating income                                                 |  |                           | 252,502  
|Other   income (expense):                                        |  |                           |          
|Investment   income                                              |  |                           | 20,259   
|Loss   on investments                                            |  |                           | (10,007  
|Interest   expense                                               |  |                           | (8,165   
|                                                                 |  |                           |          
|                                                                 |  |                           | 2,087    
|Income before income taxes                                       |  |                           | 254,589  
|Deferred income tax expense                                      |  |                           | 86,459   
|                                                                 |  |                           |          
|NET INCOME                                                       |  | $                         | 168,130  
|                                                                 |  |                           |          
|Net income   per share - basic and diluted                       |  | $                         | 0.02     
|                                                                 |  |                           |          
|Weighted   average common shares outstanding - basic and diluted |  |                           | 8,838,152
|                                                                 |  |                           |          

See accompanying notes to financial statements.

F-3

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

Years ended December 31, 2005 and 2004

|                                                                                                                                      |  |                |           |                    |   |                     | Accumulated   other   Comprehensive   Income |   |           |   |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | --------- | ------------------ | - | ------------------- | -------------------------------------------- | - | --------- | - | -
|                                                                                                                                      |  |                |           |                    |   |                     |                                              |   |           |  
|                                                                                                                                      |  | Common   stock |           |                    |   |                     |                                              |   |           |   |  
|                                                                                                                                      |  |                |           | Paid-in    Capital |   | Retained   earnings |                                              |   |           |   |  
|                                                                                                                                      |  | Shares         |           | Amount             |   |                     |                                              |   | Total     |  
|                                                                                                                                      |  |                |           |                    |   |                     |                                              |   |           |   |  
|Balance at December 31, 2003                                                                                                          |  |                | 8,695,652 |                    | $ | 8,696               |                                              | $ | 1,768,345 |   | $
|Exchange of 5,700,000 common   stock warrants with an exercise price of $1 expiring in July 2005 for 142,500   shares of common stock |  |                | 142,500   |                    |   | 142                 |                                              |   | (142      | ) |  
|Net income                                                                                                                            |  |                |          |                    |   |                    |                                              |   |          |   |  
|Change in unrealized gain on   marketable securities, net of tax                                                                      |  |                |          |                    |   |                    |                                              |   |          |   |  
|                                                                                                                                      |  |                |           |                    |   |                     |                                              |   |           |   |  
|Comprehensive income                                                                                                                  |  |                |          |                    |   |                    |                                              |   |          |   |  
|                                                                                                                                      |  |                |           |                    |   |                     |                                              |   |           |   |  
|Balance at December 31, 2004                                                                                                          |  |                | 8,838,152 |                    |   | 8,838               |                                              |   | 1,768,203 |   |  
|Net income                                                                                                                            |  |                |          |                    |   |                    |                                              |   |          |   |  
|Change in unrealized gain on   marketable securities, net of tax                                                                      |  |                |          |                    |   |                    |                                              |   |          |   |  
|                                                                                                                                      |  |                |           |                    |   |                     |                                              |   |           |   |  
|Comprehensive income                                                                                                                  |  |                |          |                    |   |                    |                                              |   |          |   |  
|                                                                                                                                      |  |                |           |                    |   |                     |                                              |   |           |   |  
|Balance at December 31, 2005                                                                                                          |  |                | 8,838,152 |                    | $ | 8,838               |                                              | $ | 1,768,203 |   | $
|                                                                                                                                      |  |                |           |                    |   |                     |                                              |   |           |   |  

See accompanying notes to financial statements.

F-4

---



Avatar Systems, Inc.STATEMENTS OF CASH FLOWS

|                                                                                            |  | Year ended   December 31, |           
|------------------------------------------------------------------------------------------- |  | ------------------------- | ----------
|                                                                                            |  |                           |           
|                                                                                            |  | 2005                      |           
|                                                                                            |  |                           |           
|Cash flows   from operating activities                                                      |  |                           |           
|Net   income                                                                                |  | $                         | 168,130   
|Adjustments   to reconcile net income to net cash provided by operating activities:         |  |                           |           
|Depreciation   and amortization                                                             |  |                           | 627,834   
|Loss   on investments                                                                       |  |                           | 10,007    
|Deferred   income taxes                                                                     |  |                           | 86,458    
|Changes   in operating assets and liabilities                                               |  |                           |           
|Accounts   receivable                                                                       |  |                           | 64,591    
|Prepaid   expenses and other current assets                                                 |  |                           | (19,480   
|Other   Assets                                                                              |  |                           | (10,569   
|Accounts   payable                                                                          |  |                           | 49,022    
|Accrued   expenses                                                                          |  |                           | 23,698    
|Deferred   revenue                                                                          |  |                           | 28,624    
|Other   Long-term liabilities                                                               |  |                           | 19,377    
|                                                                                            |  |                           |           
|Net   cash provided by operating activities                                                 |  |                           | 1,047,692 
|Cash flows   from investing activities                                                      |  |                           |           
|Software   development costs capitalized                                                    |  |                           | (628,644  
|Purchases   of property and equipment                                                       |  |                           | (292,083  
|Purchases   of marketable securities                                                        |  |                           | (483,683  
|Proceeds   from sale of marketable securities                                               |  |                           | 354,621   
|                                                                                            |  |                           |           
|Net   cash used in investing activities                                                     |  |                           | (1,049,789
|Cash flows   from financing activities                                                      |  |                           |           
|Principal   payments on capital lease obligations                                           |  |                           | (25,199   
|Principal   payments on long-term debt                                                      |  |                           | (6,794    
|                                                                                            |  |                           |           
|Net   cash used in financing activities                                                     |  |                           | (31,993   
|                                                                                            |  |                           |           
|Net   decrease in cash and cash equivalents                                                 |  |                           | (34,090   
|Cash and equivalents at   beginning of year                                                 |  |                           | 291,146   
|                                                                                            |  |                           |           
|Cash and cash equivalents at   end of year                                                  |  | $                         | 257,056   
|                                                                                            |  |                           |           
|Supplemental disclosure of cash paid for:                                                   |  |                           |           
|Interest                                                                                    |  | $                         | 8,165     
|                                                                                            |  |                           |           
|Supplemental disclosure of   noncash investing and financing activities:                    |  |                           |           
|Purchase   of equipment under capital lease obligation                                      |  | $                         | 18,428    
|Purchase   of vehicle through issuance of note payable                                      |  | $                         | 33,716    
|Change   in unrealized gain on marketable securities, net of tax                            |  | $                         | (3,496    
|Debt   repayment through non-cash asset transfer                                            |  | $                         | 22,479    
|Issuance   of capital stock in exchange for outstanding warrants to purchase common   stock |  | $                         |          

See accompanying notes to financial statements.

F-5

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

NOTE A  ORGANIZATION AND SUMMARY OF ACCOUNTING POLICIES

Nature of Business

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

Use of Estimates and Certain Significant Estimates

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

Concentrations of Credit Risk

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

Fair Value of Financial Instruments

In accordance with the reporting requirements of Statement of Financial Accounting Standards (SFAS) No. 107, Disclosures About Fair Value of Financial Instruments, the Company calculates the fair value of its assets and liabilities which qualify as financial instruments under this statement and includes this additional information in the notes to financial statements when the fair value is different than the carrying value of these financial instruments.  The estimated fair value of accounts receivable, accounts payable and accrued 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.

Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.  The Company maintains deposits primarily in one financial institution, which may at times exceed amounts covered by insurance provided by the U.S. Federal Deposit Insurance Corporation.  At December 31, 2005 and 2004, the uninsured portion of these deposits was approximately $97,000 and $224,000, respectively.  The Company has not incurred any losses related to its uninsured deposits with financial institutions.

F-6

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

Marketable Securities

Marketable securities at December 31, 2005 of consisted of corporate equities and at December 31, 2004 consisted of corporate equities and corporate bond mutual funds.  SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires certain investments be recorded at fair value or amortized cost.  The appropriate classification of the investments in marketable equity is determined at the time of purchase and re-evaluated at each balance sheet date.  As of December 31, 2005 and 2004, the Companys marketable securities were classified as available-for-sale, which are carried at fair value, with unrealized gains and losses reported as other comprehensive income 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.  The Company had realized losses of $10,007 and $2,271 related to marketable securities for the year ended December 31, 2005 and 2004, respectively.  Marketable securities held at December 31, 2005 and 2004 have a cost basis of $427,709 and $308,655, respectively.

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 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 $628,644 and $624,948 of software development costs during the years ended December 31, 2005 and 2004, respectively.  Capitalized software development costs are amortized using the greater of the amount computed by the ratio of current year net revenue to estimated future net revenue of the product, or the amount computed by the straight-line method over a period
which approximates the estimated economic life of the products, which historically has been seven years.  The amount, by which unamortized software costs exceed the net realizable value, if any, is recognized in the period the excess is determined.  Amortization of capitalized software charged to expense was $390,120 and $335,952 for the years ended December 31, 2005 and 2004, respectively.

Property and Equipment

Property and equipment are recorded at cost.  Expenditures for maintenance and repairs are expensed as incurred.  Depreciation of property and equipment is provided primarily on the straight-line method over the estimated useful lives ranging from 3 to 7 years.  Amortization of leasehold improvements is provided on the straight-line method over the shorter of the useful lives of the assets or the terms of the corresponding leases.

Impairment of Long-Lived Assets

The Company reviews its long-lived assets and certain identifiable intangibles for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amounts of the assets to future net cash flows expected to be generated by the assets.  If such assets are considered impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets based on estimated future cash flows.  During the years ended December 31, 2005 and 2004, the Company recorded no impairment charges.

F-7

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

Revenue Recognition

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

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

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

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

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

Stock-based Compensation

The Company accounts for stock-based awards to employees using the intrinsic
value method described in Accounting Principles Board Opinion (APB)
No. 25, Accounting for Stock Issued to Employees and its related
interpretations.  Accordingly, no compensation expense has been recognized
in the accompanying financial statements for stock-based awards to employees
when the exercise price of the award is equal to or greater than the quoted
market price of the stock on the date of the grant.  SFAS No. 123,
Accounting for Stock-Based Compensation and SFAS No. 148, Accounting
for Stock-Based Compensation - Transition and Disclosure  an
amendment of FASB Statement No. 123, require disclosures as if the Company
had applied the fair value method to employee awards rather than the intrinsic
value method.  The fair value of stock-based awards to employees is
calculated using option pricing models, which were developed for estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable.  These models also require subjective assumptions, including
future stock price volatility and expected time to exercise, which greatly
affect the calculated values.  There were no options granted in 2005 and
2004.

Income Taxes

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

F-8

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

Comprehensive Income

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

Earnings Per Share

The Company computes earnings per share in accordance with SFAS No. 128, Earnings Per Share.  SFAS No. 128 provides for the calculation of basic and diluted earnings per share.  Basic earnings per share includes no dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period.  Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of the Company.  The impact of dilutive stock options does not change earnings per share, therefore basic and diluted earnings per share are the same.

Recent Accounting Pronouncements

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

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

In December 2004, the FASB issued SFAS 123R, Share-Based Payment, which is a revision of SFAS 123 Accounting for Stock-Based Compensation and supersedes APB Opinion 25, Accounting for Stock Issued to Employees.  SFAS 123R focuses primarily on share-based payments for employee services, requiring these payments to be recorded as an expense using a fair-value-based method.  The use of APB 25s intrinsic value method of accounting for employee stock options has been eliminated.  The impact on the results of operations of the Company will be dependent on the number of options granted and the fair value of those options.  For the Company, SFAS 123R will be effective beginning January 1, 2006.

F-9

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

NOTE B  MARKETABLE SECURITIES

At December 31, 2005, marketable securities were summarized as follows:

|                                                |  | Cost |         | Gross   Unrealized   Gains |   | Gross   Unrealized   Losses |  | Aggregate   Fair Value |       
|----------------------------------------------- |  | ---- | ------- | -------------------------- | - | --------------------------- |  | ---------------------- | ------
|                                                |  |      |         |                            |   |                             |  |                        |       
|Corporate equities exchange   traded index fund |  | $    | 100,851 |                            | $ | 14,200                      |  | $                      |      
|Corporate equities mutual   fund                |  |      | 101,087 |                            |   |                            |  |                        | (1,124
|Corporate equities preferred   stock            |  |      | 225,771 |                            |   |                            |  |                        | (265  
|                                                |  |      |         |                            |   |                             |  |                        |       
|                                                |  | $    | 427,709 |                            | $ | 14,200                      |  | $                      | (1,389
|                                                |  |      |         |                            |   |                             |  |                        |       

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

|                                                          |  | Cost |         | Gross   Unrealized   Gains |   | Gross   Unrealized   Losses |  | Aggregate   Fair Value |      
|--------------------------------------------------------- |  | ---- | ------- | -------------------------- | - | --------------------------- |  | ---------------------- | -----
|                                                          |  |      |         |                            |   |                             |  |                        |      
|Corporate equities exchange   traded index fund           |  | $    | 99,987  |                            | $ | 14,463                      |  | $                      |     
|Corporate bond mutual fund   one to three year maturities |  |      | 104,079 |                            |   |                            |  |                        | 1,386
|Corporate bond mutual fund   intermediate maturities      |  |      | 104,589 |                            |   | 5,031                       |  |                        |     
|                                                          |  |      |         |                            |   |                             |  |                        |      
|                                                          |  | $    | 308,655 |                            | $ | 19,494                      |  | $                      | 1,386
|                                                          |  |      |         |                            |   |                             |  |                        |      

The Companys marketable securities are classified as
available-for-sale.  Management has the ability and intent, if necessary,
to liquidate any of these investments in order to meet liquidity needs with the
normal operating cycle.  Accordingly, all marketable securities are
classified as current assets.  Gross realized losses on the sales of
marketable securities were $10,007 and $2,271in 2005 and 2004, respectively.

NOTE C  PROPERTY AND EQUIPMENT

Property and equipment are summarized as follows:

|                                  |  | December   31, |        
|--------------------------------- |  | -------------- | -------
|                                  |  |                |        
|                                  |  | 2005           |        
|                                  |  |                |        
|Computer equipment and   software |  | $              | 427,856
|Furniture and fixtures            |  |                | 75,294 
|Leasehold Improvements            |  |                | 54,647 
|Transportation                    |  |                | 33,716 
|Telecommunication equipment       |  |                | 15,344 
|Assets under capital lease        |  |                | 96,618 
|                                  |  |                |        
|                                  |  |                | 703,475
|Less accumulated   depreciation   |  |                | 265,343
|                                  |  |                |        
|Property and equipment, net       |  | $              | 438,132
|                                  |  |                |        

During the years ended December 31, 2005 and 2004, the Company recorded
depreciation expense of $148,369 and $95,795, respectively.  Depreciation
expense in 2005 and 2004 also included the depreciation expense on assets
recorded under capital leases.

F-10

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

NOTE D  PURCHASED SOFTWARE

Purchased software is summarized as follows:

|                              |  | December   31, |        
|----------------------------- |  | -------------- | -------
|                              |  |                |        
|                              |  | 2005           |        
|                              |  |                |        
|Purchased software            |  | $              | 861,662
|Less accumulated amortization |  |                | 859,136
|                              |  |                |        
|Purchased software, net       |  | $              | 2,526  
|                              |  |                |        

Purchased software is recorded at cost.  Amortization of purchased software is provided on the straight-line method over 7 years.  During the years ended December 31, 2005 and 2004, the Company recorded amortization expense of $89,345.

As of December 31, 2005, future purchased software amortization expense for the year ending December 31, 2006 is $2,526.

NOTE E  DEVELOPED SOFTWARE

Developed software is summarized as follows:

|                                  |  | December   31, |          
|--------------------------------- |  | -------------- | ---------
|                                  |  |                |          
|                                  |  | 2005           |          
|                                  |  |                |          
|Software development costs        |  | $              | 3,776,687
|Less accumulated   amortization   |  |                | 1,373,073
|                                  |  |                |          
|Software development costs,   net |  | $              | 2,403,614
|                                  |  |                |          

Developed software is recorded at cost.  Amortization of developed software is provided on the straight-line method over 7 years.  During the years ended December 31, 2005 and 2004, the Company recorded amortization expense of $390,120 and $335,952, respectively.

Software development costs in process at December 31, 2005 and 2004 were $1,045,841 and $417,197, respectively.

As of December 31, 2005, developed software amortization expense for each calendar year ending December 31 is:  $390,119 for 2006; $324,846 for 2007; $245,647 for 2008; $189,225 for 2009, $127,532 for 2010, and $1,126,245 thereafter.

F-11

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

NOTE F - LONG-TERM DEBT

At December 31, 2005 long-term debt consisted of 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, beginning in August 2005 through maturity in July 2009.

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

LONG-TERM DEBT

|                                    |  | December   31, |       
|----------------------------------- |  | -------------- | ------
|                                    |  |                |       
|                                    |  | 2005           |       
|                                    |  |                |       
|Current portion of long-term   debt |  | $              | 8,159 
|Long-term debt                      |  |                | 23,908
|                                    |  |                |       
|                                    |  | $              | 32,067
|                                    |  |                |       

Future long-term debt obligations in effect at December 31, 2005 were as follows:

|     |  | Year   ending   December 31, |       
|---- |  | ---------------------------- | ------
|     |  |                              |       
|2006 |  | $                            | 8,159 
|2007 |  |                              | 8,748 
|2008 |  |                              | 9,380 
|2009 |  |                              | 5,780 
|     |  |                              |       
|     |  | $                            | 32,067
|     |  |                              |       

F-12

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

NOTE G  CAPITAL LEASE OBLIGATIONS

During 2005, we entered into a capital lease arrangement for the rental of computer equipment in our ASP hosting facility for $18,428.  The lease agreement requires monthly payments of principal and interest of $718 at an interest rate of approximately 23% and matures on October 1, 2008.

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

|                                                 |  | December   31, |       
|------------------------------------------------ |  | -------------- | ------
|                                                 |  |                |       
|                                                 |  | 2005           |       
|                                                 |  |                |       
|Current portion of capital lease   obligations   |  | $              | 32,562
|Long-term portion of capital   lease obligations |  |                | 24,552
|                                                 |  |                |       
|Total   capital lease obligations                |  | $              | 57,114
|                                                 |  |                |       

Future minimum capital lease obligations in effect at December 31, 2005 were as follows:

|                                                 |  | Year ending   December 31, |       
|------------------------------------------------ |  | -------------------------- | ------
|                                                 |  |                            |       
|2006                                             |  | $                          | 32,562
|2007                                             |  |                            | 18,807
|2008                                             |  |                            | 5,745 
|                                                 |  |                            |       
|Total   Future minimum capital lease obligations |  | $                          | 57,114
|                                                 |  |                            |       

F-13

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

NOTE H  LEASE OBLIGATIONS

The Company leases its 5,765 square foot facility at 2801 Network Drive, 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.  Rental payments are abated for the first ten months of the lease until September 1, 2006.  Prepaid rent of $10,569 will be applied to the eleventh month of the lease on October 1, 2006.  Monthly rental payments of $10,569 will begin on November 1, 2006 and will continue until October 31, 2015 when the lease expires.  Deferred rent of $19,377 has been included in Other Long-Term Liabilities for the year ended December 31, 2005.

The Company leases a 1,496 square foot facility at 6 Desta Drive, Suite 3350, Midland, Texas 79705.  The lease for the Midland facility was entered into on September 27, 2005 for a twelve-month lease term commencing on October 1, 2005 and expiring on September 30, 2006.

The company leases a 250 square foot facility at 1901 Rickety, Suite 216, Tyler, Texas.  The lease for the Tyler facility was entered into on May 5, 2005 for a twelve-month lease term commencing on June 1, 2005 and expiring on May 30, 2006.

Future minimum payments are as follows:

|                                |  | Year ending   December 31, |          
|------------------------------- |  | -------------------------- | ---------
|                                |  |                            |          
|2006                            |  |                            | 55,808   
|2007                            |  |                            | 126,830  
|2008                            |  |                            | 126,830  
|2009                            |  |                            | 126,830  
|2010                            |  |                            | 126,830  
|Thereafter                      |  |                            | 613,012  
|                                |  |                            |          
|Minimum   future lease payments |  | $                          | 1,176,140
|                                |  |                            |          

Rent expense under the operating leases was $159,027 and $152,486 for the years ended December 31, 2005 and 2004, respectively.

F-14

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

NOTE I  INCOME TAXES

The Companys income tax expense in 2005 and 2004 consisted only of deferred taxes.  The Company had no current income tax expense primarily because software development costs are charged to expense for federal income tax purposes and capitalized for financial reporting purposes.

Deferred tax assets and liabilities consist of the following:

|                                           |  | December   31, |         
|------------------------------------------ |  | -------------- | --------
|                                           |  |                |         
|                                           |  | 2005           |         
|                                           |  |                |         
|Deferred tax assets                        |  |                |         
|Net   operating loss carryforwards         |  | $              | 77,212  
|Purchased   software amortization          |  |                | 95,991  
|Accrued   expenses                         |  |                | 24,702  
|                                           |  |                |         
|                                           |  |                | 197,905 
|Deferred tax liabilities                   |  |                |         
|Capitalized   software                     |  |                | 543,780 
|Property   and equipment                   |  |                | 62,128  
|Unrealized   gain on marketable securities |  |                | 4,355   
|                                           |  |                |         
|                                           |  |                | 610,263 
|                                           |  |                |         
|Net deferred tax liability                 |  | $              | (412,358
|                                           |  |                |         
|Net   deferred tax asset - current         |  | $              | 20,347  
|Net   deferred tax liability - long term   |  |                | (432,705
|                                           |  |                |         
|Net deferred tax liability                 |  | $              | (412,358
|                                           |  |                |         

At December 31, 2005, the Company had federal net operating loss carryforwards
of approximately $231,000, which expire in 2023 and 2024.

F-15

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

NOTE J - RELATED PARTIES

The Company sells computer hardware and provides software maintenance, training, and consulting/development services to a company that is controlled by two members of the Companys Board of Directors.  Total revenues from that company were $23,446 and $22,060 in 2005 and 2004, respectively.  The Company had $2,035 and $1,861 of accounts receivable at December 31, 2005 and 2004, respectively, related to services performed for that company.

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

NOTE K  MAJOR CUSTOMERS

The Company had no customers that accounted for more than 10% of revenues during 2005.  The Company completed a hardware sale with one customer during 2004 for $739,826.  The Company completed hardware sales with three customers during 2004 totaling $941,329 which accounted for 86% of hardware revenue and 35% of total revenue for the year ended December 31, 2004.

F-16

---



Avatar Systems, Inc.

NOTES TO FINANCIAL STATEMENTS

December 31, 2005 and 2004

NOTE L - STOCK COMPENSATION PLAN AND WARRANTS

In 2000, the Companys shareholders approved the adoption of a stock compensation plan.  Stock options are granted at the quoted market price of the Companys stock at the date of grant, becoming exercisable over periods of up to three years and expire ten years from the date of grant.  No stock options were granted by the Company during the years ended December 31, 2005 or 2004.  At December 31, 2005, 1,443,192 shares of common stock were reserved for future grant under the 2000 Stock Compensation Plan.

Option activity for the years ended December 31, 2005 and 2004 is summarized as follows:

|                                           |  | 2005    |        | 2004                                |  
|------------------------------------------ |  | ------- | ------ | ----------------------------------- | -
|                                           |  |         |        |                                     |  
|                                           |  | Options |        | Weighted   Average   Exercise Price |  
|                                           |  |         |        |                                     |  
|Options outstanding at   beginning of year |  |         | 56,808 |                                     | $
|Options granted                            |  |         |       |                                     |  
|Options exercised                          |  |         |       |                                     |  
|Options forfeited                          |  |         |       |                                     |  
|                                           |  |         |        |                                     |  
|Options outstanding at end   of year       |  |         | 56,808 |                                     | $
|                                           |  |         |        |                                     |  
|Options exercisable at end   of year       |  |         | 56,808 |                                     | $
|                                           |  |         |        |                                     |  

The options outstanding at December 31, 2005 have a weighted average remaining life of 5 years with an exercise price of $1.25 per share.

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

NOTE M - EMPLOYEE RETIREMENT PLAN

The Company sponsors an Internal Revenue Code section 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 $20,504 and $17,445 for the years ended December 31, 2005 and 2004, respectively.

F-17

---



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

None.

Item 8a. Controls And Procedures

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

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

Item 8b. Other Information

Not applicable.

PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(A) Of The Exchange Act

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

|Name                  |  | Age |    | Position   with Avatar | 
|--------------------- |  | --- | -- | ---------------------- | 
|                      |  |     |    |                        | 
|Robert C. Shreve, Jr. |  |     | 43 |                        | 
|Charles Timothy Allen |  |     | 55 |                        | 
|Allen D. Farris       |  |     | 54 |                        | 
|Stephen A. Komlosy    |  |     | 65 |                        | 
|John J. May           |  |     | 57 |                        | 
|Cindy Skelton         |  |     | 47 |                        | 

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

Charles Timothy (Tim) Allen has served as a director of our Company since November 14, 2000.  Mr. Allen was a limited partner of Avatar Systems, Ltd. and an officer of Avatar Systems, Inc., the predecessors of our Company, from 1996 to November 2000.  Mr. Allen is primarily in the investment business focusing on oil & gas and real estate.  He serves on several boards involving various businesses that he and his family have formed or purchased.

-18-

---



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

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

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

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

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

Committees of the Board of Directors

The Company 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.

-19-

---



Code of Ethics

The Company has not formally approved a written code of ethics because it has only one member of management making it impractical and cost prohibitive for the Company to implement.

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, 2005, all Section 16(a) filing requirements applicable to the Companys officers, directors, and 10% stockholders were met.

Item 10. Executive Compensation

Executive Officers

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

Employment Agreements

We have entered into a
management agreement with Robert C. Shreve, Jr., our President and Chief
Executive Officer and Chief Financial Officer, which terminates on July 10,
2006.  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 $150,000, which may be increased at the discretion of our
Board.  Additionally, Mr. Shreve may be eligible to receive an annual bonus
based on our financial performance in the form of stock options and cash not to
exceed 15% of his base salary.  Upon agreeing to the terms of the
management agreement, we issued to Mr. Shreve a five-year warrant to purchase
1.6 million shares of our common stock at an exercise price of $1.00 per
share.  On December 10, 2004, Mr. Shreves warrants were exchanged for
40,000 shares of the Companys common stock.  See Part III, Item
11- Security Ownership of Certain Beneficial Owners and
Management.

Key Man Insurance

We currently pay an annual premium of $3,252 for a life insurance policy for $1,000,000 on the life of Robert C. Shreve, Jr., our President, Chief Executive Officer and Chief Financial Officer.  The proceeds of the policy are payable to us.

Stock Option Plan

On November 14,
2000, our shareholders approved our 2000 Stock Compensation Plan.  The
number of shares of common stock which may be issued under the 2000 Plan shall
initially be 400,000 shares which amount may, at the discretion of the Board, be
increased from time to time to a number of shares of common stock equal
to 5% of the total outstanding shares of common stock, provided that the aggregate
number of shares of common stock which may be granted under the 2000 Plan shall
not exceed 1,500,000 shares.

-20-

---



We may also utilize the granting of options under the 2000 Plan to attract
qualified individuals to become our employees and non-employee directors, as
well as to ensure the retention of management of any acquired business
operations.  Under the 2000 Plan, we may also grant restricted stock
awards.  Restricted stock represents shares of common stock issued to
eligible participants under the 2000 Plan subject to the satisfaction by the
recipient of certain conditions and enumerated in the specific restricted stock
grant.  Conditions, which may be imposed, include, but are not limited to,
specified periods of employment, attainment of personal performance standards or
our overall financial performance.  The granting of restricted stock
represents an additional incentive for eligible participants under the 2000 Plan
to promote our development and growth, and may be used by our management as
another means of attracting and retaining qualified individuals to serve as our
employees and directors.  Currently, options to purchase 56,808 shares of
our common stock at an exercise price of $1.25 per share are outstanding to nine
employees.  Such options expire on January 10, 2011.  No options have
been granted to our officers or directors.

|                                                           |  | (a)                                                                                            |        | (b)                                                                            |  | (c)                                                                                                                                   | 
|---------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------- | ------ | ------------------------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------------------------- | 
|                                                           |  |                                                                                                |        |                                                                                |  |                                                                                                                                       | 
|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 in column
(a)) | 
|                                                           |  |                                                                                                |        |                                                                                |  |                                                                                                                                       | 
|Equity compensation plans   approved by security holders   |  |                                                                                                | 56,808 |                                                                                |  | 1.25                                                                                                                                  | 
|Equity compensation plans not approved by security holders |  |                                                                                                |       |                                                                                |  |                                                                                                                                      | 
|Total                                                      |  |                                                                                                | 56,808 |                                                                                |  | 1.25                                                                                                                                  | 

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, 2005, 2004 and 2003.  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.

-21-

---



Summary Compensation Table

|                                                                                                        |  |      |                    |              | Annual Compensation |                             | Long-Term Compensation   Awards |                          
|------------------------------------------------------------------------------------------------------- |  | ---- | ------------------ | ------------ | ------------------- | --------------------------- | ------------------------------- | -------------------------
|                                                                                                        |  |      |                    |              |                     |                             |                                 |                          
|Name/Title                                                                                              |  | Year |                    | Salary/Bonus |                     | Other Annual   Compensation |                                 | Restricted   Stock Awards
|                                                                                                        |  |      |                    |              |                     |                             |                                 |                          
|Robert C. Shreve, Jr.,   President,    Chief Executive Officer,    Chief Financial Officer and Director |  |      | 2005   2004   2003 |              | $   $   $           | 133,333   125,000   125,000 |                                 | $   $   $                

Item 11. Security Ownership Of Certain Beneficial Owners And Management and Related Stockholder Matters

The table below sets forth, as of March 24, 2006, 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    Owed | 
|--------------------------------------------------- |  | ------------------------------- | --------- | ------------------------------------------------- | 
|                                                    |  |                                 |           |                                                   | 
|Robert C. Shreve, Jr.                               |  |                                 | 1,641,200 |                                                   | 
|Charles Timothy Allen                               |  |                                 | 2,449,973 |                                                   | 
|Orville Gregory Allen                               |  |                                 | 2,406,250 |                                                   | 
|PSG Solutions Plc(2)                                |  |                                 | 1,679,002 |                                                   | 
|Stephen A. Komlosy (3)                              |  |                                 | 16,000    |                                                   | 
|Allen D. Farris (4)                                 |  |                                 | -0-       |                                                   | 
|Cindy Skelton(5)                                    |  |                                 | -0-       |                                                   | 
|Officers and directors as a   group (4 persons) (5) |  |                                 | 6,513,423 |                                                   | 

|   
|---
|(1)
|(2)
|(3)
|(4)
|(5)
|(6)

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

Item 12. Certain Relationships And Related Transactions

The Company sells computer hardware and provides software maintenance, training, and consulting/development services to a company that is controlled by two members of the Companys Board of Directors.  Total revenues from that company were $23,446 and $22,060 in 2005 and 2004, respectively.  The Company had $2,035 and $1,861 of accounts receivable at December 31, 2005 and 2004, respectively, related to services performed for that company.

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

-22-

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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 Exhibit                                                                                                                                                                                                                                                                                                                                                                                              
|---------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|2.0*             |  | Joint Plan of   Reorganization Proposed by the Debtors dated August 21, 2000 as filed with   the U.S. Bankruptcy Court for the Northern District of Texas, Dallas   Division, on August 21, 2000 (without exhibits which will be supplied to   the Commission upon request)                                                                                                                                           
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|2.1*             |  | Modification to the   Debtors Joint Plan of Reorganization Proposed by the Debtors Dated August   21, 2000                                                                                                                                                                                                                                                                                                           
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|2.2*             |  | Order Confirming Joint Plan   of Reorganization and Fixing Deadlines for Filing Administrative Claims, Fee   Claims and Rejection Claims as filed with the U.S. Bankruptcy Court for the   Northern District of Texas, Dallas Division, on September 29, 2000                                                                                                                                                         
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|2.3*             |  | Certificate of Compliance   with Reverse Acquisition Requirements as filed with the U.S. Bankruptcy Court   for the Northern District of Texas, Dallas Division, on November 20,   2000                                                                                                                                                                                                                               
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|2.4*             |  | Motion for Post   Confirmation Technical Amendment as filed with the U.S. Bankruptcy Court for   the Northern District of Texas, Dallas Division, on November 30, 2000                                                                                                                                                                                                                                                
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|2.5*             |  | Order Granting Debtors   Motion for Post-Confirmation Technical Amendment as filed with the U.S.   Bankruptcy Court for the Northern District of Texas, Dallas Division, on   January 18, 2001                                                                                                                                                                                                                       
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|2.6*             |  | Order Supplementing Order   of Confirmation as filed with the U.S. Bankruptcy Court for the Northern   District of Texas, Dallas Division, on January 18, 2001                                                                                                                                                                                                                                                        
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|2.7*             |  | Agreement and Plan of   Merger dated October 9, 2000 by and between Avatar Systems, Inc. and HCI   Acquisition 1998-2, Inc. d/b/a Precision Stainless Fabricators whereby Avatar   on November 14, 2000 merged with and into HCI Acquisition 1998-2, Inc.   with HCI Acquisition 1998-2, Inc. being the surviving corporation (without   exhibits and schedules which will be supplied to the Commission upon request)
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|2.8*             |  | Certificate of Merger of   Avatar Systems, Inc. with HCI Acquisition 1998-2, Inc. as filed on   November 14, 2000 with the Secretary of State of Texas (please see   Exhibit 3.2 attached hereto for a copy of Exhibit A to this Certificate of   Merger)                                                                                                                                                           
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|3.0*             |  | Articles of Incorporation   of HCI Acquisition 1998-2, Inc., as filed with the Secretary of State of   Texas on August 7, 1998                                                                                                                                                                                                                                                                                        
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|3.1*             |  | Articles of Amendment to   Articles of Incorporation of HCI Acquisition 1998-2, Inc. as filed with the   Secretary of State of Texas on October 23, 2000                                                                                                                                                                                                                                                              
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|3.2*             |  | Certificate of Restated Articles of Incorporation of Avatar Systems, Inc. as
filed with the Secretary of State of Texas on November 14, 2000                                                                                                                                                                                                                                                                          
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|3.3*             |  | Amended and Restated Bylaws   of Avatar Systems, Inc.                                                                                                                                                                                                                                                                                                                                                                 
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|4.0*             |  | Common Stock Specimen  Avatar   Systems, Inc.                                                                                                                                                                                                                                                                                                                                                                        
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|9.0*             |  | Shareholders Agreement by   and between Avatar Systems, Inc., Cybertec Holdings, Plc., Robert C. Shreve,   Jr., Tim Allen, Gregg Allen, Stephen A. Komlosy and Merchant Capital   Holdings, Ltd. as of July 10, 2000                                                                                                                                                                                                 
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|10.0*            |  | Stock Purchase Agreement by   and between Avatar Systems, Inc. and Cybertec Holdings, Plc. dated   July 10, 2000 (without exhibits and schedules which will be supplied to   the Commission upon request) providing for the issuance of 1,600,000 shares   of Avatars Common Stock to Cybertec for $1.6 million                                                                                                      
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|10.1*            |  | Management Agreement by and   between Avatar Systems, Inc. and Robert C. Shreve, Jr. as of July 10, 2000                                                                                                                                                                                                                                                                                                              
|                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|10.2*            |  | Consulting Agreement by and   among Avatar Systems, Inc., Merchant Capital Holdings, Ltd. and its   affiliate, First Merchants Capital Limited, as of July 10, 2000                                                                                                                                                                                                                                                   

-23-

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|Exhibit   Number |  | Description   of Exhibit                                                                                                                                                                                                
|---------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                 |  |                                                                                                                                                                                                                         
|10.3*            |  | Investors Rights Agreement   by and among Avatar Systems, Inc., Cybertec Holdings, Plc., Merchants Capital   Holdings, Ltd., Robert C. Shreve, Jr., Tim Allen, Gregg Allen and   Stephen A. Komlosy as of July 10, 2000
|                 |  |                                                                                                                                                                                                                         
|10.4*            |  | Warrant to Purchase Common   Stock of Avatar Systems, Inc. issued to Cybertec Holdings Plc. as of July 10,   2000                                                                                                       
|                 |  |                                                                                                                                                                                                                         
|10.5*            |  | Warrant to Purchase Common   Stock of Avatar Systems, Inc. issued to Robert C. Shreve, Jr. as of July 10,   2000                                                                                                        
|                 |  |                                                                                                                                                                                                                         
|10.6*            |  | Warrant to Purchase Common   Stock of Avatar Systems, Inc. issued to Merchants Capital Holdings, Ltd. as   of July 10, 2000                                                                                             
|                 |  |                                                                                                                                                                                                                         
|10.7*            |  | Warrant to Purchase Common   Stock of Avatar Systems, Inc. issued to Stephen A. Komlosy as of July 10,   2000                                                                                                           
|                 |  |                                                                                                                                                                                                                         
|10.8*            |  | Warrant to Purchase Common   Stock of Avatar Systems, Inc. issued to Tim Allen as of July 10, 2000                                                                                                                      
|                 |  |                                                                                                                                                                                                                         
|10.9*            |  | Warrant to Purchase Common   Stock of Avatar Systems, Inc. issued to Gregg Allen as of July 10, 2000                                                                                                                    
|                 |  |                                                                                                                                                                                                                         
|10.10*           |  | 2000 Stock Compensation   Plan of Avatar Systems, Inc. dated October 9, 2000                                                                                                                                            
|                 |  |                                                                                                                                                                                                                         
|10.11*           |  | Amended and Restated Loan   Agreement dated July 10, 2000 between Avatar Systems, Inc. and Bank One,   Texas, N.A.                                                                                                      
|                 |  |                                                                                                                                                                                                                         
|10.12*           |  | Amended and Restated Term   Loan Promissory Note dated July 10, 2000 in the principal amount of   $288,888.96                                                                                                           
|                 |  |                                                                                                                                                                                                                         
|10.13*           |  | Security Agreement dated   July 10, 2000 between Avatar Systems, Inc. and Bank One, Texas, N.A.                                                                                                                         
|                 |  |                                                                                                                                                                                                                         
|10.14*           |  | Copyright Security   Agreement dated July 10, 2000 between Avatar Systems, Inc. and Bank One,   Texas, N.A.                                                                                                             
|                 |  |                                                                                                                                                                                                                         
|10.15*           |  | Trademark Security   Agreement dated July 10, 2000 between Avatar Systems, Inc. and Bank One,   Texas, N.A.                                                                                                             
|                 |  |                                                                                                                                                                                                                         
|10.16*           |  | Uniform Commercial Code   Financial Statement between Avatar Systems, Inc. and Bank One, Texas, N.A.                                                                                                                    
|                 |  |                                                                                                                                                                                                                         
|10.17*           |  | Guaranty of Charles T.   Allen dated July 10, 2000 for benefit of Bank One, Texas, N.A.                                                                                                                                 
|                 |  |                                                                                                                                                                                                                         
|10.18*           |  | Guaranty of Orville G.   Allen dated July 10, 2000 for the benefit of Bank One, Texas, N.A.                                                                                                                             
|                 |  |                                                                                                                                                                                                                         
|10.19*           |  | Limited Guaranty of Robert   C. Shreve, Jr. dated July 10, 2000 for the benefit of Bank One, Texas, N.A.                                                                                                                
|                 |  |                                                                                                                                                                                                                         
|10.20*           |  | Executive Employment   Agreement dated November 23, 2000 between Talon Global Solutions, Inc. and   Chad P. Statham                                                                                                     
|                 |  |                                                                                                                                                                                                                         
|10.21*           |  | Executive Employment   Agreement dated November 23, 2000 between Talon Global Solutions, Inc. and   Carla Rogers                                                                                                        
|                 |  |                                                                                                                                                                                                                         
|22.0*            |  | Subsidiaries of the   Registrant                                                                                                                                                                                        

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

Item 14. Principal Accountant Fees And Services

Audit Fees

The aggregate fees for professional services rendered for the audit of the Companys financial statements for the years ended December 31, 2005 and 2004 were $28,902 and $18,135 respectively.  The fees for the reviews of the quarterly financial statements included in the Companys Form 10-QSB were $9,000 and $9,522 for the years ended December 31, 2005 and 2004, respectively.

All Other Fees

There were no other fees for services rendered to the Company other than those services covered in the section captioned Audit Fees for the fiscal years ended December 31, 2005 and 2004.

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Signatures

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

|                     | AVATAR SYSTEMS, INC.
|-------------------- | --------------------
|                     |                     
|Dated:March 30, 2006 | By:                 
|                     |                     
|                     |                     
|                     |                     
|                     |                     

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

|Dated:March 30, 2006 | By: | /s/      ROBERT C. SHREVE, JR. 
|-------------------- | --- | -------------------------------
|                     |     |                                
|                     |     | Robert C.   Shreve, Jr.        
|                     |     | Chief   Executive Officer      
|                     |     | Chief   Financial Officer      
|                     |     | Director                       
|                     |     |                                
|Dated:March 30, 2006 | By: | /s/      CHARLES TIMOTHY ALLEN.
|                     |     |                                
|                     |     | Charles   Timothy Allen        
|                     |     | Director                       
|                     |     |                                
|Dated:March 30, 2006 | By: | /s/   ALLEN.D.   FARRIS        
|                     |     |                                
|                     |     | Allen D.   Farris              
|                     |     | Director                       
|                     |     |                                
|Dated:March 30, 2006 | By: | /s/      STEPHEN A. KOMLOSY    
|                     |     |                                
|                     |     | Stephen A.   Komlosy           
|                     |     | Director                       
|                     |     |                                
|Dated:March 31, 2006 | By: | /s/   JOHN   J. MAY            
|                     |     |                                
|                     |     | John J. May                    
|                     |     | Director                       

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