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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-K







|x | Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ------------------------------------------------------------------------------------

For the fiscal year ended June 30, 2008

or



| ̈ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from             to
            .

Commission file number:001-31265





AVATECH SOLUTIONS, INC.

(Exact name
of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 84-1035353                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|10715 Red Run Blvd, Suite 101, Owings Mills, Maryland          |  | 21117                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

Registrants telephone number, including area code  (410) 581-8080

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common stock, par value $.01 per share





Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.    Yes   ̈    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes   ̈    No  x

Indicate by check mark whether the
registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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   ̈

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will
not be contained, to the best of registrants knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller
reporting company. See definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.



|                           |  |                             
|-------------------------- |  | ----------------------------
|Large Accelerated Filer   ̈ |  | Accelerated Filer   ̈        
|Non-Accelerated Filer   ̈   |  | Smaller Reporting Company  x

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act.    Yes   ̈     No  x

The aggregate market value of the voting and non-voting equity stock held by non-affiliates of the registrant as of September 10, 2008 was approximately $16,901,394.

The number of shares of common stock outstanding as of September 10, 2008 was 16,734,051.

DOCUMENTS INCORPORATED BY REFERENCE

Information required by Part III of this
Form 10-K is incorporated therein by reference to the Registrants definitive proxy statement to be filed in connection with its 2008 Annual Meeting of Stockholders.









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TABLE OF CONTENTS



|              |  |             |  |                                                                                                              |  |   
|------------- |  | ----------- |  | ------------------------------------------------------------------------------------------------------------ |  | --
|PART I        |  | 4          
|              |  | ITEM 1.     |  | Business                                                                                                     |  | 4 
|              |  | ITEM 2.     |  | Properties                                                                                                   |  | 9 
|              |  | ITEM 3.     |  | Legal Proceedings                                                                                            |  | 9 
|              |  | ITEM 4.     |  | Submission of Matters to a Vote of Security Holders                                                          |  | 9 
|              | 
|PART II       |  | 10         
|              |  | ITEM 5.     |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 10
|              |  | ITEM 7.     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 12
|              |  | ITEM 8      |  | Financial Statements and Supplementary Data                                                                  |  | 21
|              |  | ITEM 9.     |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosures                        |  | 21
|              |  | ITEM 9A(T). |  | Controls and Procedures                                                                                      |  | 22
|              |  | ITEM 9B.    |  | Other Information                                                                                            |  | 22
|              | 
|PART III      |  | 23         
|              |  | ITEM 10.    |  | Directors, Executive Officers and Corporate Governance                                                       |  | 23
|              |  | ITEM 11.    |  | Executive Compensation                                                                                       |  | 23
|              |  | ITEM 12.    |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 23
|              |  | ITEM 13.    |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 23
|              |  | ITEM 14.    |  | Principal Accountant Fees and Services                                                                       |  | 23
|              | 
|PART IV       |  | 24         
|              |  | ITEM 15.    |  | Exhibits and Financial Statement Schedules                                                                   |  | 24
|              | 
|SIGNATURES    |  | 26         
|              | 
|EXHIBIT INDEX |  |            



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This Annual Report of Avatech Solutions, Inc. on Form 10-K for the year ended June 30, 2008 may
contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Readers of this report should be aware of the speculative nature of forward-looking statements. Statements that are not
historical in nature, including those that include the words anticipate, estimate, should, expect, believe, intend, and similar expressions, are based on current expectations,
estimates and projections about, among other things, the industry and the markets in which Avatech Solutions, Inc. operates, and they are not guarantees of future performance. Whether actual results will conform to expectations and predictions is
subject to known and unknown risks and uncertainties, including risks and uncertainties discussed in this report; general economic, market, or business conditions; cost of capital, demand for products and services; changes in Avatech Solutions,
Inc.s competitive position or competitive actions by other companies; the ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond the Avatech Solutions,
Inc.s control. Consequently, all of the forward-looking statements made in this document are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially
realized, will have the expected consequences on the Avatech Solutions, Inc.s business or operations. Except as required by applicable laws, Avatech Solutions, Inc. does not intend to publish updates or revisions of forward-looking statements
it makes to reflect new information, future events or otherwise.



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PART I



|ITEM 1. | BUSINESS
|------- | --------

Background

Avatech Solutions, Inc. was formed as a Delaware corporation on September 9, 1996. During fiscal years 1997 through 1999, the Company consummated
business combinations with ten companies that provided design automation software, training, technical support, and professional services to corporations, government agencies, and educational institutions throughout the United States. When used
throughout this report, the terms Avatech, the Company, we, us and our refer to Avatech Solutions, Inc. and, unless the context clearly indicates otherwise, its consolidated subsidiaries.

In November 2002, Avatech Solutions, Inc. completed a merger with PlanetCAD, Inc. and became a wholly owned subsidiary of PlanetCAD, Inc.,
after which PlanetCAD changed its name to Avatech Solutions, Inc. and the original Avatech Solutions, Inc. changed its name to Avatech Solutions Subsidiary, Inc. As a result of the merger, PlanetCADs shareholders retained twenty-five percent
of the surviving company and, in exchange for all of the common stock of the original Avatech Solutions, Inc., the shareholders of the original Avatech Solutions, Inc. were issued registered shares constituting seventy-five percent of the surviving
companys outstanding common stock. The original Avatech Solutions, Inc. was deemed to have acquired PlanetCAD because its shareholders received the majority of the common stock of the surviving company.

General

The Company is a leader in design,
engineering, and facilities management technology solutions with expertise in computer aided design (CAD) software, data management, facilities management, and process optimization for the manufacturing, engineering, and building design
industries. Avatech specializes in software resale, technology consulting, implementation, integration, training, and technical support solutions that enable clients to more effectively design, develop, and manage projects, products, and facilities.
The Companys clients include corporations, government agencies, and educational institutions nationwide.

The Company differentiates
itself from traditional product resellers through a wide range of value-added services, consisting primarily of training, technical support, and professional services. It also provides software customization, data migration, computer-aided design
standards consulting, process workflow analysis, and implementation assistance for complex design environments. Its strategic focus is to provide clients a competitive advantage with technology solutions that address broad, enterprise-wide
initiatives.

Avatechs sales and service delivery network consists of approximately 204 employees operating out of eighteen business
offices across the United States. The Company has a sales database that has over 210,000 point-of-contact names collected over its history and an active customer list of approximately 30,000 private firms, federal, state, and local agencies, and
colleges and universities.

The Companys strategy is to focus on leveraging the solid core business base that has been established to
profitably grow its product and services offerings in the design engineering market space. Concurrently, the Company expects to identify and engage in diverse software and services opportunities through strategic relationship development and
acquisitions. Avatech plans on taking advantage of its established brand, its geographic footprint, its technical expertise and its solid balance sheet to accomplish their strategic objectives. Thus, the strategic plan calls for the Company to
continue to profitably grow its Autodesk business, to leverage its market position and core competencies to continue to grow the Services component of its business and to strategically diversify its product and service offerings in order to expand
its presence within its market.

Avatech has a software development team within its professional services group that is charged with the
responsibility of developing software-based solutions for customers that improve the customers design



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workflow processes. These may include sales-oriented configuration tools or engineering-oriented automation and integration tools. The solutions often
involve automating or enhancing the software products the Company sells. While focused on professional services, the team has developed a variety of small applications which are packaged and sold commercially to its customers. It is Avatechs
intention to continue the development of these applications as well as identify new areas for commercial software development.

The
Companys product sales are somewhat cyclic, and increase when the developer of a specific software product offers a new version, promotions or discontinues support of an older product. As is common among software resellers, the Company
purchases products from its suppliers with a combination of cash and credit. Except in unusual situations, the Company does not allow its customers to return merchandise.

Products

Substantially all of Avatechs business consists of the sale of prepackaged software
and associated services to customers in the United States. Sales are focused on the following three major product categories and associated value-added services.

Design Automation. More than 93% of total revenues arise from the resale of design software developed by Autodesk, Inc. (Autodesk) for the building design and land development, manufacturing,
utilities, and telecommunications industries, and the delivery of related services from the sales of these products. These product sales are primarily packaged software programs installed on a user workstation, on a local area network server, or in
a hosted environment. The programs perform and support a wide variety of functions related to design, drafting, manufacturing, workflow automation, and document management activities.

Avatech also provides 3D laser scanning products including hardware, software, equipment rentals and training. This solution provides accurate as-builts
of existing structures and facilities, resulting in a more accurate and cost effective design.

Data Management. Data management
software products help businesses reduce costs, improve quality, strengthen relationships with customers and suppliers, and deliver more innovative products and services to minimize product time-to-market by leveraging the value of existing data.

Facilities Management. Physical assets, such as real estate, buildings, equipment, materials, and furniture are a significant
percentage of an organizations total asset value. These assets are used by many different business units, departments, and individuals, and must be accurately managed in order to extend asset life cycles and keep operating costs at a minimum.

Integrated Workplace Management Systems (IWMS) and Computer Aided Facilities Management (CAFM) systems enable organizations to make
informed strategic and business decisions that optimize return on investment, lower asset lifecycle costs, and increase enterprise-wide productivity and profitability. Organizations of all sizes, spanning the financial, educational, governmental,
healthcare, and manufacturing industries, use these solutions to deliver timely, relevant facilities information as part of their strategic business plans.

Geographic Information Systems (GIS) permit users to link together disparate data files (maps, aerial photos, tax records, marketing data, etc.) and provide the user with a unified image and knowledge base of a
specific geographic location or building location. When combined with information from a facilities management system, information from GIS applications provide an integrated facilities view that allows enhanced analysis in various spatial contexts
for professionals responsible for asset tracking, maintenance, emergency preparedness, space allocation, and construction planning.

The
Company sells, customizes, and implements IWMS and CAFM solutions through its dedicated salespeople, technical specialists, and a network of strategic partners. It also provides GIS database development services to facilities management customers,
both through its employees and strategic partners.



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Services

Professional services include project-focused software implementations, software customization, data migration, computer aided design standards consulting, supplemental design staffing, drawing digitization, and symbol library development.
The Company employs over eighty five industry specialists who provide professional services to its design automation customers

Avatech
offers training courses in over fifty-five different subjects related to various software solutions offered at eighteen training facilities and through mobile labs sent to customer sites or other off-site facilities. Training is led by sixty-eight
technical experts that have formal training or proven industry experience in the topics they teach. The Company also provides training services that are highly tailored to meet the needs of a particular customer, including company-specific
operational topics, customized product usage, and other general technology or process training. As part of the training offering, the Company has developed and deployed an Internet based assessment tool that allows its clients to test their
employees knowledge and ability to use the software tools.

The Company provides end-user telephone support services through its
National Support Center (NSC). A staff of seven full-time technology consultants assist customers with questions about product features, functions, usability issues, and configurations. The NSC offers services through multiple access levels
including prepaid services, actual elapsed time, and annual support contracts. Customers can communicate with the NSC through e-mail, web, telephone, and fax channels.

Professional services include project-focused software implementations, software customization, data migration, computer aided design standards consulting, supplemental design staffing, drawing digitization, and
symbol library development. The Company employs over ninety industry specialists who provide professional services to its design automation customers.

Markets and Competition

Design Automation. In the design automation market, Avatech focuses on providing enterprise
solutions to small- and medium-sized businesses with under one billion dollars of annual revenue, primarily in the architecture, engineering, and construction (AEC) market and the mechanical design and manufacturing (MDM) market. The AEC market is
comprised of design services focused on the construction of large physical assets such as buildings, roads, factories, utility companies, and commercial infrastructure projects. The MDM market is primarily focused on the design, tooling, assembly,
and testing of instruments, electronic devices, machines, mechanical devices, and power-driven equipment.

While several local and regional
competitors exist in the various geographic territories where the Company conducts business, it believes that it has a competitive advantage in terms of geographic reach, comprehensive training and support, and the provision of other products and
services, and is one of the largest commercial Autodesk resellers in the United States. Two national competitors that could be compared to Avatech in scale, size, geographical reach, and target markets for the resale of Autodesk products are INCAT
International, Inc. (INCAT) and Rand A Technology Corporation (RAND).

INCAT, a Tata Technologies Company, is a systems integrator for
design automation products with offices located in twelve countries and has headquarters in the United States, Germany, and India. While the Company believes that INCAT has greater revenues than Avatech, the Company estimates that the Autodesk
portion of INCATs business is less than its Autodesk business.

RAND is a large, global computer-aided design and engineering
technology company, however the Company believes that its United States Autodesk-related business is larger than that of RAND. RAND, headquartered in Canada, has its U.S. offices in the Northern Pacific, Midwest, Northeast, New England and Florida.
In November 2007, RAND was purchased by Ampersand Ventures, a Massachusetts-based private equity firm.



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Data Management. In this market, the Company faces similar competition from local and regional
Autodesk resellers in its design automation business.

Facilities Management. The Company provides IWMS and CAFM solutions to
organizations of all sizes, spanning the financial, educational, governmental, healthcare, and manufacturing industries. As a reseller of technology from Autodesk, ARCHIBUS and Idisis, the Company competes with not only competitive applications but
also other resellers of the products it represents.

Arrangements with Principal Suppliers

Revenues are primarily derived from the resale of vendor software products and services. These sales are made pursuant to channel sales agreements whereby
Avatech is granted the authority to purchase and resell the vendor products and services. Under these agreements, the Company either resells software directly to its customers or acts as a sales agent for various vendors and receives commissions for
its sales efforts.

On February 1, 2008, the Company entered into a renewable Authorized Channel Partner Agreement with Autodesk. The
renewable agreement dated February 1, 2008 has a term of three years but provides targets for a one-year period. Under this agreement, Autodesk appointed the Company as a non-exclusive partner to market, distribute, and support Autodesk
software products and identifies targets for the upcoming year. The Company must achieve yearly minimum revenue in the amount of $300,000 from the sale of Autodesks software products in order to be eligible to purchase such products directly
from Autodesk. For the year ended June 30, 2008, the Companys revenue from the sale of Autodesk software and subscriptions was approximately $36.2 million. This agreement authorizes the Company to sell certain software products to certain
customers in specific geographic areas of the United States and there are no clauses in this agreement that limit or restrict the services that the Company can offer to customers.

Customers

The Company markets its products to private companies, public corporations, government
agencies, and educational institutions throughout the United States. In the fiscal year ended June 30, 2008, the revenues generated by our top ten customers represented approximately seven percent of consolidated revenues, and no single
customer accounted for ten percent or more of our consolidated revenues.

Intellectual Property

The Company regards its technology and other proprietary rights as essential to its business. As such, it relies on copyright, trade secret,
confidentiality procedures, contract provisions, and trademark law to protect its technology and intellectual property. Avatech has confidentiality agreements with its consultants and corporate partners and controls access to, and distribution of,
its products, documentation, and other proprietary information.

Avatech owns several federally registered trademarks, including
AVATECH SOLUTIONS, and AVANEWS, and has other trademark applications pending, but we have no patents or patent applications pending. There were a number of other trademarks acquired as a result of the merger with PlanetCAD.

This Annual Report contains trademarks and trade names of Avatech Solutions, Inc. and its affiliates as well as those of other companies.
All trademarks and trade names appearing in this report are the property of their respective holders.

Employees

At June 30, 2008, the Company had approximately 204 employees located in eighteen offices throughout the United States, of which 202 are full-time
employees. Approximately 35 of its employees are located at its



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corporate headquarters in Maryland, which also houses a training facility and some sales personnel. None of its employees are represented by collective
bargaining agreements, and it has never experienced a work stoppage. The Company believes that its employee relations are good.

Available Information

The Internet website for Avatech Solutions is www.avatech.com. The Company makes available free of charge on its website its annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after it electronically files with or furnishes such materials to the SEC. The Companys
executive offices are located at 10715 Red Run Blvd, Suite 101, Owings Mills, Maryland 21117 and its telephone number is (410) 581-8080.



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|ITEM 2. | PROPERTIES
|------- | ----------

Corporate offices are located in
Owings Mills, Maryland where the Company leases approximately 13,430 square feet of office space, pursuant to a lease which expires on July 31, 2011. These facilities house executive and primary administrative offices as well as accounting,
order processing operations, IT, sales, and marketing. The Company also leases office space at the following locations:



|                           |  |                |  |           
|-------------------------- |  | -------------- |  | ----------
|Location                   |  | Square Footage |  | Term      
|ColoradoGreenwood Village |  | 7,462          |  | 12/31/2011
|FloridaTampa              |  | 4,103          |  | 3/31/2014 
|IndianaIndianapolis       |  | 2,871          |  | 2/28/2013 
|Illinois Chicago          |  | 2,369          |  | 12/31/2011
|IowaCedar Rapids          |  | 4,003          |  | 5/31/2011 
|IowaDes Moines            |  | 3,027          |  | 7/31/2011 
|MinnesotaSt. Paul         |  | 2,782          |  | 3/31/2012 
|MichiganTroy              |  | 4,588          |  | 3/31/2014 
|NebraskaOmaha             |  | 5,473          |  | 8/31/2013 
|North Carolina-Charlotte   |  | 3,500          |  | 10/31/2010
|North CarolinaHigh Point  |  | 1,764          |  | 4/30/2011 
|North CarolinaMorrisville |  | 3,671          |  | 11/30/2011
|OhioBeachwood             |  | 2,528          |  | 11/30/2010
|TexasHouston              |  | 2,447          |  | 12/31/2008
|TexasIrving               |  | 6,920          |  | 4/30/2013 
|VirginiaRichmond          |  | 1,832          |  | 3/31/2011 
|VirginiaVirginia Beach    |  | 5,887          |  | 10/31/2009

Not listed are leases for space that have been vacated if the sublessees payments defray, in
whole or in substantial part, the Companys lease payment obligations. Lease payments made during the last two fiscal years with respect to these properties are discussed in Note 12 to the audited consolidated financial statements presented
elsewhere in this report.

The commercial real estate market is volatile and unpredictable in terms of available space, rental fees, and
occupancy rates and preferred locations. The Company cannot be certain that additional space will be available when it is required, or that it will be affordable or in a preferred location.

ITEM 3.    LEGAL PROCEEDINGS

From time to time, the Company is involved in legal matters or named as a defendant in legal actions arising from normal operations, or is presented with claims for damages arising out of our actions. Management
believes that these matters will not have a material adverse effect on its financial statements.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were
no matters submitted to a vote of security holders during the fourth quarter of fiscal year ended June 30, 2008.



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PART II

ITEM 5.    MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Price Data

Avatechs common stock is trading on the OTC Bulletin Board under the symbol AVSO.OB. The following table indicates the high and low bid prices per share, rounded to the nearest whole cent, as
available through the OTC market for all periods presented. The OTC quotations represent prices between dealers and do not reflect the retailer markups, markdowns or commissions, and may not represent actual transactions.



|                                |  |      |      |     |   |     
|------------------------------- |  | ---- | ---- | --- | - | ----
|Period                          |  | High |      | Low
|Fiscal Year Ended June 30, 2008 |  |      |      |     |   |     
|First Quarter                   |  | $    | 1.20 |     | $ | 0.60
|Second Quarter                  |  |      | 1.03 |     |   | 0.77
|Third Quarter                   |  |      | 0.95 |     |   | 0.77
|Fourth Quarter                  |  |      | 0.95 |     |   | 0.74
|                                |  |     
|Fiscal Year Ended June 30, 2007 |  |      |      |     |   |     
|First Quarter                   |  | $    | 2.11 |     | $ | 1.35
|Second Quarter                  |  |      | 1.90 |     |   | 1.25
|Third Quarter                   |  |      | 1.78 |     |   | 1.40
|Fourth Quarter                  |  |      | 1.55 |     |   | 1.10

Recent Closing Prices

On September 10, 2008, the last closing price for our common stock on the OTC Bulletin Board, as reported by Reuters, was $1.01.

Dividend Information

The Company has never paid cash dividends on its common stock and does not
anticipate paying any cash dividends in the foreseeable future. Rather, management intends to continue its strategy of retaining earnings for the foreseeable future for use in the expansion and operation of our businesses. The declaration and amount
of any future cash dividends is at the discretion of the Companys Board of Directors. Moreover, without the consent of our senior lender, the Company is prohibited from declaring dividends on the Companys common stock. Accordingly, there
can be no guaranty that stockholders will receive any cash dividends on their common stock in the future.

The Series D, Series E and
Series F Convertible Preferred Stock are eligible for 10% annual, cumulative dividends. The Series D and Series E dividends are payable quarterly and Series F dividends are paid semi-annually as declared by the Board of Directors. These dividends
have priority over any declaration or payment of any dividend or other distribution on the common stock and all other outstanding shares of equity securities. For the year ended June 30, 2008, dividends totaling $565,000 were paid to preferred
shareholders.

Number of Stockholders

As of September 5, 2008, there were 1,834 holders of record of common stock, 11 holders of Series D Convertible Preferred Stock, 26 holders of Series E Convertible Preferred Stock, and 2 holders of Series F Convertible Preferred Stock.



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Equity Compensation Plan Information

The following table provides information, as of June 30, 2008, with respect to all compensation arrangements that we maintain under which we may issue shares of common stock:



|                                                           |  |                                                                                            |  |                                                                             |      |                                                                                                                                              |        
|---------------------------------------------------------- |  | ------------------------------------------------------------------------------------------ |  | --------------------------------------------------------------------------- | ---- | -------------------------------------------------------------------------------------------------------------------------------------------- | -------
|Plan Category                                              |  | Number of securitiesto be issued uponexercise ofoutstanding options,warrants and
rights(a) |  | Weighted-averageexercise price ofoutstanding options,warrants and rights(b) |      | Number of securitiesremaining available forfuture issuance underequity compensationplans
(excludingsecurities reflected incolumn (a))(c) (1)
|Equity compensation plans approved by security holders     |  | 1,678,205                                                                                  |  | $                                                                           | 1.11 |                                                                                                                                              | 569,050
|Equity compensation plans not approved by security holders |  | -0-                                                                                        |  |                                                                             | -0-  |                                                                                                                                              | -0-    
|Total                                                      |  | 1,678,205                                                                                  |  | $                                                                           | 1.11 |                                                                                                                                              | 569,050
|                                                           |  |                                                                                            |  |                                                                             |      |                                                                                                                                              |        



|(1) | This amount includes 267,994 shares of stock that may be issued under the Avatech Solutions, Inc. Amended and Restated Restricted Stock Plan, which contemplates the grant of shares
of common stock upon such terms, including with respect to forfeiture and restrictions of resale and transfer, as the Board may determine.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Issuer Purchases of Equity Securities

During the fourth quarter of fiscal year 2008, we did not purchase any equity
securities of the Company.

Sales of Unregistered Equity Securities

During the fourth quarter of fiscal year 2008, we did not sell any unregistered equity securities.



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ITEM 7.    MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

THE FOLLOWING DISCUSSION AND ANALYSIS OF THE FINANCIAL
CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS REPORT.

Overview

Avatech is a leading provider of design automation and data management solutions for the
manufacturing, building design, engineering, and total infrastructure and facilities management markets. The Company specializes in technical support, training, and consulting aimed at improving design and documentation efficiencies and the seamless
integration of workflow processes. These technology solutions enable its customers to enhance productivity, profitability, and competitive position. Avatech is one of the largest Autodesk software integrators worldwide and a leading provider of
engineering document management solutions.

The Companys business strategy is built on three core principles designed to leverage its
existing strengths with expected market opportunities:



| |  |  | Maintain and profitably grow its strong position in the Autodesk software economy.
| | - |  | ----------------------------------------------------------------------------------



| |  |  | Profitably grow its consulting and services business by leveraging its experts in design engineering.
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | Acquire and integrate diverse, yet complementary, software and services businesses to extend its product offerings to its large customer base and expand its market
potential.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Product Sales. Product sales consist primarily of the resale of packaged design software, including:



| |  |  | Autodesk design automation software for mechanical, architectural and civil engineering sectors and visualization and animation technology;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Autodesk data management software;
| | - |  | ----------------------------------



| |  |  | Archibus facilities management software for space planning, strategic planning, and lease/property administration; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | Cyco engineering data management solutions using Meridian software.
| | - |  | -------------------------------------------------------------------

Product sales also include Leica 3D laser scanning equipment for the Architectural, Engineering and Construction sector.

The Company also offers Autodesks subscription programs, which entitle subscribers to receive software upgrades, web support and eLearning lessons directly from Autodesk. Because they do not participate in the
delivery of these subscription products or the web support and eLearning lesson benefits, Avatech records the gross profit from the sale of Autodesk software subscriptions as commission revenue. Approximately 93% of the Companys total product
revenue is related to the resale of Autodesk products.

Service Revenue. Avatech provides services in the form of training,
consulting services, software development, and technical support to its customers. Avatech employs a technical staff of approximately 89 personnel associated with these types of services.

Commission Revenue. The Company generates commission revenue from the resale of Autodesk software to various customers, a number of which Autodesk
considers major accounts. Autodesk designates these customers as major accounts based on specific criteria, primarily sales volume, and typically gives these customers volume discounts. The Company is responsible for managing and
reselling Autodesk products to a



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##### Table of Contents

number of these major account customers; however, software products are shipped directly from Autodesk to the customers. Avatech receives commissions upon
shipment of the products from Autodesk to the customer based on the product sales price. In addition, the Company sells technology upgrades to existing Autodesk customers through the Autodesk Subscription program where the customers receive the
latest releases of Autodesk software, incremental product enhancements, personalized web support direct from Autodesk, and self-paced training to help extend its customers skills. Based on the Companys analysis of the Autodesk Subscription
program, it records the net proceeds that it receives from Autodesk for subscription sales in accordance with the provisions of EITF 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent.

Cost of Product Sales. The cost of product sales consists of the cost of purchasing products from software suppliers or hardware manufacturers as
well as the associated shipping and handling costs.

Cost of Service Revenue. Cost of service revenue includes the direct costs
associated with the implementation of software and hardware solutions as well as training, support services, and professional services. These costs consist primarily of compensation, benefits, travel, literature, and the costs of third-party
contractors engaged by the Company. The cost of service revenue does not include an allocation of overhead costs.

Selling, General and
Administrative Expenses. Selling, general and administrative expenses consist primarily of compensation and other expenses associated with the Companys sales force, management, finance, human resources, and information systems. Advertising
and public relations expenses and expenses for facilities, such as rent and utilities, are also included in selling, general and administrative expenses.

Depreciation and Amortization Expenses. Depreciation and amortization expenses represent the period costs associated with our investment in property and equipment, consisting principally of computer equipment,
software, furniture and fixtures, leasehold improvements and acquired customer lists. The Company computes depreciation and amortization expenses using the straight-line method. Avatech leases all of its facilities and depreciates leasehold
improvements over the lesser of the lease term or the estimated useful life of the asset. Total amortization expense for the year ended June 30, 2008 was $282,000. The Company estimates total amortization expense to remain consistent for each
of the five succeeding fiscal years. Total depreciation expense for the year ended June 30, 2008 was $411,000.

Interest
Expense. For the years ended June 30, 2008 and 2007, interest expense consisted primarily of interest on a revolving line-of-credit.

Critical
Accounting Policies

General. The consolidated financial statements are impacted by the accounting policies used and the
estimates and assumptions made by management during their preparation. Critical accounting policies and estimates that impact the consolidated financial statements are those that relate to software revenue recognition, estimates of bad debts and
income taxes. All of these critical accounting policies are discussed with and reviewed by the Companys Audit Committee on a periodic basis. Presented below is a description of the accounting policies that are most critical to an understanding
of the consolidated financial statements.

Software Revenue Recognition. The Company derives most of its revenue from the resale of
packaged software products, and historically, the Company has not experienced significant customer returns. Avatech earns service revenue from training and other professional services, which often are related to the products that are sold but are
not essential to the functionality of the software. Annual support contracts are also offered to customers for the software products that are sold, or the Company offers maintenance and support services under hourly billing arrangements.



13



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##### Table of Contents

Revenue from software arrangements is recognized in accordance with the provisions of AICPA Statement of
Position No. 97-2, Software Revenue Recognition, as amended by SOP No. 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. Prior to recognizing any revenue under these
arrangements, (1) persuasive evidence of an arrangement must exist, (2) delivery of the software or service must have occurred, (3) all fees must be assessed as fixed or determinable, and (4) all fees must be probable of
collection. The Company determines whether criteria (3) and (4) have been satisfied based on its judgment regarding the fixed nature of the fee charged for services rendered and products delivered and the collectibility of such fee.
Revenue recognized in a reporting period could be adversely affected if future changes in conditions related to a transaction cause management to determine these criteria are not met. In the past, it has not been necessary to adjust reported
revenues due to changes in conditions, and the Company continues to evaluate current conditions that may affect the nature and timing of our revenue recognition.

Customer arrangements can involve the sale of one or more elements (product, service, training, etc.). When this occurs, Avatech allocates revenue to each element if it can determine reliably the relative fair value
of each element. The Company limits the assessment of fair value to the price that is charged when the element is sold separately. If the fair value of each element in a multiple element arrangement cannot be reliably determined, and if the fair
value of any undelivered element cannot also be reliably determined, all revenue under the arrangement is deferred until such time as the only remaining undelivered element is maintenance, or in the absence of maintenance, implementation services,
upon which time revenue is recognized over the remaining maintenance or service period. Revenue that is deferred and recognized over a maintenance or service period is recognized in proportion to the services delivered, or ratably if no better
measure of performance can be determined. The timing of the revenue that is recognized in future periods from multiple element arrangements with customers will be dependent upon the ability to establish or continue to have vendor-specific objective
evidence of the fair value of each of the elements in these types of arrangements.

Bad Debts. The Company maintains an allowance
for doubtful accounts for estimated losses which may result from the inability of customers to pay for purchased products and services or for disputes that affect the ability to fully collect accounts receivable. Avatech estimates this allowance by
reviewing the status of past-due accounts and records general reserves based on historical bad debt expense. Actual experience has not varied significantly from estimates; however, if the financial condition of the Companys customers were to
deteriorate, resulting in their inability to pay for products or services, there may be a need to record additional allowances in future periods. To mitigate this risk, the Company performs ongoing credit evaluations of its customers.

Income Taxes. At June 30, 2008, the Company had federal net operating loss carryforwards totaling approximately $1.2 million, which will
begin to expire in 2012. The federal net operating loss carryforwards at June 30, 2008 are subject to a $92,000 annual limitation under Internal Revenue Code Section 382.

The Company recognized net deferred tax assets of $262,000 during fiscal year 2008 resulting from the Companys net operating loss carryforwards and
temporary differences between book and tax expense. In prior years, the Company fully offset such deferred tax assets with a valuation allowance because the Company could not predict with reasonable assurance that such assets could be utilized. By
the end of fiscal year 2008, however, the Company has consistently demonstrated its ability to generate taxable income and believes it is more likely than not that the $262,000 in net deferred tax assets will be realized in the future.

Recoverability of goodwill and purchased intangible assets. The Company accounts for goodwill and other intangibles under Statement of
Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 prescribes a two-phase process for impairment testing of goodwill. The first phase screens for impairment; while the
second phase, if necessary, measures the impairment. We consider the Company to be a single reporting unit. Accordingly, all of the goodwill is associated with the entire Company. The Company performs the required impairment analysis of goodwill
annually or on an interim basis if circumstances dictate. Any reduction of the enterprise fair value below the recorded amount of equity could require us to write down the value of goodwill or purchased intangibles and record an expense for an
impairment loss.



14



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##### Table of Contents

Selected Revenue Information for Years Ended June 30, 2008 and 2007

The following table sets forth the percentages of total revenue represented by selected items reflected in our audited Consolidated Statements of
Operations included elsewhere in this report. The year-to-year comparisons of financial results are not necessarily indicative of future results.



|                                       |  |                     |    |  |       |   
|-------------------------------------- |  | ------------------- | -- |  | ----- | --
|                                       |  | Year ended June 30, |   
|                                       |  | 2008                |    |  | 2007  |   
|Revenue:                               |  |                     |    |  |       |   
|Product sales                          |  | 55.7                | %  |  | 59.6  | % 
|Service revenue                        |  | 22.9                | %  |  | 21.2  | % 
|Commission revenue                     |  | 21.4                | %  |  | 19.2  | % 
|                                       |  |                     |    |  |       |   
|Total revenue                          |  | 100.0               | %  |  | 100.0 | % 
|                                       |  |                    
|Cost of revenue:                       |  |                     |    |  |       |   
|Cost of product sales                  |  | 37.9                | %  |  | 39.5  | % 
|Cost of service revenue                |  | 16.4                | %  |  | 14.7  | % 
|                                       |  |                     |    |  |       |   
|Total cost of revenue                  |  | 54.3                | %  |  | 54.2  | % 
|                                       |  |                     |    |  |       |   
|Gross margin                           |  | 45.7                | %  |  | 45.8  | % 
|                                       |  |                    
|Other operating expenses:              |  |                     |    |  |       |   
|Selling, general and administrative    |  | 37.3                | %  |  | 44.8  | % 
|Depreciation and amortization          |  | 1.4                 | %  |  | 1.4   | % 
|                                       |  |                     |    |  |       |   
|Total other operating expenses         |  | 38.7                | %  |  | 46.2  | % 
|                                       |  |                     |    |  |       |   
|Operating income (loss)                |  | 7.0                 | %  |  | (0.4  | )%
|                                       |  |                    
|Other income (expense):                |  |                     |    |  |       |   
|Interest and other income              |  | 0.3                 | %  |  | 0.1   | % 
|Interest expense                       |  | (0.1                | )% |  | (0.4  | )%
|                                       |  |                     |    |  |       |   
|Total other income (expense)           |  | 0.2                 | %  |  | (0.3  | )%
|                                       |  |                     |    |  |       |   
|                                       |  |                    
|Income (loss) from before income taxes |  | 7.2                 | %  |  | (0.7  | )%
|Income tax expense                     |  | (1.0                | )% |  | 0.4   | % 
|                                       |  |                     |    |  |       |   
|Net income (loss)                      |  | 6.2                 | %  |  | (1.1  | )%
|                                       |  |                     |    |  |       |   

Year Ended June 30, 2008 Compared to Year Ended June 30, 2007

Revenue



|                   |  |                     |            |      |   |            |  |      |   
|------------------ |  | ------------------- | ---------- | ---- | - | ---------- |  | ---- | --
|                   |  | Year ended June 30, |           
|                   |  | 2008                |            | 2007 |   | % change   | 
|Revenue:           |  |                     |            |      |   |            |  |      |   
|Product sales      |  | $                   | 27,650,000 |      | $ | 30,125,000 |  | (8.2 | )%
|Service revenue    |  |                     | 11,363,000 |      |   | 10,689,000 |  | 6.3  | % 
|Commission revenue |  |                     | 10,631,000 |      |   | 9,721,000  |  | 9.4  | % 
|                   |  |                     |            |      |   |            |  |      |   
|Total Revenue:     |  | $                   | 49,644,000 |      | $ | 50,535,000 |  | (1.8 | )%
|                   |  |                     |            |      |   |            |  |      |   



15



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##### Table of Contents

Revenue: Total revenue for the year ended June 30, 2008 decreased by $891,000 or 1.8% over
the prior fiscal year primarily as a result of a reduction in the average number of sales professionals employed by the Company. The Companys strategy for fiscal year 2008 was to realign its cost structure, including limiting the hiring of
sales and engineering professionals, in order to return to profitability. Management believes that it now has the processes and systems in place to help assure continued and consistent profitability and has begun to institute a plan to grow its
sales force gradually during fiscal 2009 and to focus on increasing its revenues. The Company is experiencing some effects of the weakened national economy which may hinder its future growth plans but remains committed to sales and personnel
strategies which should allow for revenue growth during fiscal year 2009.

Product sales decreased $2,475,000 or 8.2% for the year ended
June 30, 2008 as compared to the prior fiscal year. The decrease in product sales is due primarily to the previously discussed decrease in the number of sales professionals.

Service revenues increased $674,000 or 6.3% for the year ended June 30, 2008 as compared to the prior fiscal year. The continued growth in service
revenue resulted from a market driven need for additional services associated with upgrading to higher-end vertical and 3D software products.

Commission revenues increased $910,000 or 9.4% for the year ended June 30, 2008 as compared to the prior fiscal year. Included in commission revenues for the current fiscal year is a $770,000 commission that the Company earned from a
single sale, the largest such sale and commission in the Companys history. In addition to the large sale, commission revenues grew at a faster rate than product revenues due to improved sales processes for subscription contract renewals.

Cost of Revenue



|                        |  |                     |            |      |   |            |  |      |   
|----------------------- |  | ------------------- | ---------- | ---- | - | ---------- |  | ---- | --
|                        |  | Year ended June 30, |           
|                        |  | 2008                |            | 2007 |   | % change   | 
|Cost of revenue:        |  |                     |            |      |   |            |  |      |   
|Cost of product sales   |  | $                   | 18,801,000 |      | $ | 19,963,000 |  | (5.8 | )%
|Cost of service revenue |  |                     | 8,145,000  |      |   | 7,416,000  |  | 9.8  | % 
|                        |  |                     |            |      |   |            |  |      |   
|Total cost of revenue   |  | $                   | 26,946,000 |      | $ | 27,379,000 |  | (1.6 | )%
|                        |  |                     |            |      |   |            |  |      |   
|Gross margin            |  | $                   | 22,698,000 |      | $ | 23,156,000 |  | (2.0 | )%
|                        |  |                     |            |      |   |            |  |      |   

Cost of Revenue: Total cost of revenue decreased $433,000, or 1.6%, for the year ended
June 30, 2008 as compared to the prior fiscal year.

Cost of product sales decreased 5.8% while product sales decreased 8.2% during
the year ended June 30, 2008 as compared with the prior fiscal year. Product costs decreased at a lower rate than product revenues due to changes in costs and incentive plans made by the Companys principal supplier, Autodesk.

Cost of service revenue increased by 9.8% while service revenue increased by 6.3% during the year ended June 30, 2008 as compared with the prior
fiscal year. During fiscal year 2007, the Company received vendor funding to offset the costs of hiring new service professionals in greater amounts than during fiscal year 2008. Had the vendor funding been the same in both years, cost of service
revenue would have increased at a lower rate than service revenue.

Gross Margin: The Companys gross margin percentage
remained nearly unchanged, decreasing to 45.7% for the year ended June 30, 2008 from 45.8% for the prior fiscal year.



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##### Table of Contents

Other Operating Expenses



|                                    |  |                     |            |      |   |            |  |       |   
|----------------------------------- |  | ------------------- | ---------- | ---- | - | ---------- |  | ----- | --
|                                    |  | Year ended June 30, |           
|                                    |  | 2008                |            | 2007 |   | % change   | 
|Other operating expenses:           |  |                     |            |      |   |            |  |       |   
|Selling, general and administrative |  | $                   | 18,507,000 |      | $ | 22,659,000 |  | (18.3 | )%
|Depreciation and amortization       |  |                     | 693,000    |      |   | 689,000    |  | 0.6   | % 
|                                    |  |                     |            |      |   |            |  |       |   
|Total other operating expenses      |  | $                   | 19,200,000 |      | $ | 23,348,000 |  | (17.8 | )%
|                                    |  |                     |            |      |   |            |  |       |   

Selling, General and Administrative: Selling, general and administrative expenses for
fiscal year 2008 were approximately $18.5 million, compared to $22.7 million for the fiscal year ended June 30, 2007, a decrease of $4.2 million, or 18.3%. During fiscal year 2007, the Company incurred charges of $1.3 million resulting
primarily from severance costs and the closing of two offices. The remaining $2.9 million decrease resulted from the Companys cost reduction efforts which began during the fourth quarter of fiscal year 2007 and included a reduction in
executive and senior management positions, three office closings, and elimination of non-critical positions.

Depreciation and
Amortization: Depreciation and amortization expenses remained relatively unchanged, increasing $4,000 over fiscal year 2007 as the Company made routine acquisitions and disposals of property.

Other Income (Expense)



|                             |  |                     |         |   |      |   |          |          |  |        |   
|---------------------------- |  | ------------------- | ------- | - | ---- | - | -------- | -------- |  | ------ | --
|                             |  | Year ended June 30, |        
|                             |  | 2008                |         |   | 2007 |   |          | % change | 
|Other income (expense):      |  |                     |         |   |      |   |          |          |  |        |   
|Interest and other income    |  | $                   | 114,000 |   |      | $ | 62,000   |          |  | 83.9   | % 
|Interest expense             |  |                     | (28,000 | ) |      |   | (198,000 | )        |  | (85.9  | )%
|                             |  |                     |         |   |      |   |          |          |  |        |   
|Total other income (expense) |  | $                   | 86,000  |   |      | $ | (136,000 | )        |  | (163.2 | )%
|                             |  |                     |         |   |      |   |          |          |  |        |   

Through its cash flows from operations, the Company increased its cash balances by $3.8 million
and completely paid down its line of credit balance during fiscal year 2008. The increased cash balances resulted in increased interest income and the payoff of the line of credit balance resulted in significantly decreased interest expense.

Income Tax Expense



|                   |  |                     |         |      |   |          |  |       |  
|------------------ |  | ------------------- | ------- | ---- | - | -------- |  | ----- | -
|                   |  | Year ended June 30, |        
|                   |  | 2008                |         | 2007 |   | % change | 
|Income tax expense |  | $                   | 493,000 |      | $ | 227,000  |  | 117.2 | %
|                   |  |                     |         |      |   |          |  |       |  

Income tax expense increased to $493,000 in fiscal year 2008 from $227,000 in fiscal year 2007 as
the Company increased its pretax income to $3.6 million in 2008 from a loss of $328,000 in 2007. The Company recognized net deferred tax assets of $262,000, resulting from the Companys net operating loss carryforwards and temporary differences
between book and tax expense, which reduced income tax expense during fiscal year 2008. In prior years, the Company did not recognize deferred tax assets due to uncertainty about the Companys ability to generate sufficient taxable income to
utilize such assets. By the end of fiscal year 2008, however, the Company has consistently demonstrated its ability to generate taxable income and believes it is more likely than not that the $262,000 in net deferred tax assets will be realized in
the future.



17



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##### Table of Contents

During fiscal year 2008, the Companys taxable income was offset by approximately $600,000 of net
operating loss carryforwards. At June 30, 2008, the Companys remaining federal net operating loss carryforwards total $1.2 million and are subject to a $92,000 annual limitation.

Year Ended June 30, 2007 Compared to Year Ended June 30, 2006

Revenue



|                   |  |                     |            |      |   |            |  |      |  
|------------------ |  | ------------------- | ---------- | ---- | - | ---------- |  | ---- | -
|                   |  | Year ended June 30, |           
|                   |  | 2007                |            | 2006 |   | % change   | 
|Revenue:           |  |                     |            |      |   |            |  |      |  
|Product sales      |  | $                   | 30,125,000 |      | $ | 25,364,000 |  | 18.8 | %
|Service revenue    |  |                     | 10,689,000 |      |   | 7,399,000  |  | 44.5 | %
|Commission revenue |  |                     | 9,721,000  |      |   | 6,857,000  |  | 41.8 | %
|                   |  |                     |            |      |   |            |  |      |  
|Total Revenue:     |  | $                   | 50,535,000 |      | $ | 39,620,000 |  | 27.6 | %
|                   |  |                     |            |      |   |            |  |      |  

Revenue: Total revenue for the year ended June 30, 2007 increased by $10.9 million, or
27.6%, over the prior fiscal year with all three revenue categories showing significant increases. Approximately 74% of the revenue increases were a direct result of the May 30, 2006 acquisition of Sterling Systems & Consulting.
Ignoring the effect of the Sterling acquisition, the Companys total revenues would have increased 7.3% during fiscal year 2007. Revenues from the former Sterling offices included product sales of $6,440,000, service revenue of $1,367,000 and
commission revenue of $1,383,000 for the year ended June, 2007, or a total of $9,190,000 compared with $858,000 in product sales, $112,000 in service revenue and $110,000 in commission revenue for a total of $1,080,000 for the one month of Sterling
operations included in fiscal year 2006.

Product sales increased $4,761,000 or 18.8% for the year ended June 30, 2007 as compared to
the prior fiscal year. Product sales increased substantially, but at a lower rate than commission revenues which was the result of transitioning more customers to subscription contracts that provided customers access to all product upgrades during
the subscription period. The emphasis on selling subscription contracts resulted in increased margins in the form of commission revenues while providing a better value to our customers.

Service revenues increased $3,290,000, or 44.5%, for the year ended June 30, 2007 as compared to the prior fiscal year. The Company continued its
strategy of investing in its services business by adding personnel and expanding its training, support and consulting capabilities. This strategy, coupled with the Sterling acquisition, resulted in the large growth in its services revenues.

Commission revenues increased $2,864,000, or 41.8% for the year ended June 30, 2007 as compared to the prior fiscal year. Ignoring
the effect of the Sterling acquisition, commission revenues increased 23.6%, which was the result of transitioning more customers to subscription contracts as described above.

Cost of Revenue



|                        |  |                     |            |      |   |            |  |      |  
|----------------------- |  | ------------------- | ---------- | ---- | - | ---------- |  | ---- | -
|                        |  | Year ended June 30, |           
|                        |  | 2007                |            | 2006 |   | % change   | 
|Cost of revenue:        |  |                     |            |      |   |            |  |      |  
|Cost of product sales   |  | $                   | 19,963,000 |      | $ | 15,002,000 |  | 33.1 | %
|Cost of service revenue |  |                     | 7,416,000  |      |   | 5,167,000  |  | 43.5 | %
|                        |  |                     |            |      |   |            |  |      |  
|Total cost of revenue   |  | $                   | 27,379,000 |      | $ | 20,169,000 |  | 35.8 | %
|                        |  |                     |            |      |   |            |  |      |  
|Gross margin            |  | $                   | 23,156,000 |      | $ | 19,451,000 |  | 19.1 | %
|                        |  |                     |            |      |   |            |  |      |  



18



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##### Table of Contents

Cost of Revenue: Total cost of revenue increased $7,210,000, or 35.8%, for the year ended
June 30, 2007 as compared to the prior fiscal year.

Cost of product sales increased 33.1% while product sales increased only 18.8%
during the year ended June 30, 2007 as compared with the prior fiscal year. Product costs increased at a higher rate than product revenues due to a series of changes made by Autodesk which included decreased reseller discounts on certain
products, sharply increased targets for incentive programs, and a decreased pool of available incentives. Because Autodesk introduced the changes to its incentive plans late in the Companys fiscal year, the Company did not have sufficient time
to adapt sales policies to offset the increased costs and maximize its incentives. Beginning in May 2007, the Company refocused its sales programs and strategies and began to realize increased gross margin levels as a result of these efforts.

Cost of service revenue increased by 43.5% while service revenue increased by 44.5% during the year ended June 30, 2007 as compared
with the prior fiscal year. Cost of service revenue increased at a lower rate than did service revenue as the Company continued its focus of selling more services and increasing the billable utilization of existing services personnel.

Gross Margin: For the previously-stated reasons, the Companys gross margin percentage decreased to 45.8% for the year ended June 30,
2007 as compared to 49.1% for the same period in the prior fiscal year.

Other Operating Expenses



|                                    |  |                     |            |      |   |            |  |      |  
|----------------------------------- |  | ------------------- | ---------- | ---- | - | ---------- |  | ---- | -
|                                    |  | Year ended June 30, |           
|                                    |  | 2007                |            | 2006 |   | % change   | 
|Other operating expenses:           |  |                     |            |      |   |            |  |      |  
|Selling, general and administrative |  | $                   | 22,659,000 |      | $ | 16,522,000 |  | 37.2 | %
|Depreciation and amortization       |  |                     | 689,000    |      |   | 388,000    |  | 77.6 | %
|                                    |  |                     |            |      |   |            |  |      |  
|Total other operating expenses      |  | $                   | 23,348,000 |      | $ | 16,910,000 |  | 38.1 | %
|                                    |  |                     |            |      |   |            |  |      |  

Selling, General and Administrative: Selling, general and administrative expenses for
fiscal year 2007 were approximately $22.7 million, compared to $16.5 million for the fiscal year ended June 30, 2006, an increase of $6.1 million, or 37.2%. The operations acquired from Sterling Systems & Consulting on May 30,
2006 increased selling, general and administrative expenses by $2.1 million. In addition, during fiscal 2007 the Company incurred approximately $1.3 million of one-time charges resulting primarily from severance costs and the closing of two offices.
The remaining increase resulted from additions to sales and administrative staff.

Depreciation and Amortization: Depreciation and
amortization expenses increased $301,000, or 77.6%, for the year ended June 30, 2007 when compared to the prior fiscal year. These expenses increased due to the Companys investment in upgrading its information technology infrastructure,
purchases of new computers and the amortization of a customer list recorded as a result of the Companys purchase of Sterling in May 2006.



19



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##### Table of Contents

Other Income (Expense)



|                                     |  |                     |          |   |      |   |          |          |  |        |   
|------------------------------------ |  | ------------------- | -------- | - | ---- | - | -------- | -------- |  | ------ | --
|                                     |  | Year ended June 30, |         
|                                     |  | 2007                |          |   | 2006 |   |          | % change | 
|Other income (expense):              |  |                     |          |   |      |   |          |          |  |        |   
|Gain on early extinguishment of debt |  | $                   |         |   |      | $ | 233,000  |          |  | (100.0 | )%
|Interest and other income            |  |                     | 62,000   |   |      |   | 34,000   |          |  | 82.4   | % 
|Interest expense                     |  |                     | (198,000 | ) |      |   | (549,000 | )        |  | (63.9  | )%
|                                     |  |                     |          |   |      |   |          |          |  |        |   
|Total other income (expense)         |  | $                   | (136,000 | ) |      | $ | (282,000 | )        |  | (51.8  | )%
|                                     |  |                     |          |   |      |   |          |          |  |        |   

In January 2006, as part of a refinancing of its lines of credit, the Company prepaid a note
payable to a vendor at a discount yielding the gain on early extinguishment of debt of $233,000. Interest expense decreased due to reductions of long-term debt and reduced average borrowings on the Companys line of credit. The increase in
other income was the result of a sublease which began during the fourth quarter of fiscal year 2006 and was in place for the entire fiscal year 2007.

Income Tax Expense



|                   |  |                     |         |      |   |          |  |        |   
|------------------ |  | ------------------- | ------- | ---- | - | -------- |  | ------ | --
|                   |  | Year ended June 30, |        
|                   |  | 2007                |         | 2006 |   | % change | 
|Income tax expense |  | $                   | 227,000 |      | $ | 56,000   |  | (305.4 | )%
|                   |  |                     |         |      |   |          |  |        |   

Income tax expense was $227,000 and $56,000 in fiscal years 2007 and 2006, respectively. Tax
expense resulted from the payments of federal alternative minimum tax, state and local income taxes. Although the Company had significant net operating loss carryforwards, it was required to pay alternative minimum taxes of $47,000 for 2007.

Liquidity and Capital Resources

Historically, the Company has financed its operations and met its capital expenditure requirements primarily through cash flows provided by operations, borrowings under short-term and long-term debt arrangements, and sales of preferred
stock.

The Company has an existing line of credit which provides for up to $5
million of borrowings limited to 80% of the Companys aggregate eligible accounts receivable. The loan bears interest at a rate tied to the banks prime rate and will decrease as the Companys aggregate net worth increases. The
interest rate ranges from the banks prime rate plus two percent to a low of the prime rate prime rate plus 0.25% when the Companys net worth exceeds $4,000,000 at the end of a fiscal quarter. Based on the Companys current net
worth, the interest rate for the quarter ended June 30, 2008 was the banks prime rate plus one-half percent (1/2%),
or 5.50%. The loan will expire on December 31, 2008 and is secured by all of the Companys assets, except inventory. The Company expects to renew the line of credit prior to its expiration.

During fiscal year 2008, the Company paid off its line of credit balance and generated a $5.5 million cash balance through positive cash flows from
operations. Previously, the outstanding balance of the line of credit at June 30, 2007 was $1,408,000.

The Companys operating
assets and liabilities consist primarily of accounts receivable, accounts payable, and inventory. Changes in these balances are affected principally by the timing of sales and investments in inventory based on expected customer demand. The Company
attempts to minimize its inventory levels through arrangements with suppliers to ship products with an average delivery period of two days and centralized inventory management. The Company purchases approximately 97% of its product from one
principal supplier which provides it with credit to finance those purchases.



20



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##### Table of Contents

The Companys investing activities consist principally of investments in computer and office
equipment. Capital expenditures for fiscal 2008 decreased to $304,000 from $456,000 for the same period in 2007 as a result of a decreased need for new or upgraded IT equipment and infrastructure due to purchases in recent years.

The Company had no outstanding long-term debt at June 30, 2008, and had a working capital surplus of approximately $4.5 million. As a result of its
operations and the infusions of capital, the Companys working capital needs have stabilized and management believes the Companys near-term needs can be met from its available cash resources, cash flows from operations and its lines of
credit.

On July 1, 2008, pursuant to the agreements executed as part of its June 2006 offering of its Series F Convertible Preferred
Stock (Series F), the Company redeemed 500 of the original 4,000 Series F shares for payments to the holders of Series F totaling $500,000 plus accumulated interest of approximately $12,000. The Series F shareholders have the right to request
redemptions of up to $500,000 of the Series F stock on July 1, October 1, January 1 and April 1 of 2008 and 2009 and have expressed their intention of requesting the redemptions until their Series F stock has been fully
redeemed. The Company expects to fund these redemptions out of its excess cash balance and does not anticipate that they will have any material effect on the Companys liquidity.

Since Avatech is one of the largest resellers of Autodesk software and since Autodesk has continued to state its intention to continue to strengthen its
relationships with its resellers, the Company fully expects to continue to be a leading seller of Autodesk software at margins sufficient to grow its business and improve its financial results. The Companys Channel Partner Agreement was
renewed on February 1, 2008. In addition, the Company continues to diversify its revenues by increasing its service revenues and the sale of non-Autodesk software.

Below is a summary of the Companys contractual obligations and commitments at June 30, 2008:



|                        |  |                        |           |                 |   |             |  |             |           |                  |   |         |  |   |        
|----------------------- |  | ---------------------- | --------- | --------------- | - | ----------- |  | ----------- | --------- | ---------------- | - | ------- |  | - | -------
|                        |  | Payments due by period
|                        |  | Total                  |           | Less than1 year |   | 1  3 years |  | 3  5 years |           | More than5 years
|Contractual Obligations |  |                        |           |                 |   |             |  |             |           |                  |   |         |  |   |        
|Operating leases        |  | $                      | 4,504,000 |                 | $ | 1,293,000   |  | $           | 2,217,000 |                  | $ | 885,000 |  | $ | 109,000
|                        |  |                        |           |                 |   |             |  |             |           |                  |   |         |  |   |        
|Total obligations       |  | $                      | 4,504,000 |                 | $ | 1,293,000   |  | $           | 2,217,000 |                  | $ | 885,000 |  | $ | 109,000
|                        |  |                        |           |                 |   |             |  |             |           |                  |   |         |  |   |        

Off Balance Sheet Transactions

We are not party to any off-balance sheet transactions as defined in Item 303 of the SECs Regulation S-K.



|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------

The
information required by this Item may be found immediately after the signatures to this report and is incorporated herein by reference.



|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
|------- | -------------------------------------------------------------------------------------

None.



21



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##### Table of Contents

|ITEM 9A(T). | CONTROLS AND PROCEDURES
|----------- | -----------------------

The Company maintains a
system of disclosure controls and procedures that is designed to provide reasonable assurance that information, which is required to be disclosed by the Company in the reports that it files or submits under the Securities and Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and is accumulated and communicated to management in a timely manner. A control system,
no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally,
controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate.

The Companys Chief Executive Officer and Chief Financial Officer
have evaluated this system of disclosure controls and procedures as of the end of the period covered by this Annual Report, and based on that evaluation, have concluded that the system of disclosure controls and procedures is, in fact, effective at
the reasonable assurance level.

There have been no changes in our internal control over financial reporting during the fourth quarter of
the most recent fiscal year that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.

As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has performed an evaluation and testing of the Companys internal control over financial reporting as of June 30, 2008.
Managements report on the Companys internal control over financial reporting is included in Item 8 of this report and is incorporated herein by reference.



|ITEM 9B. | OTHER INFORMATION
|-------- | -----------------

None.



22



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##### Table of Contents

PART III



|ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|-------- | ------------------------------------------------------

The information required by this item is incorporated herein by reference to the definitive Proxy Statement of the Company to be filed with the Securities and Exchange Commission in connection with the 2008 Annual Meeting of Stockholders
(the Proxy Statement).



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------

The information required by
this item is incorporated herein by reference to the Proxy Statement.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------

The information required by this item is incorporated herein by reference to the Proxy Statement.



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|-------- | -------------------------------------------------------------------------

The information required by this item is incorporated herein by reference to the Proxy Statement.



|ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------

The
information required by this item is incorporated herein by reference to the Proxy Statement.



23



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##### Table of Contents

PART IV



|ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|-------- | ------------------------------------------

(a)(1) and (c).
Financial Statements.



|                                                                                           |  |     
|------------------------------------------------------------------------------------------ |  | ----
|                                                                                           |  | Page
|Managements Report on Internal Control over Financial Reporting                           |  | F-2 
|                                                                                           | 
|Report of Independent Registered Public Accounting Firm                                    |  | F-3 
|                                                                                           | 
|Consolidated Balance Sheets as of June 30, 2008 and 2007                                   |  | F-4 
|                                                                                           | 
|Consolidated Statements of Operations for the Years Ended June 30, 2008 and 2007           |  | F-5 
|                                                                                           | 
|Consolidated Statements of Stockholders Equity for the Years Ended June 30, 2008 and 2007 |  | F-6 
|                                                                                           | 
|Consolidated Statements of Cash Flows for the Years Ended June 30, 2008 and 2007           |  | F-8 
|                                                                                           | 
|Notes to Consolidated Financial Statements                                                 |  | F-9 



24



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##### Table of Contents

Financial Statement ScheduleSchedule II

Avatech Solutions, Inc. and Subsidiaries Valuation and Qualifying Accounts



|                                                |  |                              |           |                            |   |                                  |  |   |                     |      |  |                        |          |      |  |   |        
|----------------------------------------------- |  | ---------------------------- | --------- | -------------------------- | - | -------------------------------- |  | - | ------------------- | ---- |  | ---------------------- | -------- | ---- |  | - | -------
|                                                |  |                              |           | Additions                  |   |                                  |  |   |                     |     
|Description                                     |  | Balance atbeginning ofperiod |           | Chargedto costsandexpenses |   | Charged tootheraccountsdescribe |  |   | Deductionsdescribe |      |  | Balance atend ofperiod
|Year Ended June 30, 2008:                       |  |                              |           |                            |   |                                  |  |   |                     |      |  |                        |          |      |  |   |        
|Deducted from assets accounts:                  |  |                              |           |                            |   |                                  |  |   |                     |      |  |                        |          |      |  |   |        
|Allowance for doubtful accounts                 |  | $                            | 188,000   |                            | $ | 36,000                           |  | $ |                    |      |  | $                      | (84,000  | )(1) |  | $ | 140,000
|Valuation allowance for net deferred tax assets |  | $                            | 939,000   |                            | $ |                                 |  | $ |                    |      |  | $                      | (939,000 | )(2) |  | $ |       
|                                                |  |                              |           |                            |  
|Year Ended June 30, 2007:                       |  |                              |           |                            |   |                                  |  |   |                     |      |  |                        |          |      |  |   |        
|Deducted from assets accounts:                  |  |                              |           |                            |   |                                  |  |   |                     |      |  |                        |          |      |  |   |        
|Allowance for doubtful accounts                 |  | $                            | 112,000   |                            | $ | 174,000                          |  | $ |                    |      |  | $                      | (98,000  | )(1) |  | $ | 188,000
|Valuation allowance for net deferred tax assets |  | $                            | 1,202,000 |                            | $ |                                 |  | $ | (263,000            | )(2) |  | $                      |         |      |  | $ | 939,000



|(1) | Uncollectible accounts written off, net of recoveries
|--- | -----------------------------------------------------



|(2) | Decrease in valuation allowance, net of temporary differences
|--- | -------------------------------------------------------------

All other financial statement schedules are not required under the related instructions or are inapplicable and therefore have been omitted.

(a)(3) and (c). Exhibits required to be filed by Item 601 of Regulation S-K

The exhibits filed or furnished with this
annual report are listed in the Exhibit List that immediately follows page F-21 of this report, which list is incorporated herein by reference.



25



---

##### Table of Contents

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, thereto duly authorized.



|                         |  |                         |  |                                      
|------------------------ |  | ----------------------- |  | -------------------------------------
|                         |  | AVATECH SOLUTIONS, INC.
|                         |  |                        
|Date: September 29, 2008 |  | By:                     |  | /s/    GEORGE M.
DAVIS               
|                         |  |                         |  | George M. Davis                      
|                         |  |                         |  | President and Chief Executive Officer

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



|                   |  |                                                        |  |     |  |                                          
|------------------ |  | ------------------------------------------------------ |  | --- |  | -----------------------------------------
|By:                |  | /s/    GARNETT Y. CLARK,
JR.                           |  | By: |  | /s/    W. JAMES
HINDMAN                  
|                   |  | Garnett Y. Clark, Jr. , Director                       |  |     |  | W. James Hindman, Director               
|                   | 
|September 29, 2008 |  | September 29, 2008                                    
|                   |  |                                                        | 
|By:                |  | /s/    GEORGE W.
COX                                   |  | By: |  | /s/    ROBERT J.
POST                    
|                   |  | George W. Cox, Director                                |  |     |  | Robert J. Post, Director                 
|                   | 
|September 29, 2008 |  | September 29, 2008                                    
|                   |  |                                                        | 
|By:                |  | /s/    EUGENE J.
FISCHER                               |  | By: |  | /s/    DAVE
REYMANN                      
|                   |  | Eugene J. Fischer, Director                            |  |     |  | Dave Reymann, Director                   
|                   | 
|September 29, 2008 |  | September 29, 2008                                    
|                   |  |                                                        | 
|By:                |  | /s/    GEORGE M.
DAVIS                                 |  | By: |  | /s/    THOM
WAYE                         
|                   |  | George M. Davis, President and Chief Executive Officer |  |     |  | Thom Waye, Director and Board Chair      
|                   | 
|September 29, 2008 |  | September 29, 2008                                    
|                   |  |                                                        | 
|                   |  |                                                        |  | By: |  | /s/    LAWRENCE
RYCHLAK                  
|                   |  |                                                        |  |     |  | Lawrence Rychlak, Chief Financial Officer
|                   | 
|                   |  | September 29, 2008                                    



26



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##### Table of Contents

FINANCIAL STATEMENTS AND SCHEDULES

Avatech Solutions, Inc. and Subsidiaries

Index to Consolidated Financial Statements



|                                                                 |  |     
|---------------------------------------------------------------- |  | ----
|                                                                 |  | Page
|                                                                 | 
|Managements Report on Internal Control Over Financial Reporting |  | F2 
|                                                                 | 
|Report of Independent Registered Public Accounting Firm          |  | F3 
|                                                                 | 
|Consolidated Balance Sheets                                      |  | F4 
|                                                                 | 
|Consolidated Statements of Operations                            |  | F5 
|                                                                 | 
|Consolidated Statements of Stockholders Equity                  |  | F6 
|                                                                 | 
|Consolidated Statements of Cash Flows                            |  | F8 
|                                                                 | 
|Notes to Consolidated Financial Statements                       |  | F9 



F-1



---

##### Table of Contents

MANAGEMENTS REPORT ON INTERNAL CONTROL OVER
FINANCIAL REPORTING

The management of the Company is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. The Companys internal control over financial reporting includes those policies and
procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management
and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material effect on the financial
statements.

This annual report on Form 10-K does not include an attestation report of the Companys registered public accounting firm
regarding internal control over financial reporting because managements report was not subject to attestation pursuant to temporary rules of the SEC that permit the Company to provide only this managements report.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A control system, no matter
how well designed and operated can provide only reasonable, but not absolute, assurance that the control systems objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits
of controls must be considered relative to their cost.

Management assessed the effectiveness of the Companys internal control over
financial reporting as of June 30, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (the COSO
Framework). Based on its evaluation, management has concluded that Companys internal control over financial reporting is effective.



|                                      |  |                                                     
|------------------------------------- |  | ----------------------------------------------------
|September 17, 2008                    |  |                                                     
|                                      | 
|                                      |  |                                                     
|/s/ George M.
Davis                   |  | /s/ Lawrence
Rychlak                                
|President and Chief Executive Officer |  | Executive Vice President and Chief Financial Officer



F-2



---

##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM

To the Stockholders and Board of Directors

Avatech
Solutions, Inc.

We have audited the consolidated balance sheets of Avatech Solutions, Inc. and Subsidiaries as of June 30, 2008 and
2007 and the related consolidated statements of operations, stockholders equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements based on our audits.

We conducted our audit in accordance with the standards
of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.
Avatech Solutions, Inc. is not required to have, nor were we engaged to perform, an audit of internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of Avatech Solutions, Inc.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 consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as
well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Avatech Solutions, Inc. and Subsidiaries as of June 30, 2008 and 2007
and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ Stegman & Company

Baltimore, Maryland

September 18, 2008



F-3



---

##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets



|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------- | ---------- | - | ---- | - | ---------- | -
|                                                                                                                                                                                                                                                                                                             |  | June 30, |           
|                                                                                                                                                                                                                                                                                                             |  | 2008     |            |   | 2007 |  
|Assets                                                                                                                                                                                                                                                                                                       |  |          |            |   |      |   |            |  
|Current assets:                                                                                                                                                                                                                                                                                              |  |          |            |   |      |   |            |  
|Cash and cash equivalents                                                                                                                                                                                                                                                                                    |  | $        | 5,488,000  |   |      | $ | 1,688,000  |  
|Accounts receivable, less allowance of $140,000 in 2008 and $188,000 in 2007                                                                                                                                                                                                                                 |  |          | 7,394,000  |   |      |   | 7,402,000  |  
|Other receivables                                                                                                                                                                                                                                                                                            |  |          | 264,000    |   |      |   | 492,000    |  
|Inventory                                                                                                                                                                                                                                                                                                    |  |          | 422,000    |   |      |   | 902,000    |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                                                                    |  |          | 387,000    |   |      |   | 356,000    |  
|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  
|Total current assets                                                                                                                                                                                                                                                                                         |  |          | 13,955,000 |   |      |   | 10,840,000 |  
|                                                                                                                                                                                                                                                                                                             |  |         
|Property and equipment:                                                                                                                                                                                                                                                                                      |  |          |            |   |      |   |            |  
|Computer software and equipment                                                                                                                                                                                                                                                                              |  |          | 3,189,000  |   |      |   | 2,907,000  |  
|Office furniture and equipment                                                                                                                                                                                                                                                                               |  |          | 1,176,000  |   |      |   | 1,212,000  |  
|Leasehold improvements                                                                                                                                                                                                                                                                                       |  |          | 167,000    |   |      |   | 167,000    |  
|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  
|                                                                                                                                                                                                                                                                                                             |  |          | 4,532,000  |   |      |   | 4,286,000  |  
|Less accumulated depreciation and amortization                                                                                                                                                                                                                                                               |  |          | (3,751,000 | ) |      |   | (3,352,000 | )
|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  
|                                                                                                                                                                                                                                                                                                             |  |          | 781,000    |   |      |   | 934,000    |  
|Customer list, net of accumulated amortization of $666,000 in 2008 and $387,000 in 2007                                                                                                                                                                                                                      |  |          | 1,521,000  |   |      |   | 1,803,000  |  
|Goodwill                                                                                                                                                                                                                                                                                                     |  |          | 5,968,000  |   |      |   | 5,888,000  |  
|Deferred income taxes, net                                                                                                                                                                                                                                                                                   |  |          | 262,000    |   |      |   |           |  
|Other assets                                                                                                                                                                                                                                                                                                 |  |          | 109,000    |   |      |   | 109,000    |  
|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  
|Total assets                                                                                                                                                                                                                                                                                                 |  | $        | 22,596,000 |   |      | $ | 19,574,000 |  
|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  
|Liabilities and stockholders equity                                                                                                                                                                                                                                                                         |  |          |            |   |      |   |            |  
|Current liabilities:                                                                                                                                                                                                                                                                                         |  |          |            |   |      |   |            |  
|Accounts payable and accrued expenses                                                                                                                                                                                                                                                                        |  | $        | 6,823,000  |   |      | $ | 5,617,000  |  
|Accrued compensation and related benefits                                                                                                                                                                                                                                                                    |  |          | 859,000    |   |      |   | 1,461,000  |  
|Borrowings under line of credit                                                                                                                                                                                                                                                                              |  |          |           |   |      |   | 1,408,000  |  
|Current portion of long-term debt                                                                                                                                                                                                                                                                            |  |          |           |   |      |   | 31,000     |  
|Deferred revenue                                                                                                                                                                                                                                                                                             |  |          | 1,085,000  |   |      |   | 1,094,000  |  
|Income taxes payable                                                                                                                                                                                                                                                                                         |  |          | 650,000    |   |      |   | 18,000     |  
|Other current liabilities                                                                                                                                                                                                                                                                                    |  |          | 8,000      |   |      |   | 96,000     |  
|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  
|Total current liabilities                                                                                                                                                                                                                                                                                    |  |          | 9,425,000  |   |      |   | 9,725,000  |  
|                                                                                                                                                                                                                                                                                                             |  |         
|Series F Convertible Preferred Stock                                                                                                                                                                                                                                                                         |  |          | 3,629,000  |   |      |   | 3,629,000  |  
|                                                                                                                                                                                                                                                                                                             |  |         
|Stockholders equity:                                                                                                                                                                                                                                                                                        |  |          |            |   |      |   |            |  
|Convertible Preferred Stock, $0.01 par value; 1,300,537 shares authorized; 1,298,728, issued as of June 30, 2008 and 2007; 1,090,171 and
1,106,929 outstanding at June 30, 2008 and 2007 respectively; aggregate liquidation preference of $1,612,000 and $1,714,000 at June 30, 2008 and 2007, respectively |  |          | 11,000     |   |      |   | 11,000     |  
|Common stock, $0.01 par value; 80,000,000 shares authorized; issued and outstanding shares of 16,491,244 at June 30, 2008 and 15,482,036
at June 30, 2007                                                                                                                                                    |  |          | 164,000    |   |      |   | 155,000    |  
|Additional paid-in capital                                                                                                                                                                                                                                                                                   |  |          | 12,928,000 |   |      |   | 12,706,000 |  
|Accumulated deficit                                                                                                                                                                                                                                                                                          |  |          | (3,561,000 | ) |      |   | (6,652,000 | )
|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  
|Total stockholders equity                                                                                                                                                                                                                                                                                   |  |          | 9,542,000  |   |      |   | 6,220,000  |  
|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  
|Total liabilities and stockholders equity                                                                                                                                                                                                                                                                   |  | $        | 22,596,000 |   |      | $ | 19,574,000 |  
|                                                                                                                                                                                                                                                                                                             |  |          |            |   |      |   |            |  



See accompanying
notes.



F-4



---

##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations



|                                         |  |                      |            |   |      |   |            |  
|---------------------------------------- |  | -------------------- | ---------- | - | ---- | - | ---------- | -
|                                         |  | Years ended June 30, |           
|                                         |  | 2008                 |            |   | 2007 |  
|Revenues:                                |  |                      |            |   |      |   |            |  
|Product sales                            |  | $                    | 27,650,000 |   |      | $ | 30,125,000 |  
|Service revenue                          |  |                      | 11,363,000 |   |      |   | 10,689,000 |  
|Commission revenue                       |  |                      | 10,631,000 |   |      |   | 9,721,000  |  
|                                         |  |                      |            |   |      |   |            |  
|                                         |  |                      | 49,644,000 |   |      |   | 50,535,000 |  
|Cost of revenue:                         |  |                      |            |   |      |   |            |  
|Cost of product sales                    |  |                      | 18,801,000 |   |      |   | 19,963,000 |  
|Cost of service revenue                  |  |                      | 8,145,000  |   |      |   | 7,416,000  |  
|                                         |  |                      | 26,946,000 |   |      |   | 27,379,000 |  
|                                         |  |                      |            |   |      |   |            |  
|Gross margin                             |  |                      | 22,698,000 |   |      |   | 23,156,000 |  
|                                         |  |                     
|Other operating expenses:                |  |                      |            |   |      |   |            |  
|Selling, general and administrative      |  |                      | 18,507,000 |   |      |   | 22,659,000 |  
|Depreciation and amortization            |  |                      | 693,000    |   |      |   | 689,000    |  
|                                         |  |                      |            |   |      |   |            |  
|                                         |  |                      | 19,200,000 |   |      |   | 23,348,000 |  
|                                         |  |                      |            |   |      |   |            |  
|Operating income (loss)                  |  |                      | 3,498,000  |   |      |   | (192,000   | )
|                                         |  |                     
|Other income (expense):                  |  |                      |            |   |      |   |            |  
|Interest and other income                |  |                      | 114,000    |   |      |   | 62,000     |  
|Interest expense                         |  |                      | (28,000    | ) |      |   | (198,000   | )
|                                         |  |                      |            |   |      |   |            |  
|                                         |  |                      | 86,000     |   |      |   | (136,000   | )
|                                         |  |                      |            |   |      |   |            |  
|Income (loss) before income taxes        |  |                      | 3,584,000  |   |      |   | (328,000   | )
|Income tax expense                       |  |                      | 493,000    |   |      |   | 227,000    |  
|                                         |  |                      |            |   |      |   |            |  
|Net income (loss)                        |  | $                    | 3,091,000  |   |      | $ | (555,000   | )
|                                         |  |                      |            |   |      |   |            |  
|Earnings (loss) per common sharebasic   |  | $                    | 0.16       |   |      | $ | (0.07      | )
|                                         |  |                      |            |   |      |   |            |  
|Earnings (loss) per common sharediluted |  | $                    | 0.15       |   |      | $ | (0.07      | )
|                                         |  |                      |            |   |      |   |            |  



See accompanying
notes.



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##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders Equity



|                                                                                  |  |                 |   |  |              |        |   |                 |            |          |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  
|--------------------------------------------------------------------------------- |  | --------------- | - |  | ------------ | ------ | - | --------------- | ---------- | -------- | - | ------------------------ |  | - | ------------------ | - |  | ----- | ---------- | - |  | - | --------- | -
|                                                                                  |  | Preferred Stock |   |  | Common Stock |        |   |                 |            |          |   |                          |  |  
|                                                                                  |  | Number ofShares |   |  | ParValue     |        |   | Number ofShares |            | ParValue |   | AdditionalPaid-InCapital |  |   | AccumulatedDeficit |   |  | Total |           
|Balance at July 1, 2006                                                           |  | 1,190,387       |   |  | $            | 12,000 |   |                 | 13,517,296 |          | $ | 135,000                  |  | $ | 10,601,000         |   |  | $     | (6,097,000 | ) |  | $ | 4,651,000 |  
|Issuance of common stock as compensation                                          |  |                |   |  |              |       |   |                 | 54,962     |          |   |                         |  |   | 83,000             |   |  |       |           |   |  |   | 83,000    |  
|Issuance of common stock upon the exercise of warrants                            |  |                |   |  |              |       |   |                 | 30,770     |          |   |                         |  |   | 24,000             |   |  |       |           |   |  |   | 24,000    |  
|Issuance of common stock under Employee Stock Purchase Plan                       |  |                |   |  |              |       |   |                 | 173,583    |          |   | 2,000                    |  |   | 207,000            |   |  |       |           |   |  |   | 209,000   |  
|Issuance of common stock through private placement                                |  |                |   |  |              |       |   |                 | 1,085,170  |          |   | 11,000                   |  |   | 1,531,000          |   |  |       |           |   |  |   | 1,542,000 |  
|Issuance of common stock pursuant to anti-dilution provision of previous offering |  |                |   |  |              |       |   |                 | 27,840     |          |   |                         |  |   |                   |   |  |       |           |   |  |   |          |  
|Issuance of common stock upon the exercise of stock options                       |  |                |   |  |              |       |   |                 | 222,525    |          |   | 3,000                    |  |   | 111,000            |   |  |       |           |   |  |   | 114,000   |  
|Vesting of stock options issued to employees                                      |  |                |   |  |              |       |   |                 |           |          |   |                         |  |   | 656,000            |   |  |       |           |   |  |   | 656,000   |  
|Conversion of preferred stock into common stock                                   |  | (83,458         | ) |  |              | (1,000 | ) |                 | 369,890    |          |   | 4,000                    |  |   | (3,000             | ) |  |       |           |   |  |   |          |  
|Preferred stock dividends                                                         |  |                |   |  |              |       |   |                 |           |          |   |                         |  |   | (504,000           | ) |  |       |           |   |  |   | (504,000  | )
|Net loss                                                                          |  |                |   |  |              |       |   |                 |           |          |   |                         |  |   |                   |   |  |       | (555,000   | ) |  |   | (555,000  | )
|                                                                                  |  |                 |   |  |              |        |   |                 |            |          |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  
|Balance at June 30, 2007                                                          |  | 1,106,929       |   |  | $            | 11,000 |   |                 | 15,482,036 |          | $ | 155,000                  |  | $ | 12,706,000         |   |  | $     | (6,652,000 | ) |  | $ | 6,220,000 |  



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##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders Equity (Continued)



|                                                            |  |                 |   |              |          |        |                 |            |          |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  
|----------------------------------------------------------- |  | --------------- | - | ------------ | -------- | ------ | --------------- | ---------- | -------- | - | ------------------------ |  | - | ------------------ | - |  | ----- | ---------- | - |  | - | --------- | -
|                                                            |  | Preferred Stock |   | Common Stock |          |        |                 |            |          |   |                          |  |  
|                                                            |  | Number ofShares |   |              | ParValue |        | Number ofShares |            | ParValue |   | AdditionalPaid-InCapital |  |   | AccumulatedDeficit |   |  | Total |           
|Balance at June 30, 2007                                    |  | 1,106,929       |   |              | $        | 11,000 |                 | 15,482,036 |          | $ | 155,000                  |  | $ | 12,706,000         |   |  | $     | (6,652,000 | ) |  | $ | 6,220,000 |  
|Issuance of common stock as compensation                    |  |                |   |              |          |       |                 | 76,584     |          |   |                         |  |   | 70,000             |   |  |       |           |   |  |   | 70,000    |  
|Issuance of common stock upon the exercise of warrants      |  |                |   |              |          |       |                 | 133,849    |          |   | 1,000                    |  |   | 98,000             |   |  |       |           |   |  |   | 99,000    |  
|Issuance of common stock under Employee Stock Purchase Plan |  |                |   |              |          |       |                 | 91,935     |          |   | 1,000                    |  |   | 82,000             |   |  |       |           |   |  |   | 83,000    |  
|Issuance of common stock upon the exercise of stock options |  |                |   |              |          |       |                 | 531,941    |          |   | 5,000                    |  |   | 110,000            |   |  |       |           |   |  |   | 115,000   |  
|Vesting of stock options issued to employees                |  |                |   |              |          |       |                 |           |          |   |                         |  |   | 429,000            |   |  |       |           |   |  |   | 429,000   |  
|Conversion of preferred stock into common stock             |  | (16,758         | ) |              |          |       |                 | 174,899    |          |   | 2,000                    |  |   | (2,000             | ) |  |       |           |   |  |   |          |  
|Preferred stock dividends                                   |  |                |   |              |          |       |                 |           |          |   |                         |  |   | (565,000           | ) |  |       |           |   |  |   | (565,000  | )
|Net income                                                  |  |                |   |              |          |       |                 |           |          |   |                         |  |   |                   |   |  |       | 3,091,000  |   |  |   | 3,091,000 |  
|                                                            |  |                 |   |              |          |        |                 |            |          |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  
|Balance at June 30, 2008                                    |  | 1,090,171       |   |              | $        | 11,000 |                 | 16,491,244 |          | $ | 164,000                  |  | $ | 12,928,000         |   |  | $     | (3,561,000 | ) |  | $ | 9,542,000 |  
|                                                            |  |                 |   |              |          |        |                 |            |          |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  



See accompanying notes.



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##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Cash Flows



|                                                                                               |  |                      |            |   |      |   |             |  
|---------------------------------------------------------------------------------------------- |  | -------------------- | ---------- | - | ---- | - | ----------- | -
|                                                                                               |  | Years ended June 30, |           
|                                                                                               |  | 2008                 |            |   | 2007 |  
|Cash flows from operating activities                                                           |  |                      |            |   |      |   |             |  
|Net income (loss)                                                                              |  | $                    | 3,091,000  |   |      | $ | (555,000    | )
|Adjustments to reconcile net income (loss) to net cash provided by operating activities:       |  |                      |            |   |      |   |             |  
|Provision for bad debts, net of recoveries                                                     |  |                      | (30,000    | ) |      |   | 114,000     |  
|Depreciation and amortization                                                                  |  |                      | 693,000    |   |      |   | 689,000     |  
|Non-cash stock compensation expense                                                            |  |                      | 499,000    |   |      |   | 739,000     |  
|Changes in operating assets and liabilities, net of those acquired:                            |  |                      |            |   |      |   |             |  
|Accounts receivable and other receivables                                                      |  |                      | 266,000    |   |      |   | (2,217,000  | )
|Inventory                                                                                      |  |                      | 480,000    |   |      |   | 512,000     |  
|Prepaid expenses and other current assets                                                      |  |                      | (31,000    | ) |      |   | (51,000     | )
|Other assets                                                                                   |  |                      |           |   |      |   | 16,000      |  
|Deferred income taxes, net                                                                     |  |                      | (342,000   | ) |      |   |            |  
|Accounts payable and accrued expenses                                                          |  |                      | 1,206,000  |   |      |   | 535,000     |  
|Accrued compensation and related benefits                                                      |  |                      | (602,000   | ) |      |   | 736,000     |  
|Deferred revenue                                                                               |  |                      | (9,000     | ) |      |   | 72,000      |  
|Income taxes payable                                                                           |  |                      | 632,000    |   |      |   | 3,000       |  
|Other current liabilities                                                                      |  |                      | (88,000    | ) |      |   | (60,000     | )
|                                                                                               |  |                      |            |   |      |   |             |  
|Net cash provided by operating activities                                                      |  |                      | 5,765,000  |   |      |   | 533,000     |  
|                                                                                               |  |                     
|Cash flows from investing activities                                                           |  |                      |            |   |      |   |             |  
|Purchase of property and equipment                                                             |  |                      | (304,000   | ) |      |   | (456,000    | )
|Acquisition of TTS assets                                                                      |  |                      |           |   |      |   | (200,000    | )
|Escrow settlement-Sterling Systems                                                             |  |                      |           |   |      |   | (24,000     | )
|Proceeds from asset sale                                                                       |  |                      | 46,000     |   |      |   |            |  
|                                                                                               |  |                      |            |   |      |   |             |  
|Net cash used in investing activities                                                          |  |                      | (258,000   | ) |      |   | (680,000    | )
|                                                                                               |  |                     
|Cash flows from financing activities                                                           |  |                      |            |   |      |   |             |  
|Proceeds from borrowings under lines of credit                                                 |  |                      | 1,460,000  |   |      |   | 61,077,000  |  
|Repayments of borrowings under lines of credit                                                 |  |                      | (2,868,000 | ) |      |   | (61,078,000 | )
|Repayments of long-term debt                                                                   |  |                      | (31,000    | ) |      |   | (63,000     | )
|Proceeds from issuance of common stock through private placement                               |  |                      |           |   |      |   | 1,542,000   |  
|Proceeds from issuance of common stock to employees and exercise of stock options and warrants |  |                      | 297,000    |   |      |   | 347,000     |  
|Dividends paid to preferred shareholders                                                       |  |                      | (565,000   | ) |      |   | (504,000    | )
|Decrease in other long-term liabilities                                                        |  |                      |           |   |      |   | (67,000     | )
|                                                                                               |  |                      |            |   |      |   |             |  
|Net cash (used in) provided by financing activities                                            |  |                      | (1,707,000 | ) |      |   | 1,254,000   |  
|                                                                                               |  |                      |            |   |      |   |             |  
|Net increase in cash                                                                           |  |                      | 3,800,000  |   |      |   | 1,107,000   |  
|Cash and cash equivalentsbeginning of year                                                    |  |                      | 1,688,000  |   |      |   | 581,000     |  
|                                                                                               |  |                      |            |   |      |   |             |  
|Cash and cash equivalentsend of year                                                          |  | $                    | 5,488,000  |   |      | $ | 1,688,000   |  
|                                                                                               |  |                      |            |   |      |   |             |  

See accompanying notes.



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##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

1. Summary of Significant Accounting Policies

Nature of Business and Basis of Presentation

Avatech Solutions, Inc. and Subsidiaries provides design automation software, hardware, training, technical support and professional services to
corporations, government agencies and educational institutions throughout much of the United States.

The consolidated financial statements
include the accounts of Avatech Solutions, Inc. and its subsidiaries (the Company or Avatech). All intercompany accounts and transactions between the Company and its subsidiaries have been eliminated in consolidation.

Use of Estimates

The
preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

Inventory

Inventory, consisting of computer
software and hardware, is stated at the lower of first-in, first-out cost, or market.

Property and Equipment

Property and equipment is stated at cost. Depreciation for computer software and equipment and office furniture and equipment is provided for by the
straight-line method over estimated useful lives ranging from three to seven years. Leasehold improvements are amortized over the lesser of the lease term or the useful life of the asset using the straight-line method.

Impairment of Long-Lived Assets Excluding Goodwill

Long-lived assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. These events or changes in
circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future cash flows. If an impairment indicator is present, the Company evaluates recoverability by a comparison of the
carrying amount of the assets to future undiscounted net cash flows expected to be generated by the assets. Assets are grouped at the lowest levels for which there are identifiable cash flows that are largely independent of the cash flows generated
by other asset groups. If the assets are impaired, the impairment recognized is measured by the amount by which the carrying amount exceeds the fair value of the assets. Fair value is generally determined by estimates of discounted cash flows. The
discount rate used in any estimate of discounted cash flows would be the rate required for a similar investment of like risk.

Goodwill

Goodwill is the excess of the purchase price paid over the fair value of the identifiable net assets acquired in purchase business
combinations. The Company accounts for goodwill in accordance with Statement of Financial



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##### Table of Contents

Accounting Standards No. 142, Goodwill and Other Intangible Assets (Statement 142). Under Statement 142, goodwill and other
intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. The implied fair value of
goodwill is the amount determined by deducting the estimated fair value of all tangible and identifiable intangible net assets of the reporting unit to which goodwill has been allocated from the estimated fair value of the reporting unit. If the
recorded value of goodwill exceeds its implied value, an impairment charge is recorded for the excess.

The carrying amount of goodwill was
$5,968,000 and $5,888,000 as of June 30, 2008 and 2007, respectively.

Stock Options and Stock Granted to Employees

The Board of Directors may grant options under the Avatech Solutions, Inc. 2002 Stock Option Plan to purchase shares of the Companys common stock at
a price not less than the fair market value of the common stock at the grant date. The Plan provides for the granting of either qualified or non-qualified stock options to purchase an aggregate of up to 4,955,000 shares of common stock to eligible
employees, officers, and directors of the Company. The exercise price of each stock option equals no less than 100% of the market price of the Companys stock on the date of grant and generally has a maximum term of 10 years. Options generally
vest ratably over three or four years, depending on the specific grant award. In addition, the Company may grant shares of stock to directors, officers and employees under the Avatech Solutions, Inc. Amended and Restated Restricted Stock Plan. The
effect of applying Statement 123R to these option grants was a decrease to net income of $429,000 and $656,000, for the years ended June 30, 2008 and 2007, respectively, or $0.03 per basic and $0.02 per diluted share in 2008 and $0.04 per basic
and $0.03 per diluted share in 2007. For the fiscal years ended June 30, 2008, and 2007, the Company also issued 76,584, and 54,962 shares, respectively, of fully vested common stock to members of the Board of Directors with an aggregate market
value of $70,000 and $83,000. For the fiscal years ended June 30, 2008 and 2007, total stock compensation expense charged against income for these plans was $499,000 and, $739,000, respectively.

The Company uses the Black-Scholes option pricing model. The Black-Scholes option pricing model was developed for estimating the fair value of traded
options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Companys stock options
have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in managements opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its stock-based awards. The following are the assumptions made in computing the fair value of stock-based awards:



|                                               |  |                    |  |                
|---------------------------------------------- |  | ------------------ |  | ---------------
|                                               |  | Year Ended June 30
|                                               |  | 2008               |  | 2007           
|Average risk-free interest rate                |  | 3.3%  4.4%        |  | 4.6%  5.1%    
|Dividend yield                                 |  | 0 %                |  | 0 %            
|Expected life                                  |  | 5.0  10.0 years   |  | 5.5  6.2 years
|Expected volatility                            |  | 82.7%  95.9%      |  | 97.2%  108.7% 
|Weighted average fair value of granted options |  | $ 0.74             |  | $ 1.39         

Revenue Recognition and Accounts Receivable

The Companys revenue recognition policies are in accordance with the Securities and Exchange Commissions (SEC) Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements, as amended by SEC Staff Accounting Bulletin No. 104, Revenue Recognition and with the AICPAs Statement of Position 97-2 Software Revenue Recognition.



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##### Table of Contents

Software products are sometimes sold in an arrangement that includes implementation services or
maintenance services. Maintenance services are limited to help desk support and training. The Company allocates the total arrangement fee among each element based on vendor-specific objective evidence of the relative fair value of each of the
elements. The Company limits its assessment of fair value of each element to the price charged when the same element is sold separately. If the fair value of each element in a multiple element arrangement cannot be reliably determined, and if the
fair value of any undelivered element cannot also be reliably determined, all revenue under the arrangement is deferred until such time as the only remaining undelivered element is maintenance, or in the absence of maintenance, implementation
services, upon which time revenue is recognized over the remaining maintenance or service period. Revenue that is deferred and recognized over a maintenance or service period is recognized in proportion to the services delivered, or ratably if no
better measure of performance can be determined.

Revenues for software product sales are recognized as revenue when four criteria are met.
These four criteria are (i) a signed purchase order has been obtained (ii) delivery of the software has occurred (iii) the fee is fixed or determinable and (iv) the fee is probable of collection. Software product sales billed and
not recognized as revenue are included in deferred revenue. The Company generally does not require collateral for accounts receivable. The Company provides a 30-day return policy to its customers. The Company has historically not experienced
significant returns, and accordingly, allowances for returned products are not recorded.

Maintenance services are sold for stated periods
or for stated numbers of hours. Revenues are recognized ratably over the service period for arrangements to provide maintenance over a stated period. Revenues for maintenance billed on an hourly basis are recognized as the services are performed.
Revenues from implementation and training services are recognized as the services are provided. Advance payments for these services are deferred and revenue is recognized in the periods when the services are performed.

The Company also receives commissions from vendors for transactions in which the Company essentially acts as an agent for the vendor. In these
transactions, the Company does not take title to the product, have responsibility for the delivery of any services, or have risk of loss for collection. These commissions are recorded as revenue when earned.

Allowance for Doubtful Accounts

The Company
uses estimates to determine the amount of the allowance for doubtful accounts necessary to reduce accounts receivable to its expected net realizable value. The Company estimates the amount of the required allowance by reviewing the status of
past-due receivables and analyzing historical bad debt trends. Actual collection experience has not varied significantly from estimates, due primarily to credit policies, collection experience, and a lack of concentration of accounts receivable. The
Company charges-off receivables deemed to be uncollectible to the allowance for doubtful accounts. Accounts receivable balances are not collateralized.

Cost of Product Sales

Cost of product sales includes the costs of purchasing software and hardware from suppliers
and the associated shipping and handling costs.

Cost of Service Revenue

Cost of service revenue consists primarily of direct employee compensation and related benefits of all service personnel, the cost of subcontracted
services and direct expenses billable to customers. Cost of service revenue does not include an allocation of overhead costs.

Warranty Costs

The Company does not provide for warranty costs for its products as such costs are incurred by the manufacturer of the products.



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##### Table of Contents

Advertising Costs

Costs incurred for producing and communicating advertisements are expensed as incurred and included in selling, general and administrative expenses in the accompanying statements of operations. Advertising expenses
approximated $1,180,000 and $1,449,000 for years ended June 30, 2008 and 2007, respectively.

Business Segment Reporting

The Companys operations are reviewed by the Companys chief operating decision maker as a single segment.

Income Taxes

The Company uses the liability
method to account for income taxes. Income tax expense includes income taxes currently payable and deferred taxes arising from temporary differences between financial reporting and income tax bases of assets and liabilities. Deferred income taxes
are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income
tax expense, if any, consists of the taxes payable for the current period. Valuation allowances are established when the realization of deferred tax assets are not considered more likely than not.

Recent Accounting Pronouncements

In
September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements but instead is intended to eliminate inconsistencies with respect to this topic found in various
other accounting pronouncements. This Statement is effective for the Company as of July 1, 2008. The Company does not believe the adoption of SFAS 157 will have a material effect on its consolidated financial position, results of operations or
cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for
Financial Assets and Financial Liabilitiesincluding an amendment of FASB Statement No. 115 (SFAS 159), which expands the use of fair value measurement by permitting entities to choose to measure many financial
instruments and certain other items at fair value at specified election dates. This statement is required to be adopted by the Company as of July 1, 2008. The Company does not believe the adoption of SFAS 159 will have a material effect on its
consolidated financial position, results of operations or cash flows.

In December 2007, the FASB issued Statement of Financial Accounting
Standards (SFAS) 141, Revised 2007 (SFAS 141R), Business Combinations. SFAS 141Rs objective is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in
its financial reports about a business combination and its effects. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after December 15, 2008.

In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements. SFAS 160s objective
is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards for the noncontrolling interest in
a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 shall be effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company does not expect the implementation of
SFAS 160 to have a material impact on its consolidated financial statements.



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##### Table of Contents

2. Supplemental Disclosure of Cash Flow Information

The Company paid interest of approximately $26,000 and $149,000 in 2008 and 2007, respectively, and paid federal and state taxes of approximately $149,000
and $233,000 in 2008 and 2007, respectively.

3. Borrowings Under Line of Credit

On January 27, 2006, the Company replaced its existing line of credit with a new credit
facility with another bank. The new line of credit provides for up to $5 million of borrowings limited to 80% of the Companys aggregate eligible accounts receivable. The loan bears interest at a rate tied to the banks prime rate and will
decrease as the Companys aggregate net worth increases. The interest rate ranges from the banks prime rate plus two percent to a low of the prime rate prime rate plus 0.25% when the Companys net worth exceeds $4,000,000 at the end
of a fiscal quarter. Based on the Companys current net worth, the interest rate for the quarter ended June 30, 2008 was the banks prime rate plus one-half percent (1/2%), or 5.50%. The loan will expire on December 31, 2008 and is secured by all of the Companys assets, except inventory. The Company expects to renew the line of credit prior to its
expiration.

The aggregate outstanding borrowings from the bank under its credit line were $0 and $1,408,000 at June 30, 2008
and 2007, respectively.

4. Long-Term Debt

The Company entered into two loans in connection with its April 2005 acquisition of Comtrex Corporation which were paid in full as of June 30, 2008. The balance was $31,000 as of June 30, 2007.

5. Series F Convertible Preferred Stock

In June 2006
the Company issued 4,000 shares of Series F Convertible Preferred Stock which raised $4,000,000 to pay down debt. In connection with this issuance, the Company granted 800,000 warrants to purchase its common stock at an exercise price of $2.00 per
share, expiring on June 12, 2010. In January 2007, the Company issued equity securities through a private placement which triggered the anti-dilution provisions of the Series F offering. Those provisions resulted in a lowering of the exercise
price of the warrants to $1.946 per share.

The Series F shares have the following terms:

Redemption Feature- The preferred stock is redeemable in the event that the Company is engaged in a business combination that is
approved by the Board of Directors and subsequently submitted and approved by a vote of the Companys shareholders. The original redemption price was $2.40 per share (upon conversion) plus an amount equal to all declared and unpaid dividends
accrued on such shares since the original issue date. The redemption price was lowered to $2.301 as a result of the previously discussed anti-dilution provisions. The redemption may be made in cash or common stock, at the Companys option.
Payments in common stock will be priced at a 7.5% discount to the market price at that time, and the investors are permitted to convert the amount which the Company would otherwise redeem before redemptions at the conversion price.

Voting Rights- Each holder of the preferred stock shall vote together with all other classes and series of stock of the Company as
a single class on all actions. Each share shall entitle the holder to one vote per share of common stock into which the preferred stock is then convertible on each such action. In addition, these holders have special voting rights in connection with
certain matters, including the issuance of senior stock or debentures, certain mergers, the dissolution of the Company and any amendment to the charter or the terms of the securities that would impair their rights.



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Dividend Rate- The holders of the Series F are entitled to receive cumulative
dividends at a rate of 10.0% per annum when and as declared by the Board of Directors. Dividends are paid quarterly to preferred shareholders and may be paid in cash or the Companys common stock. Payments in common stock will be priced at
a 5% discount to the market price at that time.

Conversion Feature- The preferred stock is convertible at any time
at the holders option. Each share of preferred stock is convertible into shares of common stock by multiplying the appropriate conversion rate in effect by the number of shares of preferred stock being converted. Currently, the conversion rate
is 500 shares of common stock for each share of Series F; however, this rate may be adjusted due to stock splits, dividends, and other events defined in the stock purchase agreement. The Company may force the holders of the issue to convert into its
common stock at any time once the market price of the Companys common stock is greater than $5.00 per share for twenty consecutive trading days.

Put Option- Beginning on July 1, 2008 and on the first business day of each calendar quarter thereafter, each shareholder shall have the option to exercise a put option which will require the Company to
purchase 12.5% of the aggregate number of shares of Series F Preferred Stock purchased.

Common Stock Warrants- Each
holder of Series F received common stock warrants which give the holder the right to purchase 400 shares of the Companys common stock for each Series F share held. The exercise price of the warrants is $2.40 per share and they expire on
June 12, 2010.

Liquidation Preference- In the event of a liquidation, dissolution or winding up of the Company,
the holders of Series F are entitled to receive for each share, prior and in preference to any distribution of any of the assets or surplus funds to the holders of common stock, an amount equal to $1,000 per share (upon conversion) plus all
accumulated but unpaid dividends. If upon the occurrence of such event, the assets and funds thus distributed among the holders are insufficient to permit the payment of the preferential amount, then the entire assets and funds of the Company
legally available for distribution shall be distributed ratably among the preferred stockholders.

As a result of the previously-described
Put Option, the net proceeds from the issuance of the Series F Convertible Preferred Stock are classified as temporary equity in the accompanying consolidated balance sheets as the terms of the issuance do not warrant classification as a liability
nor as equity. The Series F stock has a $0.01 par value with 4,000 shares authorized, issued and outstanding at June 30, 2008 with an aggregate liquidation preference of $4,000,000 as of June 30, 2008.

6. Preferred Stock

The Companys preferred
stock included in the equity section of the accompanying consolidated balance sheets consists of the following as of June 30, 2008 and 2007:



|                                                                                                                                                                                                                                                                                     |  |         |        |      |   |       
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------- | ------ | ---- | - | ------
|                                                                                                                                                                                                                                                                                     |  | June 30
|                                                                                                                                                                                                                                                                                     |  | 2008    |        | 2007
|Series D Convertible Preferred Stock, $0.01 par value; 1,297,537 shares authorized and issued; 1,089,213 and 1,105,879 shares outstanding at
June 30, 2008 and 2007, respectively; aggregate liquidation preference of $654,000 and $664,000 at June 30, 2008 and 2007, respectively |  | $       | 11,000 |      | $ | 11,000
|                                                                                                                                                                                                                                                                                     |  |        
|Series E Convertible Preferred Stock, $0.01 par value; 3,000 shares authorized; 1,191 shares issued; 958 and 1,050 shares outstanding at
June 30, 2008 and 2007, respectively; aggregate liquidation preference of $958,000 and $1,050,000 at June 30, 2008 and 2007, respectively   |  |         |       |      |   |      
|                                                                                                                                                                                                                                                                                     |  |         |        |      |   |       
|Total Preferred Stock                                                                                                                                                                                                                                                                |  | $       | 11,000 |      | $ | 11,000
|                                                                                                                                                                                                                                                                                     |  |         |        |      |   |       



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##### Table of Contents

At June 30, 2008 and 2007, 1,089,213 and 1,105,879 shares of Series D Convertible Preferred Stock
were outstanding, respectively, with the following terms:

Redemption Feature-The preferred stock is redeemable in
the event that the Company is engaged in a business combination that is approved by the Board of Directors and subsequently submitted and approved by a vote of the Companys shareholders. Any director who holds shares of Series D is not
eligible to vote on the proposed business combination. The redemption price is $0.30 (upon conversion) per share plus an amount equal to all declared and unpaid dividends accrued on such shares since the original issue date.

Voting Rights- Each holder of the preferred stock shall vote together with all other classes and series of stock of the Company as
a single class on all actions. Each share shall entitle the holder to one vote per share of common stock into which the preferred stock is then convertible on each such action. In addition, these holders have special voting rights in connection with
certain matters, including the issuance of senior stock or debentures, certain mergers, the dissolution of the Company and any amendment to the charter or the terms of the securities that would impair their rights.

Dividend Rate- The holders of the Series D are entitled to receive cumulative dividends at a rate of 10.0% per annum when and
as declared by the Board of Directors. Dividends are paid quarterly to preferred shareholders.

Conversion Feature-
The preferred stock is convertible at any time beginning 120 days after the original issuance date at the option of the holder and automatically converts into common stock if the common stock trades for more than $2.25 per share for 60 consecutive
trading days. Each share of preferred stock is convertible into shares of common stock by multiplying the appropriate conversion rate in effect by the number of shares of preferred stock being converted. Currently, the conversion rate is two shares
of common stock for each share of Series D; however, this rate may be adjusted due to stock splits, dividends, and other events defined in the stock purchase agreement.

Liquidation Preference- In the event of a liquidation, dissolution or winding up of the Company, the holders of Series D are
entitled to receive for each share, prior and in preference to any distribution of any of the assets or surplus funds to the holders of common stock, an amount equal to $0.60 per share plus all accumulated but unpaid dividends. If upon the
occurrence of such event, the assets and funds thus distributed among the holders are insufficient to permit the payment of the preferential amount, then the entire assets and funds of the Company legally available for distribution shall be
distributed ratably among the preferred stockholders.

In July 2005 the Company issued 1,191 shares of Series E Convertible Preferred Stock
which raised $1,191,000 for working capital purposes. In connection with this issuance, the Company granted 366,475 warrants to purchase its common stock at an exercise price of $0.65 per share which expired on July 29, 2008. The Series E
shares have the following terms:

Redemption Feature- The preferred stock is redeemable in the event that the Company
is engaged in a business combination that is approved by the Board of Directors and subsequently submitted and approved by a vote of the Companys shareholders. Any director who holds shares of Series E is not eligible to vote on the proposed
business combination. The redemption price is $0.65 per share (upon conversion) plus an amount equal to all declared and unpaid dividends accrued on such shares since the original issue date.

Voting Rights- Each holder of the preferred stock shall vote together with all other classes and series of stock of the Company as
a single class on all actions. Each share shall entitle the holder to one vote per share of common stock into which the preferred stock is then convertible on each such action. In addition, these holders have special voting rights in connection with
certain matters, including the issuance of senior stock or debentures, certain mergers, the dissolution of the Company and any amendment to the charter or the terms of the securities that would impair their rights.

Dividend Rate- The holders of the Series E are entitled to receive cumulative dividends at a rate of 10.0% per annum when and
as declared by the Board of Directors. Dividends are paid quarterly to preferred shareholders.



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##### Table of Contents

Conversion Feature- The preferred stock is convertible at any time beginning 120
days after the original issuance date at the option of the holder and automatically converts into common stock if the common stock trades for more than $2.25 per share for 60 consecutive trading days. Each share of preferred stock is convertible
into shares of common stock by multiplying the appropriate conversion rate in effect by the number of shares of preferred stock being converted. Currently, the conversion rate is 1,538.5 shares of common stock for each share of Series E; however,
this rate may be adjusted due to stock splits, dividends, and other events defined in the stock purchase agreement.

Common Stock Warrants- Each holder of Series E received common stock warrants which give the holder the right to purchase 307.7 shares the Companys common stock for each Series E share held. The exercise price of the warrants
is $0.65 per share and they expired on June 28, 2008.

Liquidation Preference- In the event of a liquidation,
dissolution or winding up of the Company, the holders of Series E are entitled to receive for each share, prior and in preference to any distribution of any of the assets or surplus funds to the holders of common stock, an amount equal to $0.65 per
share (upon conversion) plus all accumulated but unpaid dividends. If upon the occurrence of such event, the assets and funds thus distributed among the holders are insufficient to permit the payment of the preferential amount, then the entire
assets and funds of the Company legally available for distribution shall be distributed ratably among the preferred stockholders.

7. Earnings (Loss)
Per Share

Basic earnings (loss) per common share is computed as net earnings (loss) available to common stockholders divided by the
weighted-average number of common shares outstanding for the period. Diluted earnings (loss) per common share include the potential dilution that would occur from common shares issuable upon the exercise of outstanding stock options and warrants and
the conversion of preferred stock. The dilutive effects of stock options were not included for fiscal year 2007 as these options would have an anti-dilutive effect due to the losses of the Company. As of June 30, 2008, 10,014,004 shares of
common stock were issuable upon the conversion or exercise of options, warrants and preferred stock. The following summarizes the computations of basic and diluted loss per common share:



|                                                           |  |                     |            |   |      |   |            |  
|---------------------------------------------------------- |  | ------------------- | ---------- | - | ---- | - | ---------- | -
|                                                           |  | Year ended June 30, |           
|                                                           |  | 2008                |            |   | 2007 |  
|Numerator:                                                 |  |                     |            |   |      |   |            |  
|Net income (loss)                                          |  | $                   | 3,091,000  |   |      | $ | (555,000   | )
|Less: preferred stock dividends                            |  |                     | (565,000   | ) |      |   | (504,000   | )
|                                                           |  |                     |            |   |      |   |            |  
|Net income (loss) available to common shareholders         |  | $                   | 2,526,000  |   |      | $ | (1,059,000 | )
|                                                           |  |                     |            |   |      |   |            |  
|Denominator:                                               |  |                     |            |   |      |   |            |  
|Weighted average shares outstandingbasic                  |  |                     | 16,166,067 |   |      |   | 14,246,390 |  
|Assumed conversion of preferred stock                      |  |                     | 3,654,090  |   |      |   |           |  
|Effect of outstanding stock options                        |  |                     | 217,047    |   |      |   |           |  
|Effect of outstanding stock warrants                       |  |                     | 84,693     |   |      |   |           |  
|                                                           |  |                     |            |   |      |   |            |  
|Weighted average shares outstandingdiluted                |  |                     | 20,121,896 |   |      |   | 14,246,390 |  
|                                                           |  |                     |            |   |      |   |            |  
|Basic earnings (loss) per common share                     |  | $                   | 0.16       |   |      | $ | (0.07      | )
|                                                           |  |                     |            |   |      |   |            |  
|Diluted earnings (loss) per common share                   |  | $                   | 0.15       |   |      | $ | (0.07      | )
|                                                           |  |                     |            |   |      |   |            |  
|Antidilutive stock options, warrants and conversion rights |  |                     | 5,009,309  |   |      |   | 10,958,186 |  
|                                                           |  |                     |            |   |      |   |            |  



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##### Table of Contents

8. Stock Purchase Warrants

As of June 30, 2008, the Company had 2,681,749 outstanding warrants to purchase common stock. A summary of these warrants is as follows:



|                 |  |                |      |                 |                 
|---------------- |  | -------------- | ---- | --------------- | ----------------
|Number of Shares |  | Exercise Price |      | Expiration Date
|164,931          |  | $              | 0.65 |                 | July 29, 2008   
|100,000          |  | $              | 1.02 |                 | October 21, 2008
|51,838           |  | $              | 0.45 |                 | April 1, 2009   
|800,000          |  | $              | 2.30 |                 | June 12, 2010   
|200,000          |  | $              | 1.95 |                 | June 12, 2010   
|600,000          |  | $              | 2.00 |                 | June 14, 2010   
|38,878           |  | $              | 0.60 |                 | July 1, 2010    
|726,102          |  | $              | 1.52 |                 | January 29, 2011
|                 |  |                |      |                 |                 
|2,681,749        |  |                |      |                 |                 
|                 |  |                |      |                 |                 

9. Employee Stock Compensation Plans

Employee Stock Option Plans

The Board of Directors may grant options under the Avatech Solutions,
Inc. 2002 Stock Option to purchase shares of the Companys common stock at a price not less than the fair market value of the common stock at the grant date. The Plan provides for the granting of either qualified or non-qualified stock options
to purchase an aggregate of up to 4,955,000 shares of common stock to eligible employees, officers, and directors of the Company.

A
summary of stock option activity and related information is included in the following table:



|                                                                   |  |           |   |      |                              |           |         |           |   |                              |   |          
|------------------------------------------------------------------ |  | --------- | - | ---- | ---------------------------- | --------- | ------- | --------- | - | ---------------------------- | - | ---------
|                                                                   |  | 2008      |   | 2007
|                                                                   |  | Options   |   |      | WeightedAverageExercisePrice |           | Options |           |   | WeightedAverageExercisePrice
|Outstanding at beginning of year                                   |  | 1,625,301 |   |      | $                            | 0.93      |         | 2,001,558 |   |                              | $ | 0.92     
|Granted                                                            |  | 639,000   |   |      |                              | 0.89      |         | 330,000   |   |                              |   | 1.20     
|Exercised                                                          |  | (531,941  | ) |      |                              | 0.22      |         | (222,525  | ) |                              |   | 0.51     
|Forfeited                                                          |  | (54,155   | ) |      |                              | 1.39      |         | (483,732  | ) |                              |   | 1.55     
|Cancelled                                                          |  |          |   |      |                              |          |         |          |   |                              |   |         
|                                                                   |  |           |   |      |                              |           |         |           |   |                              |   |          
|Outstanding at end of year                                         |  | 1,678,205 |   |      | $                            | 1.11      |         | 1,625,301 |   |                              | $ | 0.93     
|                                                                   |  |           |   |      |                              |           |         |           |   |                              |   |          
|Exercisable at end of year                                         |  | 1,167,037 |   |      | $                            | 1.15      |         | 1,264,699 |   |                              | $ | 0.83     
|                                                                   |  |           |   |      |                              |           |         |           |   |                              |   |          
|Weighted-average remaining contractual life of outstanding options |  |           |   |      |                              | 7.7 Years |         |           |   |                              |   | 7.2 Years
|                                                                   |  |           |   |      |                              |           |         |           |   |                              |   |          

The aggregate intrinsic value of the stock options outstanding and exercisable at June 30,
2008 and 2007 was $178,000 and $795,000, respectively. The aggregate intrinsic value of options exercised was $327,000 and $219,000 during the years ended June 30, 2008 and 2007, respectively.



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##### Table of Contents

All options granted have an exercise price equal to the fair value of the Companys common stock on
the date of grant. Exercise prices for options outstanding as of June 30, 2008 ranged from $0.167 to $63.33 as follows:



|                        |  |                    |  |                                                      |  |                                                               |  |                     |  |                                                      |  |                                                              
|----------------------- |  | ------------------ |  | ---------------------------------------------------- |  | ------------------------------------------------------------- |  | ------------------- |  | ---------------------------------------------------- |  | -------------------------------------------------------------
|Range of ExercisePrices |  | OptionsOutstanding |  | WeightedAverage ExercisePrices of OptionsOutstanding |  | WeightedAverageRemainingContractual Lifeof
OptionsOutstanding |  | Options Exercisable |  | WeightedAverage ExercisePrices of OptionsExercisable |  | WeightedAverageRemainingContractual Lifeof
OptionsExercisable
|$ 0.167    0.34        |  | 107,998            |  | $0.29                                                |  | 5.4 years                                                     |  | 107,998             |  | $0.29                                                |  | 5.4 years                                                    
|0.35    0.91           |  | 1,098,000          |  | 0.77                                                 |  | 8.0 years                                                     |  | 732,458             |  | 0.73                                                 |  | 7.3 years                                                    
|1.05  63.33            |  | 472,207            |  | 2.10                                                 |  | 7.7 years                                                     |  | 326,581             |  | 2.38                                                 |  | 7.5 years                                                    
|                        |  |                    |  |                                                      |  |                                                               |  |                     |  |                                                      |  |                                                              
|                        |  | 1,678,205          |  |                                                      |  |                                                               |  | 1,167,037           |  |                                                      |  |                                                              
|                        |  |                    |  |                                                      |  |                                                               |  |                     |  |                                                      |  |                                                              

Assuming that no additional share-based payments are granted after June 30, 2008, unamortized
stock compensation expense of $373,000 will be recognized in the statement of operations over a weighted average period of 5.7 years.

Employee Stock
Purchase Plan

In June 1996, the Board of Directors adopted, and its stockholders subsequently approved, the Employee Stock Purchase
Plan (the Plan), under which 100,000 shares of common stock were initially reserved for issuance. As a result of an amendment to the Plan approved at the 2007 annual meeting of shareholders, the Plan is authorized to issue up to
2,000,000 shares of common stock, of which 941,969 were available for future issuance at June 30, 2008.

The Plan is administered by
the Compensation Committee of the Board of Directors. Generally, each offering is of six months duration, but can extend as long as twenty-seven months. Eligible employees who work a minimum of 20 hours a week may purchase up to 15% of their
compensation in common stock at a price equal to 85% of the lower of the fair value of the common stock at the beginning or end of the offering period. Employees may purchase up to $25,000 of common stock in any calendar year under this Plan.

As of June 30, 2008, the balance withheld from employees pay totaled approximately $29,000 and in July 2008, 38,327 shares of
common stock were issued to employees under the Plan.

Restricted Stock Award Plan

In May 2003, the Companys Board of Directors approved the Avatech Solutions, Inc. Restricted Stock Award Plan, which was amended and restated on
August 23, 2005. Employees and consultants of the Company are eligible to receive stock awards under this plan if they are already shareholders or hold options to purchase shares of common stock. Additionally, officers or directors of the
Company are eligible to receive restricted stock awards regardless of any pre-existing ownership of common stock or stock options. Vesting for restricted stock awards granted under this plan may vary, but awards will generally vest based on
continued service of the recipient or achievement of specific performance goals. After amendments, the Company reserved a total of 1,000,000 shares of common stock for issuance under the Restricted Stock Award Plan and 287,035 shares are available
future issuance as of June 30, 2008.

During fiscal year 2008, the Company awarded 76,893 shares of restricted stock to certain
directors as compensation for service on the Companys Board of Directors. These shares were issued at quoted market prices on the date of grant (weighted-average fair value of $0.91 per share). For the years ended June 30, 2008 and 2007,
the Company recorded aggregate expense of $70,000 and $83,000, respectively, for common stock grants to officers and directors.



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##### Table of Contents

10. Shares Reserved for Future Issuance

At June 30, 2008, the Company has reserved 260,278 shares of common stock for future issuance upon the exercise of stock options granted under the
Companys stock option plans, exercise of outstanding stock purchase warrants, issuance of restricted stock awards, purchases under the employee stock purchase plan and the conversion of preferred stock.

11. Income Taxes

Significant components of the
Companys deferred tax assets and liabilities are as follows:



|                                            |  |                    |         |      |   |           |  
|------------------------------------------- |  | ------------------ | ------- | ---- | - | --------- | -
|                                            |  | Year ended June 30 |        
|                                            |  | 2008               |         | 2007 |  
|Deferred tax assets:                        |  |                    |         |      |   |           |  
|Net operating loss carryforward             |  | $                  | 479,000 |      | $ | 766,000   |  
|Accrued compensation                        |  |                    | 26,000  |      |   | 383,000   |  
|AMT credit carryforward                     |  |                    |        |      |   | 111,000   |  
|Allowance for doubtful accounts             |  |                    | 73,000  |      |   | 73,000    |  
|Book over tax depreciation and amortization |  |                    | 43,000  |      |   | 23,000    |  
|Book over tax lease expense                 |  |                    | 41,000  |      |   | 49,000    |  
|Other assets                                |  |                    | 95,000  |      |   | 59,000    |  
|                                            |  |                    |         |      |   |           |  
|Total deferred tax assets                   |  |                    | 757,000 |      |   | 1,464,000 |  
|                                            |  |                    |         |      |   |           |  
|Deferred tax liabilities:                   |  |                    |         |      |   |           |  
|Customer list                               |  |                    | 495,000 |      |   | 525,000   |  
|Other                                       |  |                    |        |      |   |          |  
|                                            |  |                    |         |      |   |           |  
|Total deferred tax liabilities              |  |                    | 495,000 |      |   | 525,000   |  
|                                            |  |                    |         |      |   |           |  
|Deferred tax assets, net of liabilities     |  |                    | 262,000 |      |   | 939,000   |  
|Valuation allowance                         |  |                    |        |      |   | (939,000  | )
|                                            |  |                    |         |      |   |           |  
|Net deferred tax assets                     |  | $                  | 262,000 |      | $ |          |  
|                                            |  |                    |         |      |   |           |  

The Companys provision for income taxes resulted in effective tax rates attributable to loss
from continuing operations before cumulative effect of change in accounting principal that varied from the statutory federal income tax rate of 34%, as summarized in the table below.



|                                                                                |  |                    |           |   |      |   |          |  
|------------------------------------------------------------------------------- |  | ------------------ | --------- | - | ---- | - | -------- | -
|                                                                                |  | Year ended June 30 |          
|                                                                                |  | 2008               |           |   | 2007 |  
|Expected federal income tax expense (benefit) from continuing operations at 34% |  | $                  | 1,218,000 |   |      | $ | (112,000 | )
|Expenses not deductible for income tax purposes                                 |  |                    | 137,000   |   |      |   | 357,000  |  
|State income taxes, net of federal benefit                                      |  |                    | 29,000    |   |      |   | 132,000  |  
|Change in valuation allowance for deferred tax assets                           |  |                    | (891,000  | ) |      |   | (150,000 | )
|                                                                                |  |                    |           |   |      |   |          |  
|Income tax expense                                                              |  | $                  | 493,000   |   |      | $ | 227,000  |  
|                                                                                |  |                    |           |   |      |   |          |  

Income tax expense includes current state income taxes of approximately $82,000 and $193,000 for
2008, and 2007, respectively.

At June 30, 2008, the Company has federal net operating loss carryforwards totaling approximately $1.2
million, which will begin to expire in 2012. The federal net operating loss carryforwards at June 30, 2008 are subject to a $92,000 annual limitation under Internal Revenue Code Section 382.



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##### Table of Contents

12. Commitments and Contingencies

Operating Leases

The Company leases certain office space and equipment under noncancellable
operating lease agreements that expire in various years through 2014, and generally do not contain significant renewal options. Future minimum payments under all noncancellable operating leases with initial terms of one year or more consisted of the
following at June 30, 2008:



|                             |  |   |          
|---------------------------- |  | - | ---------
|Year ending June 30:         |  |   |          
|2009                         |  | $ | 1,293,000
|2010                         |  |   | 1,175,000
|2011                         |  |   | 1,042,000
|2012                         |  |   | 542,000  
|2013                         |  |   | 343,000  
|Thereafter                   |  |   | 109,000  
|                             |  |   |          
|Total minimum lease payments |  | $ | 4,504,000
|                             |  |   |          

Rent expense consisted of the following:



|             |  |                    |           |      |   |          
|------------ |  | ------------------ | --------- | ---- | - | ---------
|             |  | Year ended June 30
|             |  | 2008               |           | 2007
|Office space |  | $                  | 1,300,000 |      | $ | 1,389,000
|Equipment    |  |                    | 189,000   |      |   | 166,000  
|             |  |                    |           |      |   |          
|             |  | $                  | 1,489,000 |      | $ | 1,555,000
|             |  |                    |           |      |   |          

There was no rent paid to a related party for the years ended June 30, 2008 and 2007.

13. Employee Benefit and Incentive Compensation Plans

Effective January 1, 1998, the Company adopted the Avatech Solutions, Inc. 401(k) Retirement
Savings Plan and Trust (the Plan). The Plan is a defined contribution plan, which covers substantially all employees of the Company, or its wholly-owned subsidiaries, who have attained age 21 and have completed three months of service.
Participants may elect a pre-tax payroll deduction up to $15,500 (if under age 50), or $20,500 (if age 50 or older by December 31stof any
calendar year). As amended, the Plan provides that the Company will match 100% of the participant salary deferrals up to 3% of a participants compensation and 50% of the next 2% of a participants compensation, or a total possible maximum
matching contribution of 4% of a participants compensation, for all participants. The Company may also make discretionary profit-sharing contributions to the Plan for all participants who are employed on the last day of the Plan year. The
total amount recorded by the Company as expense during the years ended June 30, 2008 and 2007 was approximately $446,000 and $445,000, respectively.

14. Significant Supplier

Approximately 95% and 97% of the Companys inventory purchases for the years ended
June 30, 2008 and 2007, respectively, were from one vendor and approximately 83% and 77% of accounts payable at June 30, 2008 and 2007, respectively, were due to this vendor. Approximately 93% of the Companys total product revenues
are related to this suppliers products.



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##### Table of Contents

15. Liquidity and Capital Resources

The Company had no outstanding long-term debt at June 30, 2008 and the Company had a working capital surplus of approximately $4,530,000. As a result of its operations and the infusions of capital, the
Companys management believes that its near-term needs can be met from its available cash resources, cash flows from operations and its line of credit.

16. Subsequent event

On July 1, 2008, pursuant to the agreements executed as part of its June 2006 offering of its
Series F Convertible Preferred Stock (Series F), the Company redeemed 500 of the original 4,000 Series F shares for payments to the holders of Series F totaling $500,000 plus accumulated interest of approximately $12,000. The Series F shareholders
have the right to request redemptions of up to $500,000 of the Series F stock on July 1, October 1, January 1 and April 1 of 2008 and 2009 and have expressed their intention of requesting the redemptions until their
Series F stock has been fully redeemed. The Company expects to fund these redemptions out of its excess cash balance and does not anticipate that they will have any material effect on the Companys liquidity.



F-21



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##### Table of Contents

EXHIBIT INDEX



|        |  |                                                                                                                                                                                                                                                                                                                                                                         
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                                                                                                                                                                                                             
|3.1     |  | Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)                                                                                                                                                                                                             
|        | 
|3.2     |  | First Amendment to Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)                                                                                                                                                                                          
|        | 
|3.3     |  | Reverse Split Amendment to Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386)                                                                                                                                                                                        
|        | 
|3.4     |  | Amendment of PlanetCADs Certificate of Incorporation to change the name of PlanetCAD, Inc. to Avatech Solutions, Inc. (incorporated by reference to our Registration Statement on form S-4
filed on May 30, 2002, File No. 333-89386)                                                                                                                                  
|        | 
|3.5     |  | Certificate of Amendment to Amended and Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No. 333-114230)                                                                                                                                                                        
|        | 
|3.6     |  | By-Laws (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)                                                                                                                                                                                                                                           
|        | 
|3.7     |  | Certificate of Designation, Preferences and Rights of Series D Convertible Preferred Stock (incorporated by reference to our Current Report on form
8-K, filed on May 28, 2002, File No. 001-31265)                                                                                                                                                                     
|        | 
|3.8     |  | Certificate of Amendment to Certificate of Designation of Series D Convertible Preferred Stock (incorporated by reference to our Quarterly Report on form 10-Q, filed on February 13, 2004, File
No. 001-31265)                                                                                                                                                         
|        | 
|4.1     |  | Certificate of Designation, Preferences and Rights of Series E Convertible Preferred Stock (incorporated by reference to our Current Report on form
8-K, filed on August 9, 2005, File No. 001-31265)                                                                                                                                                                   
|        | 
|4.2     |  | Certificate of Designation, Preferences and Rights of Series F Convertible Preferred Stock (incorporated by reference to Exhibit 4.3 hereto)                                                                                                                                                                                                                            
|        | 
|4.3     |  | Certificate of Designation of the Powers, Preferences and Relative, Participating, Optional and Other Special Rights of Preferred Stock and Qualification, Limitations and Restriction Thereof of
Series F 10% Cumulative Convertible Preferred Stock (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)
|        | 
|4.4     |  | Form of Purchase Agreement for Series D Convertible Preferred Stock (incorporated by reference to our Quarterly Report on form 10-Q, filed on February 13, 2004, File No.
001-31265)                                                                                                                                                                                    
|        | 
|4.5     |  | Warrants to purchase up to 51,828 shares of common stock issued by Avatech to W. James Hindman dated April 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on
July 19, 2004, File No. 333-114230)                                                                                                                                   
|        | 
|4.6     |  | Warrants to purchase up to 38,878 shares of common stock issued by Avatech Solutions, Inc. to W. James Hindman, dated July 1, 2005 (incorporated by reference to our Annual Report on Form 10-K,
filed on November 14, 2005, File No. 001-31265)                                                                                                                        
|        | 
|4.7     |  | Warrant to purchase up to 100,000 shares of common stock issued by Avatech to W. James Hindman, dated October 22, 2005 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on
November 14, 2005, File No 001-31265)                                                                                                                                  
|        | 
|4.8     |  | Preferred Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                                                                                                                                       
|        | 
|4.9     |  | Common Stock Purchase Warrants (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                                                                                                                                                       



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##### Table of Contents

|        |  |                                                                                                                                                                                                                                       
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                                                                           
|4.10    |  | Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                          
|        | 
|4.11    |  | Common Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                        
|        | 
|4.12    |  | Form of Common Stock Purchase Warrants issued to Sigma Opportunity Fund LLC and Pacific Asset Partners (incorporated by reference to our Registration Statement on Form S-1, filed on
June 22, 2006, File No. 333-134862)             
|        | 
|4.13    |  | Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                          
|        | 
|4.14    |  | Common Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)                                                                     
|        | 
|4.15    |  | Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)                                                                                       
|        | 
|4.16    |  | Common Stock Purchase Warrants (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)                                                                                  
|        | 
|4.17    |  | Lease by and between Merritt-DM1, LLC and Avatech Solutions, Inc. effective June 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No.
333-114230)                           
|        | 
|10.1    |  | Avatech Solutions, Inc. 2002 Stock Option Plan (incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386)                                                                        
|        | 
|10.2    |  | Avatech Solutions, Inc. Amended and Restated Restricted Stock Award Plan (incorporated by reference to Exhibit 10.3 of our Quarterly Report on Form 10-Q, filed on November 14, 2005, File No.
001-31265)                             
|        | 
|10.3    |  | Amended Avatech Solutions, Inc. Employee Stock Purchase Plan (incorporated by reference to Exhibit 4 of our Registration Statement on Form S-8, File No. 333-147823)                                                                  
|        | 
|10.4    |  | Amended and Restated Employment Agreement between George Davis and Avatech Solutions, Inc. dated September 12, 2007 (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K,
filed on September 18, 2007)        
|        | 
|10.5    |  | Renewal of Amended and Restated Employment Agreement between George Davis and Avatech Solutions, Inc. (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K, filed on
August 26, 2008)                         
|        | 
|10.6    |  | Employment Agreement by and between Donald R. Scotty Walsh and Avatech Solutions, Inc. dated July 1, 2003 (incorporated by reference to our Annual Report on form 10-K, filed on
October 3, 2003, File No. 001-31265)               
|        | 
|10.7    |  | Separation and Retirement Agreement between Donald R. Scotty Walsh and Avatech Solutions, Inc. dated August 22, 2007 (incorporated by reference to Exhibit 10.1 of our Current Report
on Form 8-K, filed on August 27, 2007)        
|        | 
|10.8    |  | Employment Agreement by and between W. Scott Harris and Avatech Solutions Subsidiary, Inc. dated as of June 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on
July 19, 2004, File No. 333-114230)
|        | 
|10.9    |  | Separation Agreement dated February 28, 2007 by and between W. Scott Harris and Avatech Solutions Subsidiary, Inc. (incorporated by reference to Exhibit 10.1 of our Form 8-K filed on
March 2, 2007)                                 
|        | 
|10.10   |  | Employment Agreement between Lawrence Rychlak and Avatech Solutions, Inc. dated May 26, 2006 (filed herewith)                                                                                                                         



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##### Table of Contents

|        |  |                                                                                                                                                                                                                                                     
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                                                                                         
|10.11   |  | Letter Agreement between Avatech Solutions, Inc. and W. James Hindman, with stock purchase warrant, dated December 6, 2004 (incorporated by reference to our Quarterly Report on form 10-Q, filed
on February 15, 2005, File No. 001-31265)         
|        | 
|10.12   |  | Promissory Note issued by Avatech Solutions Subsidiary, Inc. to Mercantile Bank & Trust Co. dated January 27, 2006 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on
November 14, 2005, File No 001-31265)                  
|        | 
|10.13   |  | Loan and Security Agreement by and between Avatech Solutions Subsidiary, Inc and Mercantile Bank & Trust Co., dated January 27, 2006 (incorporated by reference to our Quarterly Report on
Form 10-Q, filed on November 14, 2005, File No 001-31265)
|        | 
|10.14   |  | Guaranty Agreement by and between W. James Hindman and Mercantile Bank & Trust Co., dated January 27, 2006 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on
November 14, 2005, File No 001-31265)                          
|        | 
|10.15   |  | Channel Partner Agreement, dated February 1, 2006, by and between Avatech Solutions Subsidiary, Inc. and Autodesk, Inc (incorporated by reference to our Quarterly Report on Form 10-Q, filed on
November 14, 2005, File No 001-31265)              
|        | 
|21.1    |  | Subsidiaries of the Registrant (filed herewith)                                                                                                                                                                                                     
|        | 
|23.1    |  | Consent of Stegman and Company (filed herewith)                                                                                                                                                                                                     
|        | 
|31.1    |  | Rule 15d-14(a) Certification of Chief Executive Officer (filed herewith)                                                                                                                                                                            
|        | 
|31.2    |  | Rule 15d-14(a) Certification of Chief Financial Officer (filed herewith)                                                                                                                                                                            
|        | 
|32.1    |  | Section 1350 Certifications (furnished herewith)