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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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

For the fiscal year ended June 30, 2007

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



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AVATECH SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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



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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.    Yes ̈Nox

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 ̈Nox

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 ̈

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



|                         |  |                    |  |                         
|------------------------ |  | ------------------ |  | ------------------------
|Large Accelerated Filer ̈ |  | Accelerated Filer ̈ |  | Non-Accelerated Filer  x

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 stock held by non-affiliates of the registrant as of September 11, 2007 was approximately $14,014,448

The number of shares of common stock outstanding as of September 11, 2007 was 16,108,561.

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 2007 Annual Meeting of Stockholders.



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TABLE OF CONTENTS



|           |  |          |  |                                                                                                              |  |   
|---------- |  | -------- |  | ------------------------------------------------------------------------------------------------------------ |  | --
|PART I     |  | 4       
|           |  | ITEM 1.  |  | Business                                                                                                     |  | 4 
|           |  | ITEM 1A. |  | Risk Factors                                                                                                 |  | 9 
|           |  | ITEM 1B. |  | Unresolved Staff Comments                                                                                    |  | 14
|           |  | ITEM 2.  |  | Properties                                                                                                   |  | 14
|           |  | ITEM 3.  |  | Legal Proceedings                                                                                            |  | 14
|           |  | ITEM 4.  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 14
|           | 
|PART II    |  | 15      
|           |  | ITEM 5.  |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 15
|           |  | ITEM 6.  |  | Selected Financial Data                                                                                      |  | 18
|           |  | ITEM 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 19
|           |  | ITEM 8.  |  | Financial Statements and Supplementary Data                                                                  |  | 30
|           |  | ITEM 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosures                        |  | 31
|           |  | ITEM 9A. |  | Controls and Procedures                                                                                      |  | 31
|           |  | ITEM 9B. |  | Other Information                                                                                            |  | 31
|           | 
|PART III   |  | 32      
|           |  | ITEM 10. |  | Directors, Executive Officers and Corporate governance                                                       |  | 32
|           |  | ITEM 11. |  | Executive Compensation                                                                                       |  | 32
|           |  | ITEM 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 32
|           |  | ITEM 13. |  | Certain Relationships and Related Transactions, and director independence                                    |  | 32
|           |  | ITEM 14. |  | Principal Accountant Fees and Services                                                                       |  | 32
|           | 
|PART IV    |  | 33      
|           |  | ITEM 15. |  | Exhibits and Financial Statement Schedules                                                                   |  | 33
|           | 
|SIGNATURES |  | 36      



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This Annual Report of Avatech Solutions, Inc. on Form 10-K for the year ended June 30, 2007 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 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 Avatech Solutions, Inc.s business or operations. These and other risk factors are discussed in detail in Item 1A of Part I of this report. 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. (Avatech or the Company) 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.

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., its shareholders 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 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 231 employees operating out of nineteen business offices across the United
States. The Company has a sales database that has over 210,000 point-of-contact names collected over an eighteen-year time span and an active customer list of approximately 30,000 private firms, federal, state, and local agencies, and colleges and
universities.

The Companys strategy will focus on leveraging the solid 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 developed a Research and Development team within its professional services group that is charged with the
responsibility of developing tools for customers that facilitate workflow processes involving the software products the Company sells, and new products that complement and enhance the features of those software products. This team created Avatech
Earth Connector, a unique AutoCAD plug-in which allows



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architects, building designers, and engineers to place 2D and 3D structures developed in AutoCAD-based products directly into Google Earths 3D world.
They were also instrumental in preparing Proof Positive, a software product the Company acquired as a result of its merger with PlanetCAD, Inc. in 2002, and sold to its major vendor, Autodesk, Inc. in 2005. It is Avatechs intention to develop
similar products for sale to its customers and to third-party software vendors.

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.

Recent Developments

On January 29, 2007, the Company entered into and closed on a private placement pursuant to which it sold an aggregate of 1,085,170 shares of common
stock and issued warrants to purchase, in the aggregate, 726,102 shares of common stock to several members of its Board of Directors and to Sigma Opportunity Fund LLC, whose managing member is also a member of the Board of Directors. The purchase
price of the common stock was $1.5205 per share, for an aggregate purchase price of $1,650,000. Each Warrant entitles the holder thereof to purchase one share of common stock, at any time until January 29, 2011, at an exercise price of $1.5205
per share.

In February 2007, the Company entered into a new Channel Partner Agreement with Autodesk, Inc., its major vendor. The renewable
agreement dated February 1, 2007 has a term of three years but provides targets for a one year period. The Company is aggressively seeking to capitalize on all of the targets identified in the new agreement with Autodesk to increase revenue and
profitability.

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.

In addition to Autodesk offerings, Avatech also provides other solutions to its design automation customers, such as electronic document
management software from Cyco Software, Inc., which provides methodical and organized processes to store, retrieve, manage, and version design files, drawings, and related documents such as customer correspondence, inventory lists, digital images,
and other items. The Company also provides a variety of services along with our design automation software sales, to assist our customers in maximizing the benefits from these software applications. These services include training, technical
support, and professional services.

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.



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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) 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 IWMS 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 (FM) 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
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.

Services

Avatech offers training courses in over
fifty-five different subjects related to various software solutions offered at nineteen training facilities and through mobile labs that it can send to customer sites or other off-site facilities. Training is led by 68 employees who serve as class
instructors and 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 and corporate technical support services through its
National Support Center (NSC) located in Omaha, Nebraska. A staff of seven full-time product and technology consultants assists customers calling 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, telephone, and fax channels.

Other professional services include project-focused offerings such as software customization, data migration, computer aided design standards consulting,
supplemental staffing for design work, drawing digitization, and symbol library development. Avatech has employed 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.



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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 worldwide headquarters in the United States, Germany, and India. While INCAT is larger 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. On August 14, 2007 RAND entered into a definitive agreement with funds managed by
Ampersand Ventures (Ampersand), a private equity firm, whereby Ampersand would acquire all of the outstanding shares of RAND. The transaction is scheduled to close by December 2007, and RAND will continue to conduct its business in the design
automation market in the interim.

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

Facilities Management. The Company provides Integrated Workplace Management Solutions
(IWMS) to organizations of all sizes, spanning the financial, educational, governmental, healthcare, and manufacturing industries. Its major competitors in the IWMS market are integrators such as CFI, Business Resource Group (BRG), and AOS. CFI is a
privately held company based in Southfield, MI. It resells ARCHIBUS/FM products, as well as provides consulting services and outsourced staffing. BRG is a privately held company based in Dallas, Texas, whose primary business is the resale of
commercial furniture systems. BRG resells ARCHIBUS/FM products and provides consulting, implementation services and outsourced staffing. AOS is a corporate real estate and facility management solutions firm with its global headquarters in Paris,
France and US headquarters in Atlanta, Georgia. The Company believes that AOS is the largest ARCHIBUS/FM partner by volume.

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, 2007, the Company entered into a renewable Authorized Channel
Partner Agreement with Autodesk. The renewable agreement dated February 1, 2007 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, 2007, the Companys revenue from the sale of Autodesk software and subscriptions was approximately $35.9 million. This agreement authorizes it 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 it can offer to customers.



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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, 2007, the revenues generated by our top ten
customers represented approximately eight 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 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, 2007, the Company had approximately 231 employees located in nineteen offices throughout the United States.
Approximately 39 of its employees are located at its 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.avatechsolutions.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 1A.     RISK FACTORS

Risk Factors Relating to Our Business Generally

We have a history of significant losses and may never achieve consistent profitability.

In the last five fiscal years of operation, we have reported net income only in fiscal years ended June 30, 2006 and 2005. Although we believe we
will be profitable in future reporting periods on a quarterly and annual basis, we may not be able to sustain or increase profitability on a quarterly or an annual basis in the future.

We have a limited operating history, which makes it difficult to evaluate our business and prospects.

We began operations in 1997, with the merger of four founding companies. Since that time, we have acquired 16 additional companies. Management believes it has successfully integrated these businesses and their disparate operations,
employees and management structures and personnel. The limited history and continuing evolution of our operations makes it difficult to evaluate our business and prospects. Our prospects must be considered in light of the risks, uncertainties,
expenses, and difficulties frequently encountered by companies in their early stages of development. If we fail to address these risks and uncertainties, we may be unable to grow our business, increase our revenue, or continue to be profitable.

Our reliance on the sale and integration of a single software vendors products could decrease our revenues and our profitability.

We derive over 90% of our net revenues from the sale and integration of Autodesk products and from providing upgrades and related services
for those products. As such, if sales of Autodesk products and upgrades decrease, our revenues will decrease, which will adversely affect our profitability.

If our relationship with Autodesk is not renewed, our revenues would significantly decrease and such decrease would jeopardize our viability.

Our continued growth and future success are largely dependent upon maintaining our relationship with Autodesk. While our current relationship with Autodesk is good, there can be no assurance that this relationship
will continue. Under the terms of the Autodesk Channel Partner Agreement, this relationship must be renewed every three years. Because over 90% of our revenues are attributable to the resale of Autodesk products and related services, Autodesks
failure to renew its relationship with us would significantly decrease our sales, revenues and overall financial condition, and would jeopardize our viability.

Our products may contain undetected errors that could harm our sales and revenue and result in increased operating expenses and liabilities.

Our business depends on complex computer software, both internally developed and licensed from third parties. Complex software often contains defects, particularly when first introduced or when new versions are
released. Although we conduct extensive testing, we may not discover software defects that affect new or current products and services or enhancements until after they are deployed. In the past, we have discovered software errors in some new
products and enhancements after their introduction, and we may find errors in current or future new products or releases after commencement of commercial use. If we market products and services that contain errors or that do not function properly,
we may experience negative publicity, loss of or delay in market acceptance, or claims against us by customers, any of which could harm our current and future sales or result in expenses and liabilities that could reduce our operating results and
adversely affect our financial condition and the market for our common stock.



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We may inadvertently infringe on third party proprietary rights, which could result in costly litigation, reduced
sales and revenue and a decline in the price of our stock.

We may be subject to claims alleging that we have infringed third party
proprietary rights. Litigating such claims, whether meritorious or not, is costly. The expenditure of such costs, and the accompanying diversion of management time to such litigation, may cause a decrease in attention to sales and product
development and a corresponding decrease in revenue. These claims might require us to enter into royalty or license agreements with terms unfavorable to us. If we were found to have infringed upon the proprietary rights of third parties, we could be
required to pay damages, cease sales of the infringing products, or redesign or discontinue such products, any of which could materially reduce our sales and revenue and cause a decline in the market price for our common stock.

If we are unable to raise additional capital on favorable terms, our ability to fund growth and otherwise operate our business will be significantly limited.

We may need to raise additional capital to develop and enhance our services and products, fund expansion, respond to competitive
pressures, or acquire complementary businesses or technologies. We may not be able to raise additional financing on favorable terms, if at all. Our agreements with our lenders restrict the types of capital we can raise without the consent of our
lenders. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and the securities issued may have rights, preferences, or privileges senior to those
of our common stock. If we cannot raise adequate funds on acceptable terms, our ability to fund growth, take advantage of business opportunities, develop or enhance services or products, or otherwise respond to competitive pressures will be
significantly limited. Insufficient funds may require us to scale-back or eliminate some or all of our plans for growth.

The terms of our
indebtedness imposes restrictions on our ability to raise capital, if necessary.

Without the consent of our senior lender, our
existing outstanding indebtedness restricts our ability to, among other things:



| |  |  | incur additional debt;
| | - |  | ----------------------



| |  |  | repay other debt;
| | - |  | -----------------



| |  |  | pay dividends to common stockholders;
| | - |  | -------------------------------------



| |  |  | make certain investments, mergers or acquisitions;
| | - |  | --------------------------------------------------

These restrictions could significantly hamper our ability to raise additional capital. Our ability to receive the necessary approvals is largely dependent upon our relationship with our senior lender and our financial
performance, and no assurances can be given that we will be able to obtain the necessary approvals in the future. Our inability to raise additional capital could lead to working capital deficits that could have a materially adverse effect on our
operations in future periods.

In addition, failure to meet any of these covenants could result in an event of default under our
outstanding loan arrangement. If an event of default were to occur, our lenders may take one or more of the following actions:



| |  |  | increase our borrowing costs;
| | - |  | -----------------------------



| |  |  | restrict our ability to obtain additional borrowings;
| | - |  | -----------------------------------------------------



| |  |  | accelerate all amounts outstanding; or
| | - |  | --------------------------------------



| |  |  | enforce their interests against collateral pledged.
| | - |  | ---------------------------------------------------

If our lender was to accelerate our debt payments, our assets may not be sufficient to fully repay the debt.



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In addition, we cannot declare dividends or incur additional debt without the written approval from our
lender, which could significantly restrict our ability to raise additional capital. Our ability to receive the necessary approvals is largely dependent upon our relationship with our lender and our financial performance, and no assurances can be
given that we will be able to obtain the necessary approvals in the future. Our inability to raise additional capital could lead to working capital deficits that could have a materially adverse effect on our operations in future periods.

We may not be able to successfully expand through strategic acquisitions, which could decrease our profitability.

A key element of our strategy is to pursue strategic acquisitions that either expand or complement our business, in order to increase revenues and
earnings. We may not be able to identify additional attractive acquisition candidates on terms favorable to us or in a timely manner. We may require additional debt or equity financing for future acquisitions, which may not be available on terms
favorable to us, if at all. Moreover, we may not be able to successfully integrate any acquired businesses into our business or to operate any acquired businesses profitably. Each of these factors may contribute to our inability to successfully
expand through strategic acquisitions, which could ultimately result in increased costs without a corresponding increase in revenues, which would result in decreased profitability.

Integrating product acquisitions and completing any future acquisitions could cause significant diversions of management time and resources. Managing
acquired businesses entails numerous operational and financial risks. These risks include difficulty in assimilating acquired operations, diversion of managements attention, and the potential loss of key employees or customers of acquired
operations.

Any acquisition we make could disrupt our business and harm our financial condition and operations.

In an effort to effectively compete in the design automation solutions and facilities management markets where increasing competition and industry
consolidation prevail, we may acquire complementary businesses in the future. In the event of any future acquisitions, we could:



| |  |  | issue additional securities that would dilute the Companys current stockholders percentage ownership or provide the purchasers of the additional
securities with certain preferences over those of common stockholders, such as dividend or liquidation preferences;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | incur debt and assume liabilities;
| | - |  | ----------------------------------



| |  |  | incur amortization expenses related to intangible assets; or
| | - |  | ------------------------------------------------------------



| |  |  | incur large and immediate write-offs of intangible assets, accounts receivable or other assets.
| | - |  | -----------------------------------------------------------------------------------------------

These events could result in significant expenses and decreased revenue, or could substantially affect the market price of the Companys common
stock.

Risk Factors Relating to our Stock and Capital Structure

Several factors could materially and adversely affect the price of our stock.

The market
price of our common stock has been highly volatile and is likely to continue to be volatile. Factors affecting our stock price may include:



| |  |  | fluctuations in sales or operating results;
| | - |  | -------------------------------------------



| |  |  | illiquidity resulting from relatively low average daily volume of transactions in our stock;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | announcements of technological innovations or new software standards by us or our competitors;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | published reports of securities analysts;
| | - |  | -----------------------------------------



11



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| |  |  | developments in patent or other proprietary rights;
| | - |  | ---------------------------------------------------



| |  |  | changes in our relationships with development partners and other strategic alliance partners; and
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | general market conditions, especially regarding the general performance of comparable technology stocks.
| | - |  | --------------------------------------------------------------------------------------------------------

Many of these factors are beyond our control. These factors may materially adversely affect the market price of our common stock, regardless of our
operating performance.

The conversion of our Series D Convertible Preferred Stock, the conversion of our Series E Convertible Preferred Stock, the
conversion of our Series F Cumulative Convertible Preferred Stock, and the exercise of a substantial number of outstanding warrants issued in connection with those Preferred Stock issuances, and certain other warrants, would increase the amount of
our common stock in the trading market, which could substantially affect the market price of our common stock.

On July 29,
2005, we sold units consisting of one share of Series E Convertible Preferred Stock, which in the aggregate were initially convertible into 1,832,306 shares of common stock (currently, 1,812,308 shares), and warrants, expiring on July 29, 2008,
to purchase an aggregate of 366,475 shares of common stock, in each case for $.65 per share. On June 12, 2006, we sold units consisting of Series F Cumulative Convertible Preferred Stock, convertible into 2,000,000 shares of our Common Stock,
and 800,000 stock purchase warrants which expire on June 12, 2010. In the event of (i) the exercise of a substantial number of warrants accompanying the Series E Convertible Preferred Stock and Series F Cumulative Convertible Preferred
Stock, or (ii) the conversion of a substantial number of shares of Series D, Series E, or Series F Convertible Preferred Stock, the resulting increase in the amount of our common stock in the trading market could substantially affect the market
price of our common stock.

The exercise of outstanding options will dilute the percentage ownership of our stockholders, and any sales in the public
market of shares of our common stock underlying such options may adversely affect prevailing market prices for our common stock.

As
of September 11, 2007, there are outstanding options to purchase an aggregate of 1,165,790 shares of our common stock at per share exercise prices ranging from $.12 to $63.33. The exercise of such outstanding options would dilute the percentage
ownership of our existing stockholders, and any sales in the public market of shares of our common stock underlying such options may adversely affect prevailing market prices for our common stock.

The Selling Stockholders may choose to sell shares at prices below the current trading price.

The Selling Stockholders are not restricted as to the prices at which they may sell their shares of our common stock. Sales of shares of our common stock
below the then-current trading prices may adversely affect the market price of our common stock.

Risk Factors Relating to our Certificate of
Incorporation

Our Certificate of Incorporation and bylaws could delay or prevent the acquisition or sale of our company and prevent our
shareholders from receiving any potential benefit from an offer to acquire us.

Our charter and bylaws as well as the General
Corporation Law of the State of Delaware, may deter, discourage, or make more difficult a change in control, even if such a change in control would benefit our shareholders. As a result, shareholders may be unable to receive any economic or other
benefit contained in any proposal. In particular, the board of directors may issue preferred stock having such designations, rights, and preferences as they determine; only shareholders owning not less than two-thirds of the outstanding shares may



12



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##### Table of Contents

call special meetings of shareholders; advance notice is required for presentation of new business and nominations of directors at meetings of shareholders;
and our bylaws may be amended only by the board of directors or by the holders of two-thirds of the outstanding voting stock.

The liability of our
directors is limited.

Our charter limits the liability of directors to the maximum extent permitted by Delaware law.

It is unlikely that we will issue dividends on our common stock in the foreseeable future.

We have never declared or paid cash dividends on our common stock and do not intend to pay cash dividends in the foreseeable future. The payment of
dividends in the future will be at the discretion of our board of directors.



13



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##### Table of Contents

ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

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Englewood         |  | 6,006          |  | 12/31/2011
|FloridaTampa              |  | 4,103          |  | 3/31/2009 
|IndianaIndianapolis       |  | 3,129          |  | 12/31/2007
|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Madison Heights   |  | 5,130          |  | 5/31/2008 
|NebraskaOmaha             |  | 5,473          |  | 2/29/2008 
|North CarolinaChapel Hill |  | 2,137          |  | 1/31/2008 
|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          |  | 1/31/2008 
|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.

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, 2007.



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##### Table of Contents

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 sales 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, 2007 |  |      |      |     |   |     
|First Quarter                   |  | $    | 2.10 |     | $ | 1.53
|Second Quarter                  |  |      | 1.87 |     |   | 1.44
|Third Quarter                   |  |      | 1.75 |     |   | 1.45
|Fourth Quarter                  |  |      | 1.60 |     |   | 1.15
|                                |  |     
|Fiscal Year Ended June 30, 2006 |  |      |      |     |   |     
|First Quarter                   |  | $    | 1.27 |     | $ | 0.46
|Second Quarter                  |  |      | 1.72 |     |   | 1.02
|Third Quarter                   |  |      | 2.43 |     |   | 1.30
|Fourth Quarter                  |  |      | 2.51 |     |   | 1.80

Recent Closing Prices

On September 11, 2007, the last closing price for our common stock on the OTC Bulletin Board, as reported by Reuters, was $0.87.

Performance Graph

The Securities and Exchange Commission requires us to provide a five-year
comparison of the cumulative total return on the Companys common stock compared with that of a broad equity market index and either a published industry index or a constructed peer group index.

The following chart compares the cumulative total stockholder return on the Companys common stock for the period beginning June 30, 2003 and
ending June 30, 2007, with the cumulative total return on the Nasdaq Composite (U.S.) and Nasdaq Computer and Data Processing indices. The comparison assumes $100 was invested on June 30, 2003, in shares of the Companys common stock
and in each of the foregoing indices and assumes reinvestment of any dividends.

We do not make, nor do we endorse, any predictions as to
future stock performance.



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##### Table of Contents

LOGO



|                        |  |      |     |      |   |      |  |      |     |      |   |     |  |   |    
|----------------------- |  | ---- | --- | ---- | - | ---- |  | ---- | --- | ---- | - | --- |  | - | ---
|                        |  | 2003 |     | 2004 |   | 2005 |  | 2006 |     | 2007
|NASDAQ Composite Index  |  | $    | 100 |      | $ | 126  |  | $    | 127 |      | $ | 134 |  | $ | 160
|NASDAQ Computer Index   |  | $    | 100 |      | $ | 125  |  | $    | 124 |      | $ | 123 |  | $ | 154
|Avatech Solutions, Inc. |  | $    | 100 |      | $ | 182  |  | $    | 110 |      | $ | 430 |  | $ | 230

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
currently outstanding shares of equity securities. For the year ended June 30, 2007, dividends totaling $504,000 were paid to preferred shareholders.

Number of Stockholders

As of September 11, 2007 there were 300 holders of record of common stock, 11 holders of Series
D Convertible Preferred Stock, 30 holders of Series E Convertible Preferred Stock, and 2 holders of Series F Convertible Preferred Stock.



16



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##### Table of Contents

Equity Compensation Plan Information

The following table provides information, as of June 30, 2007, 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 for future issuance underequity compensationplans (excludingsecurities reflected incolumn (a)) (c)
|Equity compensation plans approved by security holders     |  | 1,650,301                                                                                  |  | $                                                                            | 0.93 |                                                                                                                                            | 845,123
|Equity compensation plans not approved by security holders |  | -0-                                                                                        |  |                                                                              | -0-  |                                                                                                                                            | -0-    
|                                                           |  |                                                                                            |  |                                                                              |      |                                                                                                                                            |        
|Total                                                      |  | 1,650,301                                                                                  |  | $                                                                            | 0.93 |                                                                                                                                            | 845,123

Issuer Purchases of Equity Securities

During the fourth quarter of fiscal year 2007, we did not purchase any equity securities of the Company.

Sales of Unregistered Equity Securities

During the
fourth quarter of fiscal year 2007, we did not sell any unregistered equity securities.



17



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##### Table of Contents

ITEM 6.    SELECTED FINANCIAL DATA

The following selected historical annual
consolidated financial data is derived from our audited financial statements as of and for the five years ended June 30, 2007. The following consolidated financial data should be read in conjunction with Managements Discussion and
Analysis of Financial Condition and Results of Operations and the consolidated financial statements and related notes included elsewhere in this Report.



|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|------------------------------------------------------------ |  | ------------------- | ---------- | - | ------- | - | ---------- | ------- |  | - | ---------- | - |  | ---- | ---------- | - |  | - | ---------- | -
|                                                             |  | Year ended June 30, |           
|                                                             |  | 2007                |            |   | 2006(1) |   |            | 2005(2) |  |   | 2004       |   |  | 2003 |           
|Statement of Operations Data:                                |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Revenue:                                                     |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Product sales                                                |  | $                   | 30,125,000 |   |         | $ | 25,364,000 |         |  | $ | 20,703,000 |   |  | $    | 17,710,000 |   |  | $ | 12,370,000 |  
|Service revenue                                              |  |                     | 10,689,000 |   |         |   | 7,399,000  |         |  |   | 6,066,000  |   |  |      | 5,471,000  |   |  |   | 5,932,000  |  
|Commission revenue                                           |  |                     | 9,721,000  |   |         |   | 6,857,000  |         |  |   | 5,475,000  |   |  |      | 4,770,000  |   |  |   | 4,199,000  |  
|Sale of developed software                                   |  |                     |           |   |         |   |           |         |  |   | 1,900,000  |   |  |      |           |   |  |   |           |  
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Total revenue                                                |  |                     | 50,535,000 |   |         |   | 39,620,000 |         |  |   | 34,144,000 |   |  |      | 27,951,000 |   |  |   | 22,501,000 |  
|                                                             |  |                     |            |   |        
|Cost of revenue:                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Cost of product sales                                        |  |                     | 19,963,000 |   |         |   | 15,002,000 |         |  |   | 13,211,000 |   |  |      | 12,648,000 |   |  |   | 8,776,000  |  
|Cost of service revenue                                      |  |                     | 7,416,000  |   |         |   | 5,167,000  |         |  |   | 4,606,000  |   |  |      | 4,086,000  |   |  |   | 3,767,000  |  
|Cost of developed software                                   |  |                     |           |   |         |   |           |         |  |   | 77,000     |   |  |      |           |   |  |   |           |  
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Total cost of revenue                                        |  |                     | 27,379,000 |   |         |   | 20,169,000 |         |  |   | 17,894,000 |   |  |      | 16,734,000 |   |  |   | 12,543,000 |  
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Gross margin                                                 |  |                     | 23,156,000 |   |         |   | 19,451,000 |         |  |   | 16,250,000 |   |  |      | 11,217,000 |   |  |   | 9,958,000  |  
|                                                             |  |                     |            |   |        
|Other operating expenses:                                    |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Selling, general and administrative                          |  |                     | 22,659,000 |   |         |   | 16,522,000 |         |  |   | 13,399,000 |   |  |      | 11,073,000 |   |  |   | 12,201,000 |  
|Depreciation and amortization                                |  |                     | 689,000    |   |         |   | 388,000    |         |  |   | 359,000    |   |  |      | 331,000    |   |  |   | 412,000    |  
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Total other operating expenses                               |  |                     | 23,348,000 |   |         |   | 16,910,000 |         |  |   | 13,758,000 |   |  |      | 11,404,000 |   |  |   | 12,613,000 |  
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|                                                             |  |                     |            |   |        
|Operating income (loss)                                      |  |                     | (192,000   | ) |         |   | 2,541,000  |         |  |   | 2,492,000  |   |  |      | (187,000   | ) |  |   | (2,655,000 | )
|                                                             |  |                     |            |   |        
|Other income (expense):                                      |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Gain on the extinguishment of debt                           |  |                     |           |   |         |   | 233,000    |         |  |   |           |   |  |      |           |   |  |   | 1,960,000  |  
|Minority interest                                            |  |                     |           |   |         |   |           |         |  |   | (59,000    | ) |  |      | (153,000   | ) |  |   | (94,000    | )
|Interest and other income                                    |  |                     | 62,000     |   |         |   | 34,000     |         |  |   | 107,000    |   |  |      | 39,000     |   |  |   | 16,000     |  
|Interest expense                                             |  |                     | (198,000   | ) |         |   | (549,000   | )       |  |   | (524,000   | ) |  |      | (352,000   | ) |  |   | (291,000   | )
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|                                                             |  |                     | (136,000   | ) |         |   | (282,000   | )       |  |   | (476,000   | ) |  |      | (466,000   | ) |  |   | 1,591,000  |  
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Income (loss) from continuing operations before income taxes |  |                     | (328,000   | ) |         |   | 2,259,000  |         |  |   | 2,016,000  |   |  |      | (653,000   | ) |  |   | (1,064,000 | )
|Income tax expense                                           |  |                     | 227,000    |   |         |   | 56,000     |         |  |   | 82,000     |   |  |      | 30,000     |   |  |   | 408,000    |  
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Income (loss) from continuing operations                     |  | $                   | (555,000   | ) |         | $ | 2,203,000  |         |  | $ | 1,934,000  |   |  | $    | (683,000   | ) |  | $ | (1,472,000 | )
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Earnings (loss) per common sharebasic                       |  | $                   | (0.07      | ) |         | $ | 0.18       |         |  | $ | 0.18       |   |  | $    | (0.08      | ) |  | $ | (0.18      | )
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Earnings (loss) per common sharediluted                     |  | $                   | (0.07      | ) |         | $ | 0.12       |         |  | $ | 0.14       |   |  | $    | (0.08      | ) |  | $ | (0.18      | )
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Weighted average number of common shares outstandingbasic   |  |                     | 14,246,390 |   |         |   | 11,469,548 |         |  |   | 10,355,150 |   |  |      | 9,341,785  |   |  |   | 8,028,030  |  
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Weighted average number of common shares outstandingdiluted |  |                     | 14,246,390 |   |         |   | 18,992,154 |         |  |   | 13,947,055 |   |  |      | 9,341,785  |   |  |   | 8,028,030  |  
|                                                             |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|                                                             |  |                     |            |   |        
|Balance Sheet Data:                                          |  |                     |            |   |         |   |            |         |  |   |            |   |  |      |            |   |  |   |            |  
|Cash                                                         |  |                     | 1,688,000  |   |         |   | 581,000    |         |  |   | 295,000    |   |  |      | 690,000    |   |  |   | 540,000    |  
|Working capital (deficit)                                    |  |                     | 1,115,000  |   |         |   | (361,000   | )       |  |   | (1,546,000 | ) |  |      | (2,979,000 | ) |  |   | (3,822,000 | )
|Total assets                                                 |  |                     | 19,574,000 |   |         |   | 16,850,000 |         |  |   | 8,219,000  |   |  |      | 6,567,000  |   |  |   | 5,272,000  |  
|Total debt                                                   |  |                     | 1,439,000  |   |         |   | 1,503,000  |         |  |   | 5,868,000  |   |  |      | 4,218,000  |   |  |   | 2,851,000  |  
|Total stockholders equity (deficit)                         |  |                     | 6,220,000  |   |         |   | 4,651,000  |         |  |   | (2,702,000 | ) |  |      | (6,389,000 | ) |  |   | (5,974,000 | )

---

|(1) | In May 2006, the Company acquired the outstanding stock and membership interests of Sterling Systems & Consulting, Inc. and affiliates for aggregate consideration of
$8,000,000. The consolidated financial statements include the results of operations of Sterling commencing May 30, 2006.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | In April 2005, the Company acquired the assets and certain liabilities of Comtrex Corporation for aggregate consideration of $573,000. The consolidated financial statements include
the results of operations of Comtrex commencing April 8, 2005.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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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.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

This strategy was designed to match the Companys product and service offerings more precisely with the needs of its
customers. In July 2003, the Company entered into an Authorized Reseller Agreement with Dassault Systèmes Corp., an international developer and distributor of product life cycle management (PLM) application software and services. In
connection with the Reseller Agreement, Dassault provided Avatech with certain financial assistance to create a dedicated PLM sales force and to conduct related marketing efforts. Over the next two years, the Company determined that the resources
that it was employing to fulfill the Dassault Reseller Agreement could be better utilized in other areas of its operations in order to achieve its growth targets. Therefore, in July 2005 the Company made the decision to discontinue its relationship
with Dassault and restructured the terms of the loan that it had received in connection with its agreement with Dassault. In connection with the refinancing of its line of credit, in January 2006 the Company prepaid the outstanding principal to
Dassault at a discount and recorded a gain on early extinguishment of debt of approximately $233,000.

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 the Discreet product line for animation;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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



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##### Table of Contents

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 99 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 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 technical experts, and self-paced training to help extend its customers 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.

Sale of Developed Software and Related Costs.In January 2005, the Company sold a software product, Proof Positive, to Autodesk,
Inc. The revenue from that sale was $1,900,000 and is shown as sale of developed software with the corresponding direct costs shown as cost of developed software.

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.

Interest Expense. For the year ended June 30, 2007, interest expense consisted primarily of interest on a revolving
line-of-credit. For all prior years presented, interest expense consisted of interest on a revolving line of credit, a note payable to a member of the Board of Directors, and a loan from a vendor.

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



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##### Table of Contents

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.

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, 2007, the Company had deferred tax assets of approximately $1.5 million that were fully offset by a valuation
allowance because the Company cannot determine with reasonable assurance that they will be realized. For the year ended June 30, 2007, the Company reported a loss of $555,000; however the Companys taxable income was approximately $1.7
million. The realization of the deferred tax assets will be dependent on the Companys ability to continue to generate taxable income in future periods.

The Companys estimates of the realization of the deferred tax assets may change in future periods if they are able to predict with reasonable assurance that their operations will be profitable. Future reductions
in the valuation allowance will reduce current or deferred income tax expense.



21



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##### Table of Contents

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.

Years Ended June 30, 2007, 2006, and 2005

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, |   
|                                       |  | 2007                |    |  | 2006  |    |  | 2005  |   
|Revenue:                               |  |                     |    |  |       |    |  |       |   
|Product sales                          |  | 59.6                | %  |  | 64.0  | %  |  | 60.6  | % 
|Service revenue                        |  | 21.2                | %  |  | 18.6  | %  |  | 17.8  | % 
|Commission revenue                     |  | 19.2                | %  |  | 17.4  | %  |  | 16.0  | % 
|Sale of developed software             |  |                    |    |  |      |    |  | 5.6   | % 
|                                       |  |                     |    |  |       |    |  |       |   
|Total revenue                          |  | 100.0               | %  |  | 100.0 | %  |  | 100.0 | % 
|                                       |  |                     |   
|Cost of revenue:                       |  |                     |    |  |       |    |  |       |   
|Cost of product sales                  |  | 39.5                | %  |  | 37.8  | %  |  | 38.7  | % 
|Cost of service revenue                |  | 14.7                | %  |  | 13.0  | %  |  | 13.5  | % 
|Cost of developed software             |  |                    |    |  |      |    |  | 0.2   | % 
|                                       |  |                     |    |  |       |    |  |       |   
|Total cost of revenue                  |  | 54.2                | %  |  | 50.8  | %  |  | 52.4  | % 
|                                       |  |                     |    |  |       |    |  |       |   
|Gross margin                           |  | 45.8                | %  |  | 49.2  | %  |  | 47.6  | % 
|                                       |  |                     |   
|Other operating expenses:              |  |                     |    |  |       |    |  |       |   
|Selling, general and administrative    |  | 44.8                | %  |  | 41.7  | %  |  | 39.2  | % 
|Depreciation and amortization          |  | 1.4                 | %  |  | 1.0   | %  |  | 1.1   | % 
|                                       |  |                     |    |  |       |    |  |       |   
|Total other operating expenses         |  | 46.2                | %  |  | 42.7  | %  |  | 40.3  | % 
|                                       |  |                     |    |  |       |    |  |       |   
|Operating income (loss)                |  | (0.4                | )% |  | 6.5   | %  |  | 7.3   | % 
|                                       |  |                     |   
|Other income (expense):                |  |                     |    |  |       |    |  |       |   
|Gain on the extinguishment of debt     |  |                    | %  |  | 0.4   | %  |  |      | % 
|Minority interest                      |  |                    | %  |  |      |    |  | (0.2  | )%
|Interest and other income              |  | 0.1                 | %  |  | 0.1   | %  |  | 0.3   | % 
|Interest expense                       |  | (0.4                | )% |  | (1.4  | )% |  | (1.5  | )%
|                                       |  |                     |    |  |       |    |  |       |   
|Total other income (expense)           |  | (0.3                | )% |  | (0.9  | )% |  | (1.4  | )%
|                                       |  |                     |    |  |       |    |  |       |   
|                                       |  |                     |   
|Income (loss) from before income taxes |  | (0.7                | )% |  | 5.6   | %  |  | 5.9   | % 
|Income tax expense                     |  | 0.4                 | %  |  | 0.1   | %  |  | 0.2   | % 
|                                       |  |                     |    |  |       |    |  |       |   
|Net income (loss)                      |  | (1.1                | )% |  | 5.5   | %  |  | 5.7   | % 
|                                       |  |                     |    |  |       |    |  |       |   



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##### Table of Contents

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 are 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 provide 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 | %
|                        |  |                     |            |      |   |            |  |      |  

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.



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##### Table of Contents

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 of $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.

Other Non-operating 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)  | %
|                                     |  |                     |           |      |   |           |  |         |  



24



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##### Table of Contents

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 is
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 has significant net operating loss carryforwards, it was required to pay alternative minimum taxes of $47,000 for 2007.

Year Ended June 30, 2006 Compared to Year Ended June 30, 2005

Revenue



|                           |  |                     |            |      |   |            |  |        |   
|-------------------------- |  | ------------------- | ---------- | ---- | - | ---------- |  | ------ | --
|                           |  | Year ended June 30, |           
|                           |  | 2006                |            | 2005 |   | % change   | 
|Revenue:                   |  |                     |            |      |   |            |  |        |   
|Product sales              |  | $                   | 25,364,000 |      | $ | 20,703,000 |  | 22.5   | % 
|Service revenue            |  |                     | 7,399,000  |      |   | 6,066,000  |  | 22.0   | % 
|Commission revenue         |  |                     | 6,857,000  |      |   | 5,475,000  |  | 25.2   | % 
|Sale of developed software |  |                     |           |      |   | 1,900,000  |  | (100.0 | )%
|                           |  |                     |            |      |   |            |  |        |   
|Total Revenue:             |  | $                   | 39,620,000 |      | $ | 34,144,000 |  | 16.0   | % 
|                           |  |                     |            |      |   |            |  |        |   

Total revenue for the year ended June 30, 2006 increased by 16.0%, or $5.5 million, over the
prior fiscal year. The Company realized double digit sales growth during fiscal 2006 in all three of its revenue categories, with commission revenue showing the largest increase, up 25.2% from the prior year. The demand for the Companys main
product line of Autodesk software solutions continues to be very strong and Avatech benefited from that continuing trend. During fiscal 2006, Avatech continued to add to its growing sales force and technical support personnel resulting in a
strengthening of its market share in many of the locations in which it operates and completed an acquisition of Sterling Systems & Consulting, a Michigan-based company. This acquisition was completed on May 30, 2006 and as a result
added $1,080,000 in revenues to the Companys operations.

In January 2005 Avatech completed the sale to Autodesk, Inc. of all of its
ownership interest in Proof Positive, a software product developed by PlanetCAD, Inc., and acquired by the Company in 2002. Net proceeds of the sale were $1.9 million and are shown as sale of developed software in the Companys financial
statements. In addition, in April 2005 the Company acquired the assets of an Autodesk reseller with three offices in North Carolina which increased its fiscal 2006 sales by approximately $2,230,000.

Service revenue for fiscal 2006 was $7.4 million, compared to $6.1 million in fiscal 2005, an increase of 22.0%. During fiscal year 2005 and continuing
through fiscal 2006, the Company added sales and service delivery resources in order to expand its services operation. As these technical resources complete their training and become experienced in the product and service offerings that the Company
sells, they become billable to customers for training, implementation and support services. The Company will continue to invest in this category of its business and expects it to become a larger share of its ongoing revenues in the future.



25



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##### Table of Contents

Avatechs commission revenue grew significantly during fiscal year 2006, from $5.5 million in 2005
to $6.9 million, an increase of 25.2%. The growth in this revenue category can be attributed to the continuing industry-wide increase in sales volume related to major account and subscription sales.

Cost of Revenue



|                           |  |                     |            |      |   |            |  |        |   
|-------------------------- |  | ------------------- | ---------- | ---- | - | ---------- |  | ------ | --
|                           |  | Year ended June 30, |           
|                           |  | 2006                |            | 2005 |   | % change   | 
|Cost of revenue:           |  |                     |            |      |   |            |  |        |   
|Cost of product sales      |  | $                   | 15,002,000 |      | $ | 13,211,000 |  | 13.6   | % 
|Cost of service revenue    |  |                     | 5,167,000  |      |   | 4,606,000  |  | 12.2   | % 
|Cost of developed software |  |                     |           |      |   | 77,000     |  | (100.0 | )%
|                           |  |                     |            |      |   |            |  |        |   
|Total cost of revenue      |  | $                   | 20,169,000 |      | $ | 17,894,000 |  | 12.7   | % 
|                           |  |                     |            |      |   |            |  |        |   
|Gross margin               |  | $                   | 19,451,000 |      | $ | 16,250,000 |  | 19.7   | % 
|                           |  |                     |            |      |   |            |  |        |   

Cost of product sales was $15.0 million for fiscal year 2006, compared to $13.2 million for fiscal
year 2005, a 13.6% increase. However, cost of product sales as a percentage of related revenue for fiscal 2006 decreased significantly to 59.1% from 63.8% in fiscal 2005. The reason for this large reduction is due to the successful efforts of the
Company to maximize the sales incentives offered to it by Autodesk by exceeding Autodesk targets for Avatech and focusing on the sales of industry specific products as directed by Autodesk.

Cost of service revenue for fiscal 2006 was $5.2 million, compared to $4.6 million for fiscal 2005, increasing by 12.2%, or approximately $561,000. Cost
of service revenue as a percentage of related revenue for fiscal 2006 decreased to 69.8% from 75.9% in fiscal 2005. This decrease can be attributed to the Companys focus on the higher-margin vertical products and reflects some monies received
from its main supplier, Autodesk, in order to increase technical personnel in selected markets.

For the reasons noted above, the
Companys gross margin percentage increased to 49.1% for fiscal 2006, compared to 47.6% in fiscal 2005. The total amount of gross margin increased approximately $3.2 million, or 19.7% from fiscal 2005 to fiscal 2006.

Other Operating Expenses



|                                    |  |                     |            |      |   |            |  |      |  
|----------------------------------- |  | ------------------- | ---------- | ---- | - | ---------- |  | ---- | -
|                                    |  | Year ended June 30, |           
|                                    |  | 2006                |            | 2005 |   | % change   | 
|Other operating expenses:           |  |                     |            |      |   |            |  |      |  
|Selling, general and administrative |  | $                   | 16,522,000 |      | $ | 13,399,000 |  | 23.3 | %
|Depreciation and amortization       |  |                     | 388,000    |      |   | 359,000    |  | 8.1  | %
|                                    |  |                     |            |      |   |            |  |      |  
|Total other operating expenses      |  | $                   | 16,910,000 |      | $ | 13,758,000 |  | 22.9 | %
|                                    |  |                     |            |      |   |            |  |      |  

Selling, General and Administrative.Selling general and administrative expenses for fiscal
year 2006 were $16.5 million, compared to $13.4 million for the fiscal year ended June 30, 2005, an increase of $3.1 million. During fiscal year 2006 the Company continued to add to its sales force in order to capitalize on the strong market
demand for the products and services that it sells, resulting in the overall increase in selling, general and administrative expenses.

Depreciation and Amortization. Depreciation and amortization expense for fiscal 2006 was $388,000, compared to $359,000 for fiscal 2005, increasing by $29,000. The increase is due primarily to the amortization of a customer list
acquired from Comtrex Corporation in April 2005.



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##### Table of Contents

Other Income (Expense)



|                                     |  |                     |          |   |      |   |          |          |  |        |   
|------------------------------------ |  | ------------------- | -------- | - | ---- | - | -------- | -------- |  | ------ | --
|                                     |  | Year ended June 30, |         
|                                     |  | 2006                |          |   | 2005 |   |          | % change | 
|Other income (expense):              |  |                     |          |   |      |   |          |          |  |        |   
|Gain on early extinguishment of debt |  | $                   | 233,000  |   |      |   |         |          |  | 100.0  | % 
|Minority interest                    |  |                     |         |   |      | $ | (59,000  | )        |  | (100.0 | )%
|Interest and other income            |  |                     | 34,000   |   |      |   | 107,000  |          |  | (68.2  | )%
|Interest expense                     |  |                     | (549,000 | ) |      |   | (524,000 | )        |  | 4.8    | % 
|                                     |  |                     |          |   |      |   |          |          |  |        |   
|Total other income (expense)         |  | $                   | (282,000 | ) |      | $ | (476,000 | )        |  | (40.8  | )%
|                                     |  |                     |          |   |      |   |          |          |  |        |   

Other non-operating expense was $282,000 and $476,000 in fiscal years 2006 and 2005, respectively.
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 the reductions in
long-term debt and lower borrowings on the Companys line of credit. The minority interest represents dividends paid on shares of preferred stock issued by one of our subsidiaries and those shares were converted into common stock in fiscal year
2006.

Income Tax Expense



|                   |  |                     |        |      |   |          |  |       |   
|------------------ |  | ------------------- | ------ | ---- | - | -------- |  | ----- | --
|                   |  | Year ended June 30, |       
|                   |  | 2006                |        | 2005 |   | % change | 
|Income tax expense |  | $                   | 56,000 |      | $ | 82,000   |  | (31.7 | )%
|                   |  |                     |        |      |   |          |  |       |   

Income tax expense was $56,000 and $82,000 in fiscal years 2006 and 2005, respectively. Tax
expense resulted from the payments of federal alternative minimum tax, state and local income taxes. Although the Company has significant net operating loss carryforwards, it was required to pay alternative minimum taxes of $25,000 for 2006.

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. During fiscal year 2006, the Company refinanced its short-term line of credit and repaid virtually all of its remaining long-term debt.

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 $4 million of available credit to finance those purchases.

The Companys investing activities consist principally of investments in computer and office equipment. Capital expenditures for fiscal 2007 were approximately $456,000, compared to $278,000 for the same period in 2006 as a result of
increased investments in our IT equipment and infrastructure.

On July 22, 2003, the Company entered into a marketing and channel
distribution agreement with a software vendor. Under this agreement, the Company provided marketing, distribution and related services for the vendors products. In connection with this agreement, the software vendor agreed to fund certain
marketing costs incurred by the Company. Additionally, the arrangement provided for a loan by the software vendor to fund



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working capital needs related to the distribution of these products. The terms of the loan agreement provided for a loan of $1,500,000 with repayment of
principal plus interest at 6% per annum in thirty-five equal quarterly installments commencing in January 2005. In July 2005 the Company made the decision to discontinue its relationship with the vendor and restructured the loan. The new terms
of the loan provided for quarterly principal payments of approximately $91,000 plus interest at an annual rate of 6%. These quarterly payments began in July 2005 and continued until January 2006 when the Company replaced its existing line of credit
and repaid this loan. The early extinguishment of this debt resulted in a gain to the Company of $233,000.

On October 28, 2004, a
wholly-owned subsidiary entered into a loan agreement with a bank to provide for a $700,000 revolving credit facility expiring on October 28, 2005. Borrowings under this credit facility bore interest at the greater of 7.5% or the prime rate
plus 2.0% and were secured by the assets of the Company and the guarantee of the Chairman of the Board of Directors. This credit facility was renewed through December 31, 2005 and on that date the Company determined that it no longer needed
this facility and elected to let it expire.

On July 1, 2005, the Company extended the maturity date of a $902,000 subordinated note
to a director and shareholder to July 1, 2006. The note accrued interest at 12% per annum, with quarterly interest payments due commencing October 1, 2005. In consideration for the extension of the loans maturity, the Company
issued warrants to purchase 38,878 shares of common stock for $0.60 per share expiring on June 1, 2010. Using the Black-Scholes option pricing model, these warrants were valued at $23,000. This note was fully repaid in June 2006.

In July 2005, the Company completed a limited offering of Convertible Preferred Stock (Series E) which raised a total of $1.2 million for working capital
purposes. Investors in this offering receive an annual dividend of 10%, paid quarterly, and were granted certain conversion rights and stock warrants. The number of common shares that would be issued under these conversion rights totaled 1,832,308,
and the warrants, if exercised, would result in 366,475 common shares being issued. During fiscal year 2007, certain investors exercised some of their conversion rights and exercised their warrants. As of June 30, 2007 the number of common
shares that would be issued under the outstanding conversion rights totaled 1,603,077 and the outstanding warrants, if exercised, would result in 317,242 common shares being issued.

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 as of June 30, 2007 was the banks prime rate plus one-half percent, or 8.75%. The total outstanding borrowings from the bank under this line were approximately $1.4 million at June 30, 2007. The
loan will expire on December 31, 2008 and is secured by all of the Companys assets, except inventory. The Company fully expects to renew the line of credit prior to its expiration.

On June 13, 2006, Avatech closed on a Preferred Stock and Warrant Purchase Agreement pursuant to which it sold 4,000 shares of its newly created
Series F 10% Cumulative Convertible Preferred Stock and 800,000 Common Stock Purchase Warrants to The Tail Wind Fund Ltd. and Solomon Strategic Holdings, Inc., for a purchase price of $1,000 per share of Series F Preferred Stock (the Original
Series F Issuance Price) or $4,000,000 in the aggregate. Each share of Series F Preferred Stock issued in the offering is convertible into shares of the Companys common stock, par value $.01 per share, at any time at a price per share of
common stock determined by dividing (a) the Original Series F Issuance Price plus any accumulated but unpaid dividends thereon, by (b) $2.00. Dividends are payable semi-annually at a 10% annual rate, in cash or registered common stock, at
the Registrants option. Any dividends paid in stock are priced at a 5% discount to the market price of the common stock at the payment date. Each Warrant entitles the holder thereof to purchase one share of Common Stock, at any time until
June 12, 2010, at an exercise price of $2.40 per share. The conversion price for



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the shares of Series F Preferred Stock and the exercise price for the Warrants are adjustable upon the occurrence of certain events. The Company used the
proceeds of the sale of the Series F Preferred Stock and the Common Stock, along with some borrowings on its line of credit, to pay off the outstanding principal of a $6.5 million short-term note that it executed with the Companys bank in
connection the Sterling acquisition.

On June 14, 2006, the Company closed on a Common Stock and Warrant Purchase Agreement pursuant
to which it sold 1,000,000 shares of its common stock and 600,000 Common Stock Purchase Warrants to two accredited investors, Pacific Asset Partners and Sigma Opportunity Fund, LLC, for a purchase price of $2.00 per common share, or $2,000,000 in
total. Each Common Stock Purchase Warrant entitles the holder thereof to purchase one share of common stock, at any time until June 14, 2010, at an exercise price of $2.40 per share.

On January 29, 2007, the Company entered into and closed on a private placement pursuant to which it sold an aggregate of 1,085,170 shares of common
stock and issued warrants to purchase, in the aggregate, 726,102 shares of common stock to several members of its Board of Directors and to Sigma Opportunity Fund LLC, whose managing member is also a member of the Board of Directors. The purchase
price of the common stock was $1.5205 per share, for an aggregate purchase price of $1,650,000. Each Warrant entitles the holder thereof to purchase one share of common stock, at any time until January 29, 2011, at an exercise price of $1.5205
per share.

The Company entered into two loans in connection with its April 2005 acquisition of Comtrex Corporation which totaled $31,000
as of June 30, 2007.

Outstanding long-term debt totaled approximately $31,000 at June 30, 2007, and the Company had a working
capital surplus of approximately $1,115,000. 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.

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, 2007. 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, 2007:



|                                   |  |       |           |                 |   |                        |  |             |           |  |   |        
|---------------------------------- |  | ----- | --------- | --------------- | - | ---------------------- |  | ----------- | --------- |  | - | -------
|                                   |  |       |           |                 |   | Payments due by period
|                                   |  | Total |           | Less than 1year |   | 1  3 years            |  | 3  5 years
|Contractual Obligations            |  |       |           |                 |   |                        |  |             |           |  |   |        
|Lines of credit                    |  | $     | 1,408,000 |                 | $ | 1,408,000              |  | $           |          |  | $ |       
|Long-term debt                     |  |       | 31,000    |                 |   | 31,000                 |  |             |          |  |   |       
|Interest on fixed rate obligations |  |       | 1,000     |                 |   | 1,000                  |  |             |          |  |   |       
|Operating leases                   |  |       | 4,201,000 |                 |   | 1,494,000              |  |             | 1,836,000 |  |   | 871,000
|Capital lease obligations          |  |       | 22,000    |                 |   | 22,000                 |  |             |          |  |   |       
|                                   |  |       |           |                 |   |                        |  |             |           |  |   |        
|Total obligations                  |  | $     | 5,663,000 |                 | $ | 2,956,000              |  | $           | 1,836,000 |  | $ | 871,000
|                                   |  |       |           |                 |   |                        |  |             |           |  |   |        

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.



29



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##### Table of Contents

Quarterly Results of Operations

The following table sets forth unaudited quarterly financial information for each of the eight quarters in the two years ended June 30, 2007. Management believes that this information has been prepared on the
same basis as the audited consolidated financial statements appearing elsewhere in this Annual Report and, in managements opinion, this information includes all adjustments, consisting only of normal recurring adjustments, necessary to fairly
present the unaudited quarterly operating results when read in conjunction with our audited consolidated financial statements and the notes thereto appearing elsewhere in this Annual Report. These operating results are not necessarily indicative of
results for any future period.



|                                   |  |                    |            |   |               |   |            |               |  |                |            |               |   |            |               |   |               |   |                |   |            |  |   |            |  |   |           
|---------------------------------- |  | ------------------ | ---------- | - | ------------- | - | ---------- | ------------- |  | -------------- | ---------- | ------------- | - | ---------- | ------------- | - | ------------- | - | -------------- | - | ---------- |  | - | ---------- |  | - | ----------
|                                   |  | Three Months Ended
|                                   |  | June 30, 2007      |            |   | Mar. 31, 2007 |   |            | Dec. 31, 2006 |  | Sept. 30, 2006 |            | June 30, 2006 |   |            | Mar. 31, 2006 |   | Dec. 31, 2005 |   | Sept. 30, 2005
|Revenues                           |  | $                  | 11,494,000 |   |               | $ | 14,584,000 |               |  | $              | 12,412,000 |               | $ | 12,045,000 |               | $ | 9,929,000     |   |                | $ | 11,013,000 |  | $ | 9,451,000  |  | $ | 9,227,000 
|Cost of sales                      |  |                    | 6,520,000  |   |               |   | 8,112,000  |               |  |                | 6,242,000  |               |   | 6,505,000  |               |   | 5,435,000     |   |                |   | 5,135,000  |  |   | 4,553,000  |  |   | 5,046,000 
|Gross margin                       |  |                    | 4,974,000  |   |               |   | 6,472,000  |               |  |                | 6,170,000  |               |   | 5,540,000  |               |   | 4,494,000     |   |                |   | 5,878,000  |  |   | 4,898,000  |  |   | 4,181,000 
|Operating income (loss)            |  |                    | (860,000   | ) |               |   | (111,000   | )             |  |                | 634,000    |               |   | 145,000    |               |   | 94,000        |   |                |   | 1,149,000  |  |   | 939,000    |  |   | 359,000   
|Net income (loss)                  |  |                    | (874,000   | ) |               |   | (224,000   | )             |  |                | 507,000    |               |   | 36,000     |               |   | (84,000       | ) |                |   | 1,277,000  |  |   | 805,000    |  |   | 205,000   
|Earnings (loss) per share-basic    |  | $                  | (0.07      | ) |               | $ | (0.02      | )             |  | $              | 0.02       |               | $ | 0.00       |               | $ | (0.01         | ) |                | $ | 0.11       |  | $ | 0.07       |  | $ | 0.02      
|                                   |  |                    |            |   |               |   |            |               |  |                |            |               |   |            |               |   |               |   |                |   |            |  |   |            |  |   |           
|Earnings (loss) per share-diluted  |  | $                  | (0.07      | ) |               | $ | (0.02      | )             |  | $              | 0.02       |               | $ | 0.00       |               | $ | 0.00          |   |                | $ | 0.07       |  | $ | 0.05       |  | $ | 0.01      
|                                   |  |                    |            |   |               |   |            |               |  |                |            |               |   |            |               |   |               |   |                |   |            |  |   |            |  |   |           
|Shares used in basic computation   |  |                    | 15,287,598 |   |               |   | 14,484,564 |               |  |                | 13,627,309 |               |   | 13,615,501 |               |   | 12,189,359    |   |                |   | 11,585,455 |  |   | 11,231,627 |  |   | 10,884,969
|                                   |  |                    |            |   |               |   |            |               |  |                |            |               |   |            |               |   |               |   |                |   |            |  |   |            |  |   |           
|Shares used in diluted computation |  |                    | 15,287,598 |   |               |   | 14,484,564 |               |  |                | 19,261,073 |               |   | 21,349,544 |               |   | 20,124,193    |   |                |   | 17,338,249 |  |   | 17,051,497 |  |   | 14,242,185
|                                   |  |                    |            |   |               |   |            |               |  |                |            |               |   |            |               |   |               |   |                |   |            |  |   |            |  |   |           

Operating results may vary significantly from quarter to quarter due to a variety of factors. One
such significant factor is the potential fluctuation in revenue due to seasonality of the business. Historically, the Company has experienced such seasonal fluctuations in revenue, with increased revenue in the second and third quarters, and lower
revenue in its first and fourth quarters. These seasonal fluctuations are often driven by Autodesks new product releases and promotional campaigns.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Avatech is exposed to
market risk from changes in interest rates associated with its variable rate line-of-credit facility. At June 30, 2007, approximately 98% of its outstanding debt bore interest at variable rates. Accordingly, earnings and cash flow are affected
by changes in interest rates, though not by an amount that is material to the Company. Assuming the current level of borrowings at variable rates and assuming a 100 basis point change in the 2007 average interest rate under these borrowings, it is
estimated that the 2007 interest expense and net income would have changed by less than $15,000. In the event of an adverse change in interest rates, management would likely take actions to further mitigate its exposure.

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The supplementary data
required by this item is incorporated herein by reference to the section entitled Quarter Results of Operation contained in Item 7 or Part II of this report. The financial statements, notes thereto and other information required by
this item begin on Page F-1 that immediately follows the signatures to this annual report and are incorporated herein by reference.



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

None.

ITEM 9A.    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 most recent fiscal year that have
materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.

ITEM 9B.    OTHER INFORMATION

None.



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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 Solutions, Inc. to be filed with the Securities and Exchange Commission in connection with the 2007 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.



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##### Table of Contents

PART IV



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

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



|                                                                                                            |  |     
|----------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                            |  | Page
|                                                                                                            | 
|Report of Independent Registered Public Accounting Firm                                                     |  | F-2 
|                                                                                                            | 
|Consolidated Balance Sheets as of June 30, 2007 and 2006                                                    |  | F-4 
|                                                                                                            | 
|Consolidated Statements of Operations for the Years Ended June 30, 2007, 2006, and 2005                     |  | F-5 
|                                                                                                            | 
|Consolidated Statements of Stockholders Equity (Deficit) for the Years Ended June 30, 2007, 2006, and 2005 |  | F-6 
|                                                                                                            | 
|Consolidated Statements of Cash Flows for the Years Ended June 30, 2007, 2006, and 2005                     |  | F-9 
|                                                                                                            | 
|Notes to Consolidated Financial Statements                                                                  |  | F-10



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##### Table of Contents

(a)(2) and (c). Financial Schedules. Schedule IISchedule of Valuation and Qualifying Accounts

Report of Independent Registered Public Accounting Firm on Financial Statement Schedule

The Board of Directors and Stockholders

Avatech Solutions, Inc.

We have audited the consolidated financial statements of Avatech Solutions, Inc. as of June 30, 2006 and for the year then ended and have issued
our report thereon dated September 21, 2007 (included elsewhere in this Report). Our audit also included the financial statement schedule responsive to Item 15 of this Report. This schedule is the responsibility of the Companys
management. Our responsibility is to express an opinion on this schedule based on our audit. This schedule as of June 30, 2005 was audited by other auditors whose report dated September 21, 2005, expressed an unqualified opinion on those
schedules.

In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the information set forth therein.

/s/
Stegman & Company

Baltimore, Maryland

September 21, 2007



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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, 2007:                       |  |                              |           |                            |   |                                   |  |   |                      |      |  |                        |         |      |  |   |          
|Deducted from assets accounts:                  |  |                              |           |                            |   |                                   |  |   |                      |      |  |                        |         |      |  |   |          
|Allowance for doubtful accounts                 |  | $                            | 112,000   |                            | $ | 174,000                           |  | $ |                     |      |  | $                      | (98,000 | )(3) |  | $ | 188,000  
|Valuation allowance for net deferred tax assets |  |                              | 1,202,000 |                            |   |                                  |  |   | (263,000             | )(1) |  |                        |        |      |  |   | 939,000  
|                                                |  |                              |           |                            |  
|Year Ended June 30, 2006:                       |  |                              |           |                            |   |                                   |  |   |                      |      |  |                        |         |      |  |   |          
|Deducted from assets accounts:                  |  |                              |           |                            |   |                                   |  |   |                      |      |  |                        |         |      |  |   |          
|Allowance for doubtful accounts                 |  | $                            | 149,000   |                            | $ | 11,000                            |  | $ |                     |      |  | $                      | (48,000 | )(3) |  | $ | 112,000  
|Valuation allowance for net deferred tax assets |  |                              | 2,519,000 |                            |   |                                  |  |   | (1,317,000           | )(1) |  |                        |        |      |  |   | 1,202,000
|                                                |  |                              |           |                            |  
|Year Ended June 30, 2005:                       |  |                              |           |                            |   |                                   |  |   |                      |      |  |                        |         |      |  |   |          
|Deducted from assets accounts:                  |  |                              |           |                            |   |                                   |  |   |                      |      |  |                        |         |      |  |   |          
|Allowance for doubtful accounts                 |  | $                            | 100,000   |                            | $ | 9,000                             |  | $ | 40,000               | (2)  |  | $                      |        |      |  | $ | 149,000  
|Valuation allowance for net deferred tax assets |  |                              | 3,273,000 |                            |   |                                  |  |   | (754,000             | )(1) |  |                        |        |      |  |   | 2,519,000

---

|(1) | Decrease in valuation allowance, net of temporary differences.
|--- | --------------------------------------------------------------



|(2) | Allowance recorded upon acquisition.
|--- | ------------------------------------



|(3) | Uncollectible accounts written off, net of recoveries.
|--- | ------------------------------------------------------

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-23 of this report, which list is incorporated herein by reference.



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SIGNATURES

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



|                         |  |                         |  |                                      
|------------------------ |  | ----------------------- |  | -------------------------------------
|                         |  | AVATECH SOLUTIONS, INC.
|                         |  |                        
|Date: September 28, 2007 |  | 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 28, 2007 |  | September 28, 2007                                    
|                   |  |                                                        | 
|By:                |  | /s/    GEORGE W.
COX                                   |  | By: |  | /s/    ROBERT J.
POST                    
|                   |  | George W. Cox, Director                                |  |     |  | Robert J. Post, Director                 
|                   | 
|September 28, 2007 |  | September 28, 2007                                    
|                   |  |                                                        | 
|By:                |  | /s/    EUGENE J.
FISCHER                               |  | By: |  | /s/    DAVE
REYMANN                      
|                   |  | Eugene J. Fischer, Director                            |  |     |  | Dave Reymann, Director                   
|                   | 
|September 28, 2007 |  | September 28, 2007                                    
|                   |  |                                                        | 
|By:                |  | /s/    GEORGE M.
DAVIS                                 |  | By: |  | /s/    THOM WAYE                         
|                   |  | George M. Davis, President and Chief Executive Officer |  |     |  | Thom Waye, Director and Board Chair      
|                   | 
|September 28, 2007 |  | September 28, 2007                                    
|                   |  |                                                        | 
|                   |  |                                                        |  | By: |  | /s/    LAWRENCE
RYCHLAK                  
|                   |  |                                                        |  |     |  | Lawrence Rychlak, Chief Financial Officer
|                   | 
|                   |  | September 28, 2007                                    



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FINANCIAL STATEMENTS AND SCHEDULES

Avatech Solutions, Inc. and Subsidiaries

Index to Consolidated Financial Statements



|                                                          |  |     
|--------------------------------------------------------- |  | ----
|                                                          |  | Page
|Report of Independent Registered Public Accounting Firm   |  | F-2 
|                                                          | 
|Consolidated Balance Sheets                               |  | F-4 
|                                                          | 
|Consolidated Statements of Operations                     |  | F-5 
|                                                          | 
|Consolidated Statements of Stockholders Equity (Deficit) |  | F-6 
|                                                          | 
|Consolidated Statements of Cash Flows                     |  | F-9 
|                                                          | 
|Notes to Consolidated Financial Statements                |  | F-10



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##### Table of Contents

R
EPORT 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, 2007 and 2006 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. 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, 2007 and 2006 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 21, 2007



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of Avatech Solutions, Inc.

We have audited the accompanying consolidated balance sheet of Avatech Solutions, Inc. and subsidiaries as of June 30, 2005 (not presented herein), and the related consolidated statements of operations, stockholders deficit, and
cash flows for the year then ended. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and schedule are the responsibility of the Companys management. Our responsibility is
to express an opinion on these financial statements and schedule based on our audit.

We conducted our audits in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were
not engaged to perform an audit of the Companys internal control over financial reporting. Our audit 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 purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Avatech Solutions, Inc. and subsidiaries at June 30, 2005, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with U.S.
generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information for
2005 set forth therein.

/s/ Ernst & Young LLP

Baltimore, Maryland

September 21, 2005



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##### Table of Contents

A
vatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets



|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------- | ---------- | - | ---- | - | ---------- | -
|                                                                                                                                                                                                                                                                                                              |  | June 30 |           
|                                                                                                                                                                                                                                                                                                              |  | 2007    |            |   | 2006 |  
|Assets                                                                                                                                                                                                                                                                                                        |  |         |            |   |      |   |            |  
|Current assets:                                                                                                                                                                                                                                                                                               |  |         |            |   |      |   |            |  
|Cash                                                                                                                                                                                                                                                                                                          |  | $       | 1,688,000  |   |      | $ | 581,000    |  
|Accounts receivable, less allowance of $188,000 in 2007 and $112,000 in 2006                                                                                                                                                                                                                                  |  |         | 7,402,000  |   |      |   | 5,471,000  |  
|Other receivables                                                                                                                                                                                                                                                                                             |  |         | 492,000    |   |      |   | 320,000    |  
|Inventory                                                                                                                                                                                                                                                                                                     |  |         | 902,000    |   |      |   | 1,414,000  |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                                                                     |  |         | 356,000    |   |      |   | 305,000    |  
|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  
|Total current assets                                                                                                                                                                                                                                                                                          |  |         | 10,840,000 |   |      |   | 8,091,000  |  
|                                                                                                                                                                                                                                                                                                              |  |        
|Property and equipment:                                                                                                                                                                                                                                                                                       |  |         |            |   |      |   |            |  
|Computer software and equipment                                                                                                                                                                                                                                                                               |  |         | 2,907,000  |   |      |   | 2,649,000  |  
|Office furniture and equipment                                                                                                                                                                                                                                                                                |  |         | 1,212,000  |   |      |   | 1,048,000  |  
|Leasehold improvements                                                                                                                                                                                                                                                                                        |  |         | 167,000    |   |      |   | 133,000    |  
|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  
|                                                                                                                                                                                                                                                                                                              |  |         | 4,286,000  |   |      |   | 3,830,000  |  
|Less accumulated depreciation and amortization                                                                                                                                                                                                                                                                |  |         | (3,352,000 | ) |      |   | (2,960,000 | )
|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  
|                                                                                                                                                                                                                                                                                                              |  |         | 934,000    |   |      |   | 870,000    |  
|Customer list, net of accumulated amortization of $387,000                                                                                                                                                                                                                                                    |  |         | 1,803,000  |   |      |   | 1,900,000  |  
|Goodwill                                                                                                                                                                                                                                                                                                      |  |         | 5,888,000  |   |      |   | 5,864,000  |  
|Other assets                                                                                                                                                                                                                                                                                                  |  |         | 109,000    |   |      |   | 125,000    |  
|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  
|Total assets                                                                                                                                                                                                                                                                                                  |  | $       | 19,574,000 |   |      | $ | 16,850,000 |  
|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  
|Liabilities and stockholders equity                                                                                                                                                                                                                                                                          |  |         |            |   |      |   |            |  
|Current liabilities:                                                                                                                                                                                                                                                                                          |  |         |            |   |      |   |            |  
|Accounts payable and accrued expenses                                                                                                                                                                                                                                                                         |  | $       | 5,635,000  |   |      | $ | 5,097,000  |  
|Accrued compensation and related benefits                                                                                                                                                                                                                                                                     |  |         | 1,461,000  |   |      |   | 725,000    |  
|Borrowings under line-of-credit                                                                                                                                                                                                                                                                               |  |         | 1,408,000  |   |      |   | 1,409,000  |  
|Current portion of long-term debt                                                                                                                                                                                                                                                                             |  |         | 31,000     |   |      |   | 43,000     |  
|Deferred revenue                                                                                                                                                                                                                                                                                              |  |         | 1,094,000  |   |      |   | 1,022,000  |  
|Other current liabilities                                                                                                                                                                                                                                                                                     |  |         | 96,000     |   |      |   | 156,000    |  
|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  
|Total current liabilities                                                                                                                                                                                                                                                                                     |  |         | 9,725,000  |   |      |   | 8,452,000  |  
|                                                                                                                                                                                                                                                                                                              |  |        
|Long-term debt                                                                                                                                                                                                                                                                                                |  |         |           |   |      |   | 51,000     |  
|Other long-term liabilities                                                                                                                                                                                                                                                                                   |  |         |           |   |      |   | 67,000     |  
|                                                                                                                                                                                                                                                                                                              |  |        
|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, 2007 and 2006; 1,106,929 and
1,190,387 outstanding at June 30, 2007 and 2006, respectively; aggregate liquidation preference of $1,704,000 and $1,892,000 at June 30, 2007 and 2006, respectively |  |         | 11,000     |   |      |   | 12,000     |  
|Common stock, $0.01 par value; 80,000,000 shares authorized; issued and outstanding shares of 15,482,036 at June 30, 2007 and 13,517,296
at June 30, 2006                                                                                                                                                     |  |         | 155,000    |   |      |   | 135,000    |  
|Additional paid-in capital                                                                                                                                                                                                                                                                                    |  |         | 12,706,000 |   |      |   | 10,601,000 |  
|Accumulated deficit                                                                                                                                                                                                                                                                                           |  |         | (6,652,000 | ) |      |   | (6,097,000 | )
|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  
|Total stockholders equity                                                                                                                                                                                                                                                                                    |  |         | 6,220,000  |   |      |   | 4,651,000  |  
|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  
|Total liabilities and stockholders equity                                                                                                                                                                                                                                                                    |  | $       | 19,574,000 |   |      | $ | 16,850,000 |  
|                                                                                                                                                                                                                                                                                                              |  |         |            |   |      |   |            |  



See accompanying
notes.



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##### Table of Contents

A
vatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations



|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|---------------------------------------- |  | ------------------ | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                         |  | Year ended June 30 |           
|                                         |  | 2007               |            |   | 2006 |   |            | 2005 | 
|Revenues:                                |  |                    |            |   |      |   |            |      |  |   |            |  
|Product sales                            |  | $                  | 30,125,000 |   |      | $ | 25,364,000 |      |  | $ | 20,703,000 |  
|Service revenue                          |  |                    | 10,689,000 |   |      |   | 7,399,000  |      |  |   | 6,066,000  |  
|Commission revenue                       |  |                    | 9,721,000  |   |      |   | 6,857,000  |      |  |   | 5,475,000  |  
|Sale of developed software               |  |                    |           |   |      |   |           |      |  |   | 1,900,000  |  
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|                                         |  |                    | 50,535,000 |   |      |   | 39,620,000 |      |  |   | 34,144,000 |  
|Cost of revenue:                         |  |                    |            |   |      |   |            |      |  |   |            |  
|Cost of product sales                    |  |                    | 19,963,000 |   |      |   | 15,002,000 |      |  |   | 13,211,000 |  
|Cost of service revenue                  |  |                    | 7,416,000  |   |      |   | 5,167,000  |      |  |   | 4,606,000  |  
|Cost of developed software               |  |                    |           |   |      |   |           |      |  |   | 77,000     |  
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|                                         |  |                    | 27,379,000 |   |      |   | 20,169,000 |      |  |   | 17,894,000 |  
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|Gross margin                             |  |                    | 23,156,000 |   |      |   | 19,451,000 |      |  |   | 16,250,000 |  
|                                         |  |                    |           
|Other operating expenses:                |  |                    |            |   |      |   |            |      |  |   |            |  
|Selling, general and administrative      |  |                    | 22,659,000 |   |      |   | 16,522,000 |      |  |   | 13,399,000 |  
|Depreciation and amortization            |  |                    | 689,000    |   |      |   | 388,000    |      |  |   | 359,000    |  
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|                                         |  |                    | 23,348,000 |   |      |   | 16,910,000 |      |  |   | 13,758,000 |  
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|Operating income (loss)                  |  |                    | (192,000   | ) |      |   | 2,541,000  |      |  |   | 2,492,000  |  
|                                         |  |                    |           
|Other income (expense):                  |  |                    |            |   |      |   |            |      |  |   |            |  
|Gain on the early extinguishment of debt |  |                    |           |   |      |   | 233,000    |      |  |   |           |  
|Minority interest                        |  |                    |           |   |      |   |           |      |  |   | (59,000    | )
|Interest and other income                |  |                    | 62,000     |   |      |   | 34,000     |      |  |   | 107,000    |  
|Interest expense                         |  |                    | (198,000   | ) |      |   | (549,000   | )    |  |   | (524,000   | )
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|                                         |  |                    | (136,000   | ) |      |   | (282,000   | )    |  |   | (476,000   | )
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|Income (loss) before income taxes        |  |                    | (328,000   | ) |      |   | 2,259,000  |      |  |   | 2,016,000  |  
|Income tax expense                       |  |                    | 227,000    |   |      |   | 56,000     |      |  |   | 82,000     |  
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|Net income (loss)                        |  | $                  | (555,000   | ) |      | $ | 2,203,000  |      |  | $ | 1,934,000  |  
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|Earnings (loss) per common sharebasic   |  | $                  | (0.07      | ) |      | $ | 0.18       |      |  | $ | 0.18       |  
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|Earnings (loss) per common sharediluted |  | $                  | (0.07      | ) |      | $ | 0.12       |      |  | $ | 0.14       |  
|                                         |  |                    |            |   |      |   |            |      |  |   |            |  



See accompanying
notes.



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##### Table of Contents

A
vatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders Equity (Deficit)



|                                                              |  |                 |  |              |        |                  |            |   |           |   |                          |  |   |                    |   |  |       |             |   |  |   |            |  
|------------------------------------------------------------- |  | --------------- |  | ------------ | ------ | ---------------- | ---------- | - | --------- | - | ------------------------ |  | - | ------------------ | - |  | ----- | ----------- | - |  | - | ---------- | -
|                                                              |  | Preferred Stock |  | Common Stock |        |                  |            |   |           |   |                          |  |  
|                                                              |  | Number ofShares |  | Par Value    |        | Number of Shares |            |   | Par Value |   | AdditionalPaid-InCapital |  |   | AccumulatedDeficit |   |  | Total |            
|Balance at July 1, 2004                                       |  | 1,297,537       |  | $            | 13,000 |                  | 9,460,380  |   |           | $ | 95,000                   |  | $ | 3,737,000          |   |  | $     | (10,234,000 | ) |  | $ | (6,389,000 | )
|Issuance of common stock as compensation                      |  |                |  |              |       |                  | 61,258     |   |           |   | 1,000                    |  |   | 33,000             |   |  |       |            |   |  |   | 34,000     |  
|Issuance of common stock upon the exercise of warrants        |  |                |  |              |       |                  | 381,011    |   |           |   | 4,000                    |  |   | 150,000            |   |  |       |            |   |  |   | 154,000    |  
|Issuance of common stock under Employee Stock Purchase Plan   |  |                |  |              |       |                  | 312,870    |   |           |   | 3,000                    |  |   | 80,000             |   |  |       |            |   |  |   | 83,000     |  
|Conversion of preferred stock of subsidiary into common stock |  |                |  |              |       |                  | 680,760    |   |           |   | 6,000                    |  |   | 1,518,000          |   |  |       |            |   |  |   | 1,524,000  |  
|Issuance of common stock upon the exercise of stock options   |  |                |  |              |       |                  | 2,051      |   |           |   |                         |  |   | 1,000              |   |  |       |            |   |  |   | 1,000      |  
|Issuance of warrants to purchase common stock                 |  |                |  |              |       |                  |           |   |           |   |                         |  |   | 35,000             |   |  |       |            |   |  |   | 35,000     |  
|Preferred stock dividends                                     |  |                |  |              |       |                  |           |   |           |   |                         |  |   | (78,000            | ) |  |       |            |   |  |   | (78,000    | )
|Forfeiture of restricted common stock issued as compensation  |  |                |  |              |       |                  | (30,000    | ) |           |   |                         |  |   |                   |   |  |       |            |   |  |   |           |  
|Net income                                                    |  |                |  |              |       |                  |           |   |           |   |                         |  |   |                   |   |  |       | 1,934,000   |   |  |   | 1,934,000  |  
|                                                              |  |                 |  |              |        |                  |            |   |           |   |                          |  |   |                    |   |  |       |             |   |  |   |            |  
|Balance at June 30, 2005                                      |  | 1,297,537       |  | $            | 13,000 |                  | 10,868,330 |   |           | $ | 109,000                  |  | $ | 5,476,000          |   |  | $     | (8,300,000  | ) |  | $ | (2,702,000 | )



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##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders Equity (Deficit)(Continued)



|                                                            |  |                 |   |  |              |        |   |                  |            |           |   |                          |  |   |                    |   |  |       |            |   |  |   |            |  
|----------------------------------------------------------- |  | --------------- | - |  | ------------ | ------ | - | ---------------- | ---------- | --------- | - | ------------------------ |  | - | ------------------ | - |  | ----- | ---------- | - |  | - | ---------- | -
|                                                            |  | Preferred Stock |   |  | Common Stock |        |   |                  |            |           |   |                          |  |  
|                                                            |  | Number ofShares |   |  | Par Value    |        |   | Number of Shares |            | Par Value |   | AdditionalPaid-InCapital |  |   | AccumulatedDeficit |   |  | Total |           
|Balance at June 30, 2005                                    |  | 1,297,537       |   |  | $            | 13,000 |   |                  | 10,868,330 |           | $ | 109,000                  |  | $ | 5,476,000          |   |  | $     | (8,300,000 | ) |  | $ | (2,702,000 | )
|Issuance of common stock as compensation                    |  |                |   |  |              |       |   |                  | 64,451     |           |   | 1,000                    |  |   | 60,000             |   |  |       |           |   |  |   | 61,000     |  
|Issuance of common stock upon the exercise of warrants      |  |                |   |  |              |       |   |                  | 37,269     |           |   |                         |  |   | 16,000             |   |  |       |           |   |  |   | 16,000     |  
|Issuance of common stock under Employee Stock Purchase Plan |  |                |   |  |              |       |   |                  | 210,132    |           |   | 2,000                    |  |   | 82,000             |   |  |       |           |   |  |   | 84,000     |  
|Issuance of common stock through private placement          |  |                |   |  |              |       |   |                  | 1,000,000  |           |   | 10,000                   |  |   | 1,990,000          |   |  |       |           |   |  |   | 2,000,000  |  
|Issuance of common stock for acquisition                    |  |                |   |  |              |       |   |                  | 694,445    |           |   | 7,000                    |  |   | 1,493,000          |   |  |       |           |   |  |   | 1,500,000  |  
|Issuance of common stock upon the exercise of stock options |  |                |   |  |              |       |   |                  | 405,903    |           |   | 4,000                    |  |   | 187,000            |   |  |       |           |   |  |   | 191,000    |  
|Issuance of warrants to purchase common stock               |  |                |   |  |              |       |   |                  |           |           |   |                         |  |   | 37,000             |   |  |       |           |   |  |   | 37,000     |  
|Vesting of stock options issued to employees                |  |                |   |  |              |       |   |                  |           |           |   |                         |  |   | 254,000            |   |  |       |           |   |  |   | 254,000    |  
|Issuance of preferred stock                                 |  | 1,191           |   |  |              |       |   |                  |           |           |   |                         |  |   | 1,191,000          |   |  |       |           |   |  |   | 1,191,000  |  
|Conversion of preferred stock into common stock             |  | (108,341        | ) |  |              | (1,000 | ) |                  | 236,766    |           |   | 2,000                    |  |   | (1,000             | ) |  |       |           |   |  |   |           |  
|Preferred stock dividends                                   |  |                |   |  |              |       |   |                  |           |           |   |                         |  |   | (184,000           | ) |  |       |           |   |  |   | (184,000   | )
|Net income                                                  |  |                |   |  |              |       |   |                  |           |           |   |                         |  |   |                   |   |  |       | 2,203,000  |   |  |   | 2,203,000  |  
|                                                            |  |                 |   |  |              |        |   |                  |            |           |   |                          |  |   |                    |   |  |       |            |   |  |   |            |  
|Balance at June 30, 2006                                    |  | 1,190,387       |   |  | $            | 12,000 |   |                  | 13,517,296 |           | $ | 135,000                  |  | $ | 10,601,000         |   |  | $     | (6,097,000 | ) |  | $ | 4,651,000  |  



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##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders Equity (Deficit)(Continued)



|                                                                                  |  |                 |   |  |              |        |   |                  |            |           |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  
|--------------------------------------------------------------------------------- |  | --------------- | - |  | ------------ | ------ | - | ---------------- | ---------- | --------- | - | ------------------------ |  | - | ------------------ | - |  | ----- | ---------- | - |  | - | --------- | -
|                                                                                  |  | Preferred Stock |   |  | Common Stock |        |   |                  |            |           |   |                          |  |  
|                                                                                  |  | Number ofShares |   |  | Par Value    |        |   | Number of Shares |            | Par Value |   | AdditionalPaid-InCapital |  |   | AccumulatedDeficit |   |  | Total |           
|Balance at June 30, 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 |  
|                                                                                  |  |                 |   |  |              |        |   |                  |            |           |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  

See accompanying notes.



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A
vatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Cash Flows



|                                                                                               |  |                    |             |   |      |   |             |      |  |   |             |  
|---------------------------------------------------------------------------------------------- |  | ------------------ | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                                               |  | Year ended June 30 |            
|                                                                                               |  | 2007               |             |   | 2006 |   |             | 2005 | 
|Cash flows from operating activities                                                           |  |                    |             |   |      |   |             |      |  |   |             |  
|Net income (loss)                                                                              |  | $                  | (555,000    | ) |      | $ | 2,203,000   |      |  | $ | 1,934,000   |  
|Adjustments to reconcile net income (loss) to net cash used in operating activities:           |  |                    |             |   |      |   |             |      |  |   |             |  
|Provision for bad debts, net of recoveries                                                     |  |                    | 114,000     |   |      |   | (42,000     | )    |  |   | (6,000      | )
|Gain on early extinguishment of debt                                                           |  |                    |            |   |      |   | (233,000    | )    |  |   | (11,000     | )
|Depreciation and amortization                                                                  |  |                    | 689,000     |   |      |   | 388,000     |      |  |   | 359,000     |  
|Non-cash stock compensation expense                                                            |  |                    | 739,000     |   |      |   | 315,000     |      |  |   | 34,000      |  
|Loss on disposal of property and equipment                                                     |  |                    |            |   |      |   | 6,000       |      |  |   |            |  
|Amortization of debt discount charged to interest expense                                      |  |                    |            |   |      |   | 4,000       |      |  |   | 26,000      |  
|Changes in operating assets and liabilities, net of those acquired:                            |  |                    |             |   |      |   |             |      |  |   |             |  
|Accounts receivable and other receivables                                                      |  |                    | (2,217,000  | ) |      |   | 1,464,000   |      |  |   | (1,486,000  | )
|Inventory                                                                                      |  |                    | 512,000     |   |      |   | (564,000    | )    |  |   | (298,000    | )
|Prepaid expenses and other current assets                                                      |  |                    | (51,000     | ) |      |   | (79,000     | )    |  |   | 253,000     |  
|Other assets                                                                                   |  |                    | 16,000      |   |      |   |            |      |  |   | 151,000     |  
|Accounts payable and accrued expenses                                                          |  |                    | 538,000     |   |      |   | 888,000     |      |  |   | (2,160,000  | )
|Accrued compensation and related benefits                                                      |  |                    | 736,000     |   |      |   | 133,000     |      |  |   | 41,000      |  
|Deferred revenue                                                                               |  |                    | 72,000      |   |      |   | 223,000     |      |  |   | (390,000    | )
|Other current liabilities                                                                      |  |                    | (60,000     | ) |      |   | (285,000    | )    |  |   | 96,000      |  
|                                                                                               |  |                    |             |   |      |   |             |      |  |   |             |  
|Net cash provided by (used in) operating activities                                            |  |                    | 533,000     |   |      |   | 4,421,000   |      |  |   | (1,457,000  | )
|                                                                                               |  |                    |            
|Cash flows from investing activities                                                           |  |                    |             |   |      |   |             |      |  |   |             |  
|Purchase of property and equipment                                                             |  |                    | (456,000    | ) |      |   | (278,000    | )    |  |   | (393,000    | )
|Acquisition of TTS assets                                                                      |  |                    | (200,000    | ) |      |   |            |      |  |   |            |  
|Escrow settlement-Sterling Systems                                                             |  |                    | (24,000     | ) |      |   |            |      |  |   |            |  
|Capitalized legal and financing costs                                                          |  |                    |            |   |      |   | (29,000     | )    |  |   |            |  
|Cash payment for acquisition of Sterling                                                       |  |                    |            |   |      |   | (6,441,000  | )    |  |   |            |  
|                                                                                               |  |                    |             |   |      |   |             |      |  |   |             |  
|Net cash used in investing activities                                                          |  |                    | (680,000    | ) |      |   | (6,748,000  | )    |  |   | (393,000    | )
|                                                                                               |  |                    |            
|Cash flows from financing activities                                                           |  |                    |             |   |      |   |             |      |  |   |             |  
|Proceeds from borrowings under lines-of-credit                                                 |  |                    | 61,077,000  |   |      |   | 54,834,000  |      |  |   | 42,070,000  |  
|Repayments of borrowings under lines-of-credit                                                 |  |                    | (61,078,000 | ) |      |   | (56,627,000 | )    |  |   | (40,613,000 | )
|Repayments of long-term debt                                                                   |  |                    | (63,000     | ) |      |   | (2,365,000  | )    |  |   | (104,000    | )
|Proceeds from issuance of common stock through private placement                               |  |                    | 1,542,000   |   |      |   | 2,000,000   |      |  |   |            |  
|Proceeds from the issuance of Series F Convertible Preferred Stock                             |  |                    |            |   |      |   | 4,000,000   |      |  |   |            |  
|Legal and financing fees incurred in Series F offering                                         |  |                    |            |   |      |   | (371,000    | )    |  |   |            |  
|Proceeds from the issuances of Series D and E Convertible Preferred Stock                      |  |                    |            |   |      |   | 1,191,000   |      |  |   |            |  
|Proceeds from issuance of common stock to employees and exercise of stock options and warrants |  |                    | 347,000     |   |      |   | 291,000     |      |  |   | 238,000     |  
|Dividends paid to preferred shareholders                                                       |  |                    | (504,000    | ) |      |   | (184,000    | )    |  |   | (78,000     | )
|Increase in other assets related to financing costs                                            |  |                    |            |   |      |   | 37,000      |      |  |   |            |  
|Decrease in other long-term liabilities                                                        |  |                    | (67,000     | ) |      |   | (193,000    | )    |  |   | (58,000     | )
|                                                                                               |  |                    |             |   |      |   |             |      |  |   |             |  
|Net cash provided by financing activities                                                      |  |                    | 1,254,000   |   |      |   | 2,613,000   |      |  |   | 1,455,000   |  
|                                                                                               |  |                    |             |   |      |   |             |      |  |   |             |  
|Net increase (decrease) in cash                                                                |  |                    | 1,107,000   |   |      |   | 286,000     |      |  |   | (395,000    | )
|Cashbeginning of year                                                                         |  |                    | 581,000     |   |      |   | 295,000     |      |  |   | 690,000     |  
|                                                                                               |  |                    |             |   |      |   |             |      |  |   |             |  
|Cashend of year                                                                               |  | $                  | 1,688,000   |   |      | $ | 581,000     |      |  | $ | 295,000     |  
|                                                                                               |  |                    |             |   |      |   |             |      |  |   |             |  



See accompanying
notes.



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##### Table of Contents

A
vatech 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 the United States.

The consolidated financial statements include the accounts of Avatech Solutions, Inc. and its majority-owned subsidiaries (the Company or Avatech). All intercompany accounts and transactions
between the Company and its consolidated affiliated companies 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.

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 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



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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
$5,888,000 and $5,864,000 as of June 30, 2007 and 2006, respectively.

Stock Options and Stock Granted to Employees

During fiscal year 2006, the Company adopted Financial Accounting Standards Board Statement No. 123R, Share-Based Payment (Statement
123R), which requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Previously, the Company accounted for stock-based compensation plans
and the employee stock purchase plan in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and related Interpretations and provided the required pro forma disclosures of
Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation. On July 1, 2005, the Company elected to adopt the modified prospective-transition method as provided by Statement 123R. Under this
transition method, compensation cost recognized during fiscal year 2007 and 2006 includes (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 1, 2005, based on the grant-date fair value
estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to July 1, 2005, based on the grant-date fair value estimated in accordance with the
provisions of Statement 123R. The effect of applying Statement 123R was a decrease to net income of $656,000 and $254,000, for the years ended June 30, 2007 and 2006, respectively, or $0.04 per basic and $0.03 per diluted share in 2007 and
$0.02 per basic and $0.01 per diluted share in 2006. Results for prior periods have not been restated.

The Board of Directors may grant
options under four stock option plans 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 Avatech Solutions, Inc. 2000 Stock Option Plan and the Avatech
Solutions, Inc. 2002 Stock Option Plan are the only plans with significant stock option awards available for grant. All plans provide 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. For the fiscal years ended June 30, 2007, 2006 and 2005, the Company also issued 54,962, 64,451 and 61,258 shares, respectively,
of fully vested common stock to members of the Board of Directors with an aggregate market value of $83,000, $61,000 and $35,000 respectively. For the fiscal years ended June 30, 2007, 2006 and 2005, total stock compensation expense charged
against income for these plans was $739,000, $315,000 and $34,000 respectively.



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The following table illustrates the effect on net income and income per share as if the Company had
applied the fair value recognition provisions of Statement 123R to stock-based employee compensation for fiscal year ended June 30, 2005:



|                                                                                                                                   |  |      |           |  
|---------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --------- | -
|                                                                                                                                   |  | 2005 |          
|Net income as reported                                                                                                             |  | $    | 1,934,000 |  
|Add: Stock-based employee compensation cost included in net loss, net of income taxes                                              |  |      | 34,000    |  
|Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of income
taxes |  |      | (309,000  | )
|                                                                                                                                   |  |      |           |  
|Pro forma net income                                                                                                               |  |      | 1,659,000 |  
|Less: Preferred stock dividends                                                                                                    |  |      | (78,000   | )
|                                                                                                                                   |  |      |           |  
|Pro forma net income attributable to common shareholders                                                                           |  | $    | 1,581,000 |  
|                                                                                                                                   |  |      |           |  
|Earnings per common sharebasic (as reported)                                                                                      |  | $    | 0.18      |  
|                                                                                                                                   |  |      |           |  
|Earnings per common sharebasic (pro forma)                                                                                        |  | $    | 0.15      |  
|                                                                                                                                   |  |      |           |  
|Earnings per common sharediluted (as reported)                                                                                    |  | $    | 0.14      |  
|                                                                                                                                   |  |      |           |  
|Earnings per common sharediluted (pro forma)                                                                                      |  | $    | 0.12      |  
|                                                                                                                                   |  |      |           |  

To determine the pro forma data as required by Statement 123, the Company used the Black-Scholes
stock option pricing model to measure the fair value of stock options as of the date of grant.

The minimum value method calculates the
fair value of options as the excess of the estimated fair value of the underlying stock at the date of grant over the present value of both the exercise price and the expected dividend payments, each discounted at the risk-free rate, over the
expected life of the option. For all stock options granted prior to November 19, 2002, the date the Companys common stock became publicly traded and had a readily determinable market value, the Company used the minimum value method to
calculate pro forma stock compensation expense. For all stock options granted after this date, the Company used 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
|                                               |  | 2007               |  | 2006          |  | 2005         
|Average risk-free interest rate                |  | 4.6%  5.1%        |  | 3.9%  5.1 %  |  | 3.54%  3.98%
|Dividend yield                                 |  | 0%                 |  | 0%            |  | 0%           
|Expected life                                  |  | 5.5  6.2 years    |  | 5  6.2 years |  | 5  6.2 years
|Expected volatility                            |  | 97.2%  108.7%     |  | 108%  145%   |  | 258%  320%  
|Weighted average fair value of granted options |  | $1.39              |  | $1.11         |  | $0.47        

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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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.

Deferred Costs

The Company records as
deferred costs any incremental direct costs associated with revenue that has been deferred in accordance with the Companys revenue recognition policy. Deferred costs principally consist of product costs, and are classified in other assets in
the accompanying consolidated balance sheets. These costs are subsequently recognized in earnings in the same proportion as the related revenue recognized.

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.



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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.

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 $1,098,000, $1,352,000 and $1,449,000
for years ended June 30, 2005, 2006 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. For all periods presented, valuation allowances have been provided for the full amount of net deferred tax assets.

Recent Accounting Pronouncements

In June
2006, the FASB published FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprises
financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a two-step process that involves both the recognition and measurement of a tax position taken or expected to be taken in
a tax return. With respect to recognition of a tax position, a company must determine based on the technical merits of the position, whether it is more likely than not that a tax position will be sustained upon an IRS examination. Once the
more-likely-than-not threshold is met, the enterprise must assume that the appropriate taxing authority with full knowledge of all relevant information will examine the position. In measuring the amount of the benefit to recognize in the financial
statements, a company must use the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management does not expect
the adoption of this Interpretation to have a material impact on the Companys consolidated financial statements.

In
September 2006, the FASB also 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



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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 Financial
Accounting Standards Board (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.

2. Supplemental Disclosure of Cash Flow Information

The Company paid interest of approximately $149,000, $284,000 and $604,000 in 2007, 2006 and 2005, respectively and paid federal and state taxes of approximately $233,000, $100,000 and $24,000 in 2007, 2006 and 2005, respectively.

3. Borrowings Under Line-of-Credit

On
October 28, 2004, a wholly-owned subsidiary of the Company entered into a loan agreement with the bank to provide for a $700,000 revolving credit facility expiring on October 28, 2005. Borrowings under this credit facility bore interest at
the greater of 7.5% or the prime rate plus 2.0% and were secured by the assets of the Company and the guarantee of the Chairman of the Board of Directors. This credit facility was renewed through December 31, 2005 and on that date the Company
determined that it no longer needed this facility and elected to let it expire.

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, 2007 was the banks prime rate plus one-half percent (1/2%), or 8.75%. The loan will
expire on December 31, 2008 and is secured by all of the Companys assets, except inventory. The Company fully expects to renew the line of credit prior to its expiration.

The aggregate outstanding borrowings from the bank under its credit line were $1,408,000 and $1,409,000 at June 30, 2007 and 2006, respectively.

4. Long-Term Debt and Gain on the Early Extinguishment of Debt

Loans From Software Vendor

On July 22, 2003, the Company entered into a marketing and channel distribution agreement
with a software vendor. Under this agreement, the Company provided marketing, distribution and related services for the vendors products. In connection with this agreement, the software vendor agreed to fund certain marketing costs incurred by
the Company. Additionally, the arrangement provided for a loan by the software vendor to fund working capital needs related to the distribution of these products.

The terms of the loan agreement provided for a loan of $1,500,000 with repayment of principal plus interest at 6% per annum in thirty-five equal quarterly installments commencing in January 2005. In July 2005 the



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Company made the decision to discontinue its relationship with the vendor and restructured the loan. The new terms of the loan provided for quarterly
principal payments of approximately $91,000 plus interest at an annual rate of 6%. These quarterly payments began in July 2005 and continued until January 2006 when the Company replaced its existing line of credit and repaid this loan. The early
extinguishment of this debt resulted in a gain to the Company of $233,000.

Note Payable To Related Party

On July 1, 2005, the Company received an extension for the maturity date of a $902,000 subordinated note to a director and shareholder to
July 1, 2006. The note accrued interest at 12% per annum, with quarterly interest payments due commencing October 1, 2005. In consideration for the extension of the loans maturity, the Company issued warrants to purchase 38,878
shares of common stock for $0.60 per share expiring on June 1, 2010. Using the Black-Scholes option pricing model, these warrants were valued at $23,000. This note was fully repaid on June 14, 2006.

Other Long-Term Debt

The Company entered into two
loans in connection with its April 2005 acquisition of Comtrex Corporation which totaled $75,000 of June 30, 2006 and $31,000 as of June 30, 2007 . Additionally, the Company assumed the automotive loans of Sterling Systems, which totaled
$19,000 as of June 30, 2006 and were paid in full in February 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. 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 redemption price is $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 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.

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 semi-annually 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.



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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, 2007 with an aggregate liquidation preference of $4,000,000 as of June 30, 2007.

6. Preferred Stock

The Companys preferred stock included in the equity section of the
accompanying consolidated balance sheet consists of the following as of June 30, 2007 and 2006:



|                                                                                                                                                                                                                                                                                       |  |         |        |      |   |       
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------- | ------ | ---- | - | ------
|                                                                                                                                                                                                                                                                                       |  | June 30
|                                                                                                                                                                                                                                                                                       |  | 2007    |        | 2006
|Series D Convertible Preferred Stock, $0.01 par value; 1,297,537 shares authorized and issued; 1,105,879 and 1,189,209 shares outstanding at
June 30, 2007 and 2006, respectively; aggregate liquidation preference of $654,000 and $714,000 at June 30, 2007 and 2006, respectively   |  | $       | 11,000 |      | $ | 12,000
|                                                                                                                                                                                                                                                                                       |  |        
|Series E Convertible Preferred Stock, $0.01 par value; 3,000 shares authorized; 1,191 shares issued; 1,050 and 1,178 shares outstanding at
June 30, 2007 and 2006, respectively; aggregate liquidation preference of $1,050,000 and $1,178,000 at June 30, 2006 and 2005, respectively |  |         |       |      |   |      
|                                                                                                                                                                                                                                                                                       |  |         |        |      |   |       
|Total Preferred Stock                                                                                                                                                                                                                                                                  |  | $       | 11,000 |      | $ | 12,000
|                                                                                                                                                                                                                                                                                       |  |         |        |      |   |       

During fiscal year 2004, the Company issued 813,050 shares of Series D for net cash proceeds
totaling $330,000 and a reduction in notes payable to a related party of $98,000. At June 30, 2007 and 2006, 1,105,879 and 1,189,209 shares of Series D Convertible Preferred Stock were outstanding 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.



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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, expiring 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.

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.

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 expire 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,



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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 provided for 2007 as these options would have an
anti-dilutive effect due to the losses of the Company. As of June 30, 2007, 10,342,682 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 |           
|                                                   |  | 2007               |            |   | 2006 |   |            | 2005 | 
|                                                   |  |                    |           
|Numerator:                                         |  |                    |            |   |      |   |            |      |  |   |            |  
|Net income (loss)                                  |  | $                  | (555,000   | ) |      | $ | 2,203,000  |      |  | $ | 1,934,000  |  
|Less: preferred stock dividends                    |  |                    | (504,000   | ) |      |   | (184,000   | )    |  |   | (78,000    | )
|                                                   |  |                    |            |   |      |   |            |      |  |   |            |  
|Net income (loss) available to common shareholders |  | $                  | (1,059,000 | ) |      | $ | 2,019,000  |      |  | $ | 1,856,000  |  
|                                                   |  |                    |            |   |      |   |            |      |  |   |            |  
|Denominator:                                       |  |                    |            |   |      |   |            |      |  |   |            |  
|Weighted average shares outstandingbasic          |  |                    | 14,246,390 |   |      |   | 11,469,548 |      |  |   | 10,355,150 |  
|Assumed conversion of preferred stock              |  |                    |           |   |      |   | 6,192,709  |      |  |   | 2,597,236  |  
|Effect of outstanding stock options                |  |                    |           |   |      |   | 983,969    |      |  |   | 518,615    |  
|Effect of outstanding stock warrants               |  |                    |           |   |      |   | 346,158    |      |  |   | 476,054    |  
|                                                   |  |                    |            |   |      |   |            |      |  |   |            |  
|Weighted average shares outstandingdiluted        |  |                    | 14,246,390 |   |      |   | 18,992,384 |      |  |   | 13,947,055 |  
|                                                   |  |                    |            |   |      |   |            |      |  |   |            |  
|Basic earnings (loss) per common share             |  | $                  | (0.07      | ) |      | $ | 0.18       |      |  | $ | 0.18       |  
|                                                   |  |                    |            |   |      |   |            |      |  |   |            |  
|Diluted earnings (loss) per common share           |  | $                  | (0.07      | ) |      | $ | 0.12       |      |  | $ | 0.14       |  
|                                                   |  |                    |            |   |      |   |            |      |  |   |            |  
|Antidilutive stock options and warrants            |  |                    | 4,707,213  |   |      |   | 2,009,361  |      |  |   | 495,261    |  
|                                                   |  |                    |            |   |      |   |            |      |  |   |            |  

8. Stock Purchase Warrants

As of June 30, 2007, the Company had 2,909,060 outstanding warrants to purchase common stock. A summary of these warrants is as follows:



|                 |  |                |  |                 
|---------------- |  | -------------- |  | ----------------
|Number of Shares |  | Exercise Price |  | Expiration Date 
|75,000           |  | $0.35          |  | December 6, 2007
|317,242          |  | $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          |  | $1.95          |  | June 14, 2010   
|38,878           |  | $0.60          |  | July 1, 2010    
|726,102          |  | $1.52          |  | January 29, 2011
|                 |  |                |  |                 
|2,909,060        |  |                |  |                 
|                 |  |                |  |                 



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##### Table of Contents

9. Employee Stock Compensation Plans

Employee Stock Option Plans

The Board of Directors may grant options under four stock option plans
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 Avatech Solutions, Inc. 2000 Stock Option Plan and the Avatech Solutions, Inc. 2002 Stock Option Plan are
the only plans with significant stock option awards available for grant. All plans provide 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 table below:



|                                                                   |  |                    |   |      |                              |           |         |           |   |                              |   |           |  |           |                              |  |   |          
|------------------------------------------------------------------ |  | ------------------ | - | ---- | ---------------------------- | --------- | ------- | --------- | - | ---------------------------- | - | --------- |  | --------- | ---------------------------- |  | - | ---------
|                                                                   |  | Year ended June 30
|                                                                   |  | 2007               |   | 2006 |                              | 2005     
|                                                                   |  | Options            |   |      | WeightedAverageExercisePrice |           | Options |           |   | WeightedAverageExercisePrice |   | Options   |  |           | WeightedAverageExercisePrice
|Outstanding at beginning of year                                   |  | 2,001,558          |   |      | $                            | 0.92      |         | 1,738,941 |   |                              | $ | 0.60      |  | 1,529,892 |                              |  | $ | 0.67     
|Granted                                                            |  | 330,000            |   |      |                              | 1.20      |         | 788,250   |   |                              |   | 1.23      |  | 321,000   |                              |  |   | 0.46     
|Exercised                                                          |  | (222,525           | ) |      |                              | 0.51      |         | (405,904  | ) |                              |   | 0.47      |  | (2,051    | )                            |  |   | 0.30     
|Forfeited                                                          |  | (483,732           | ) |      |                              | 1.55      |         | (119,699  | ) |                              |   | 0.47      |  | (109,900  | )                            |  |   | 0.52     
|Cancelled                                                          |  |                   |   |      |                              |          |         |          |   |                              |   |          |  |          |                              |  |   |         
|                                                                   |  |                    |   |      |                              |           |         |           |   |                              |   |           |  |           |                              |  |   |          
|Outstanding at end of year                                         |  | 1,625,301          |   |      | $                            | 0.93      |         | 2,001,588 |   |                              | $ | 0.92      |  | 1,738,941 |                              |  | $ | 0.60     
|                                                                   |  |                    |   |      |                              |           |         |           |   |                              |   |           |  |           |                              |  |   |          
|Exercisable at end of year                                         |  | 1,264,699          |   |      | $                            | 0.83      |         | 1,030,370 |   |                              | $ | 0.83      |  | 1,106,688 |                              |  | $ | 0.73     
|                                                                   |  |                    |   |      |                              |           |         |           |   |                              |   |           |  |           |                              |  |   |          
|Weighted-average remaining contractual life of outstanding options |  |                    |   |      |                              | 7.2 Years |         |           |   |                              |   | 7.7 Years |  |           |                              |  |   | 7.2 Years
|                                                                   |  |                    |   |      |                              |           |         |           |   |                              |   |           |  |           |                              |  |   |          

The aggregate intrinsic value of the stock options outstanding and exercisable at June 30,
2007 and 2006 was $795,000 and $1,667,000, respectively.

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, 2007 ranged from $0.117 to $63.33 as follows:



|                        |  |                    |  |                                                       |  |                                                               |  |                     |  |                                                      |  |                                                              
|----------------------- |  | ------------------ |  | ----------------------------------------------------- |  | ------------------------------------------------------------- |  | ------------------- |  | ---------------------------------------------------- |  | -------------------------------------------------------------
|Range of ExercisePrices |  | OptionsOutstanding |  | Weighted Average ExercisePrices of OptionsOutstanding |  | WeightedAverageRemainingContractual Lifeof
OptionsOutstanding |  | Options Exercisable |  | WeightedAverage ExercisePrices of
OptionsExercisable |  | WeightedAverageRemainingContractual Lifeof
OptionsExercisable
|$ 0.117    0.34        |  | 578,764            |  | $0.17                                                 |  | 6.0 years                                                     |  | 568,764             |  | $0.17                                                |  | 6.0 years                                                    
|0.35    0.91           |  | 578,000            |  | 0.69                                                  |  | 7.3 years                                                     |  | 505,919             |  | 0.69                                                 |  | 7.3 years                                                    
|1.05  63.33            |  | 468,537            |  | 2.18                                                  |  | 8.6 years                                                     |  | 190,016             |  | 3.18                                                 |  | 7.9 years                                                    
|                        |  |                    |  |                                                       |  |                                                               |  |                     |  |                                                      |  |                                                              
|                        |  | 1,625,301          |  |                                                       |  |                                                               |  | 1,264,699           |  |                                                      |  |                                                              
|                        |  |                    |  |                                                       |  |                                                               |  |                     |  |                                                      |  |                                                              

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 amendments to the Plan, there are 1,000,000 shares of common stock authorized for issuance, of which 33,904 were available for future issuance at June 30, 2007.

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



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##### Table of Contents

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, 2007, the balance withheld from employees pay totaled approximately $50,000 and in July 2007, 51,060 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 has reserved a
total of 1,000,000 shares of common stock for issuance under the Restricted Stock Award Plan.

During fiscal year 2007, the Company awarded
54,962 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 $1.51 per share). The
aggregate market value of these awards totaled $83,000.

For the years ended June 30, 2007 and 2006, the Company recorded aggregate
expense of $83,000 and $61,000 for common stock grants to officers and directors.

10. Shares Reserved for Future Issuance

At June 30, 2007, the Company has reserved 845,123 shares of common stock for future issuance upon the exercise of any 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 |          
|                                            |  | 2007               |           |   | 2006 |  
|Deferred tax assets:                        |  |                    |           |   |      |   |            |  
|Net operating loss carryforward             |  | $                  | 766,000   |   |      | $ | 1,477,000  |  
|Accrued compensation                        |  |                    | 383,000   |   |      |   |           |  
|AMT credit carryforward                     |  |                    | 111,000   |   |      |   | 78,000     |  
|Allowance for doubtful accounts             |  |                    | 73,000    |   |      |   | 45,000     |  
|Book over tax depreciation and amortization |  |                    | 23,000    |   |      |   | 147,000    |  
|Book over tax lease expense                 |  |                    | 49,000    |   |      |   | 60,000     |  
|Other assets                                |  |                    | 59,000    |   |      |   |           |  
|                                            |  |                    |           |   |      |   |            |  
|Total deferred tax assets                   |  |                    | 1,464,000 |   |      |   | 1,807,000  |  
|                                            |  |                    |           |   |      |   |            |  
|Deferred tax liabilities:                   |  |                    |           |   |      |   |            |  
|Customer list                               |  |                    | 525,000   |   |      |   | 600,000    |  
|Other                                       |  |                    |          |   |      |   | 5,000      |  
|                                            |  |                    |           |   |      |   |            |  
|Total deferred tax liabilities              |  |                    | 525,000   |   |      |   | 605,000    |  
|                                            |  |                    |           |   |      |   |            |  
|Net deferred tax assets                     |  |                    | 939,000   |   |      |   | 1,202,000  |  
|Valuation allowance                         |  |                    | (939,000  | ) |      |   | (1,202,000 | )
|                                            |  |                    |           |   |      |   |            |  
|Net deferred tax assets                     |  | $                  |          |   |      | $ |           |  
|                                            |  |                    |           |   |      |   |            |  



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The Company has recorded a valuation allowance for its deferred tax assets due to the inability to
conclude that it is more likely than not that these assets will be realized from future taxable income.

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 |         
|                                                                                |  | 2007               |          |   | 2006 |   |          | 2005 | 
|Expected federal income tax expense (benefit) from continuing operations at 34% |  | $                  | (112,000 | ) |      | $ | 768,000  |      |  | $ | 685,000  |  
|Expenses not deductible for income tax purposes                                 |  |                    | 357,000  |   |      |   | 32,000   |      |  |   | 51,000   |  
|State income taxes, net of federal benefit                                      |  |                    | 132,000  |   |      |   | 22,000   |      |  |   | 100,000  |  
|Change in valuation allowance for deferred tax assets                           |  |                    | (150,000 | ) |      |   | (766,000 | )    |  |   | (754,000 | )
|                                                                                |  |                    |          |   |      |   |          |      |  |   |          |  
|Income tax expense                                                              |  | $                  | 227,000  |   |      | $ | 56,000   |      |  | $ | 82,000   |  
|                                                                                |  |                    |          |   |      |   |          |      |  |   |          |  

Income tax expense (benefit) includes current state income taxes of approximately $193,000,
$34,000 and $25,000 for 2007, 2006, and 2005, respectively.

At June 30, 2007, the Company has net operating loss carryforwards
totaling approximately $1.8 million, which will begin to expire in 2012. Certain net operating loss carryforwards at June 30, 2007 are limited on their use under Internal Revenue Code Section 382.

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 2012, 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, 2007:



|                             |  |   |          
|---------------------------- |  | - | ---------
|Year ending June 30:         |  |   |          
|2008                         |  | $ | 1,494,000
|2009                         |  |   | 1,014,000
|2010                         |  |   | 822,000  
|2011                         |  |   | 698,000  
|2012                         |  |   | 173,000  
|                             |  |   |          
|Total minimum lease payments |  | $ | 4,201,000
|                             |  |   |          

Rent expense consisted of the following:



|             |  |                    |           |      |   |           |  |   |          
|------------ |  | ------------------ | --------- | ---- | - | --------- |  | - | ---------
|             |  | Year ended June 30
|             |  | 2007               |           | 2006 |   | 2005     
|Office space |  | $                  | 1,389,000 |      | $ | 1,152,000 |  | $ | 997,000  
|Equipment    |  |                    | 166,000   |      |   | 98,000    |  |   | 14,000   
|             |  |                    |           |      |   |           |  |   |          
|             |  | $                  | 1,555,000 |      | $ | 1,250,000 |  | $ | 1,011,000
|             |  |                    |           |      |   |           |  |   |          

Rent expense for the year ended June 30, 2005 included amounts paid to a related party of
approximately $44,000. There was no rent paid to a related party for the years ended June 30, 2006 and 2007.



F-22



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##### Table of Contents

Agreements with Executives

The Company has entered into agreements with certain executives and key management employees that provide for severance payments ranging from three to twelve months of salary and immediate vesting of all stock options
not previously vested upon termination of the employee or a change in control of the Company. At June 30, 2007, the total contingency was approximately $655,000 and has been reflected in the accompanying financial statements.

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 six months of service. Participants may elect a pre-tax payroll deduction up to $15,000 (if under age 50), or $20,000 (if age 50 or older by December 31,
2006). 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 employed on the last day of the Plan year. 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, 2007, 2006 and 2005 was approximately $445,000, $208,000 and $76,000, respectively.

14. Significant Supplier

Approximately 97%, 97% and
94% of the Companys inventory purchases for the years ended June 30, 2007, 2006 and 2005, respectively, were from one vendor and approximately 77% and 67% of accounts payable at June 30, 2007 and 2006, respectively, were due to this
vendor. Approximately 93% of the Companys total product revenues are related to this suppliers products.

15. Liquidity and Capital
Resources

Outstanding long-term debt totaled approximately $31,000 at June 30, 2007, and the Company had a working capital surplus
of approximately $1,115,000. 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.



F-23



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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. Restricted Stock Award Plan (incorporated by reference to our Registration Statement on form S-1, filed on March 26, 2003, File No. 333-104035)                                                                    
|        | 
|10.3    |  | Amendment to Avatech Solutions, Inc. Restricted Stock Award Plan, dated August 23, 2005 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on November 14, 2005, File No
001-31265)                                    
|        | 
|10.4    |  | Avatech Solutions, Inc. Employee Stock Purchase Plan (incorporated by reference to our Definitive Proxy Statement on form 14A, filed on May 7, 2004, File No. 001-31265)                                                                   
|        | 
|10.5    |  | 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)             
|        | 
|10.6    |  | 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   |  | 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)



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##### Table of Contents

|        |  |                                                                                                                                                                                                                                                                                    
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                                                                                                                        
|10.11   |  | 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)                                                 
|        | 
|10.12   |  | 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)                               
|        | 
|10.13   |  | 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)                                                         
|        | 
|10.14   |  | Second Modification Agreement by and between Avatech Solutions, Inc. and Avatech Solutions Subsidiary, Inc and Mercantile Bank & Trust Co., dated December 31, 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 (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-234862)                                                                                                                                  
|        | 
|23.1    |  | Consent of Stegman and Company (filed herewith)                                                                                                                                                                                                                                    
|        | 
|23.2    |  | Consent of Ernst & Young LLP (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)