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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-Q







|x | QUARTERLY REPORT PURSUANT TO THE SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
|- | -----------------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2008

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

Commission file number: 001-31265





Avatech Solutions, Inc.

(Exact Name of Registrant as Specified in its Charter)







|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|Delaware                                                       |  | 84-1035353                       
|(State or Other Jurisdiction of Incorporation or Organization) |  | (IRS Employer Identification No.)



|                                                 |  |           
|------------------------------------------------ |  | ----------
|10715 Red Run Blvd., Suite 101, Owings Mills, MD |  | 21117     
|(Address of Principal Executive Offices)         |  | (Zip Code)

(410) 581 - 8080

(Registrants telephone number, including area code)





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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller
reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈                                                |  | Accelerated filer         |  |  ̈
|                        |  |                                                  | 
|Non-accelerated filer   |  |  ̈  (Do not check if a smaller reporting company) |  | Smaller reporting company |  | 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

Indicate the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date: as of November 4, 2008, there were 16,769,744 shares of common stock, par value
$.01 per share, outstanding.









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AVATECH SOLUTIONS, INC. AND SUBSIDIARIES

INDEX



|              |  |                                                                                                     |  |     
|------------- |  | --------------------------------------------------------------------------------------------------- |  | ----
|              |  |                                                                                                     |  | Page
|PART I        |  | FINANCIAL INFORMATION                                                                               |  |     
|              |  |                                                                                                    
|ITEM 1.       |  | Consolidated Financial Statements                                                                   |  |     
|              |  |                                                                                                    
|              |  | Consolidated Balance Sheets  September 30, 2008 (Unaudited) and June 30, 2008                      |  | 3   
|              |  |                                                                                                    
|              |  | Consolidated Statements of Operations  Three months ended September 30, 2008 and 2007 (Unaudited)  |  | 5   
|              |  |                                                                                                    
|              |  | Consolidated Statements of Stockholders Equity  Three months Ended September 30, 2008 (Unaudited) |  | 6   
|              |  |                                                                                                    
|              |  | Consolidated Statements of Cash Flows  Three months ended September 30, 2008 and 2007 (Unaudited)  |  | 7   
|              |  |                                                                                                    
|              |  | Notes to Consolidated Financial Statements (Unaudited)                                              |  | 8   
|              |  |                                                                                                    
|ITEM 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations               |  | 12  
|              |  |                                                                                                    
|ITEM 4T.      |  | Controls and Procedures                                                                             |  | 17  
|              |  |                                                                                                    
|PART II       |  | OTHER INFORMATION                                                                                   |  | 17  
|              |  |                                                                                                    
|ITEM 6.       |  | Exhibits                                                                                            |  | 17  
|              |  |                                                                                                    
|SIGNATURES    |  |                                                                                                     |  | 18  
|              |  |                                                                                                    
|EXHIBIT INDEX |  |                                                                                                     |  | 19  



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PART I. FINANCIAL INFORMATION

Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance
Sheets



|                                                                                                                     |  |                   |            |              |   |           
|-------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---------- | ------------ | - | ----------
|                                                                                                                     |  | September 30,2008 |            | June 30,2008
|                                                                                                                     |  | (unaudited)       |            |             
|Assets                                                                                                               |  |                   |            |              |   |           
|Current assets:                                                                                                      |  |                   |            |              |   |           
|Cash and cash equivalents                                                                                            |  | $                 | 4,289,000  |              | $ | 5,488,000 
|Accounts receivable, less allowance of $140,000 as of September 30, 2008 and June 30, 2008                           |  |                   | 5,675,000  |              |   | 7,394,000 
|Other receivables                                                                                                    |  |                   | 442,000    |              |   | 264,000   
|Inventory                                                                                                            |  |                   | 513,000    |              |   | 422,000   
|Prepaid expenses and other current assets                                                                            |  |                   | 304,000    |              |   | 387,000   
|                                                                                                                     |  |                   |            |              |   |           
|Total current assets                                                                                                 |  |                   | 11,223,000 |              |   | 13,955,000
|                                                                                                                     |  |                  
|Property and equipment:                                                                                              |  |                   |            |              |   |           
|Computer software and equipment                                                                                      |  |                   | 3,221,000  |              |   | 3,189,000 
|Office furniture and equipment                                                                                       |  |                   | 1,202,000  |              |   | 1,176,000 
|Leasehold improvements                                                                                               |  |                   | 193,000    |              |   | 167,000   
|                                                                                                                     |  |                   |            |              |   |           
|                                                                                                                     |  |                   | 4,616,000  |              |   | 4,532,000 
|Less accumulated depreciation and amortization                                                                       |  |                   | 3,848,000  |              |   | 3,751,000 
|                                                                                                                     |  |                   |            |              |   |           
|                                                                                                                     |  |                   | 768,000    |              |   | 781,000   
|                                                                                                                     |  |                  
|Customer list, net of accumulated amortization of $736,000 as of September 30, 2008 and $666,000 as of June 30, 2008 |  |                   | 1,450,000  |              |   | 1,521,000 
|Goodwill                                                                                                             |  |                   | 5,968,000  |              |   | 5,968,000 
|Deferred income taxes, net                                                                                           |  |                   | 261,000    |              |   | 262,000   
|Other assets                                                                                                         |  |                   | 109,000    |              |   | 109,000   
|                                                                                                                     |  |                   |            |              |   |           
|                                                                                                                     |  |                  
|Total assets                                                                                                         |  | $                 | 19,779,000 |              | $ | 22,596,000
|                                                                                                                     |  |                   |            |              |   |           

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets (continued)



|                                                                                                                                                                                                                                                                                                                                          |  |                   |            |   |              |   |            |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---------- | - | ------------ | - | ---------- | -
|                                                                                                                                                                                                                                                                                                                                          |  | September 30,2008 |            |   | June 30,2008 |  
|                                                                                                                                                                                                                                                                                                                                          |  | (unaudited)       |            |   |              |  
|Liabilities and stockholders equity                                                                                                                                                                                                                                                                                                      |  |                   |            |   |              |   |            |  
|Current liabilities:                                                                                                                                                                                                                                                                                                                      |  |                   |            |   |              |   |            |  
|Accounts payable and accrued expenses                                                                                                                                                                                                                                                                                                     |  | $                 | 5,196,000  |   |              | $ | 6,823,000  |  
|Accrued compensation and related benefits                                                                                                                                                                                                                                                                                                 |  |                   | 514,000    |   |              |   | 859,000    |  
|Deferred revenue                                                                                                                                                                                                                                                                                                                          |  |                   | 1,100,000  |   |              |   | 1,085,000  |  
|Income taxes payable                                                                                                                                                                                                                                                                                                                      |  |                   |           |   |              |   | 650,000    |  
|Other current liabilities                                                                                                                                                                                                                                                                                                                 |  |                   | 4,000      |   |              |   | 8,000      |  
|                                                                                                                                                                                                                                                                                                                                          |  |                   |            |   |              |   |            |  
|Total current liabilities                                                                                                                                                                                                                                                                                                                 |  |                   | 6,814,000  |   |              |   | 9,425,000  |  
|                                                                                                                                                                                                                                                                                                                                          |  |                  
|Series F Convertible Preferred Stock                                                                                                                                                                                                                                                                                                      |  |                   | 3,187,000  |   |              |   | 3,629,000  |  
|                                                                                                                                                                                                                                                                                                                                          |  |                  
|Stockholders equity:                                                                                                                                                                                                                                                                                                                     |  |                   |            |   |              |   |            |  
|Convertible Preferred Stock, $0.01 par value; 1,300,537 shares authorized and 1,298,728 issued at September 30, 2008 and June 30,
2008; outstanding shares of 1,090,150 at September 30, 2008 and 1,090,171 at June 30, 2008 with an aggregate liquidation preference of $1,591,000 at September 30, 2008 and $1,714,000 at June 30, 2008 |  |                   | 11,000     |   |              |   | 11,000     |  
|Common stock, $0.01 par value; 80,000,000 shares authorized; issued and outstanding shares of 16,754,359 at September 30, 2008 and
16,491,244 at June 30, 2008.                                                                                                                                                                           |  |                   | 168,000    |   |              |   | 164,000    |  
|Additional paid-in capital                                                                                                                                                                                                                                                                                                                |  |                   | 13,006,000 |   |              |   | 12,928,000 |  
|Accumulated deficit                                                                                                                                                                                                                                                                                                                       |  |                   | (3,407,000 | ) |              |   | (3,561,000 | )
|                                                                                                                                                                                                                                                                                                                                          |  |                   |            |   |              |   |            |  
|Total stockholders equity                                                                                                                                                                                                                                                                                                                |  |                   | 9,778,000  |   |              |   | 9,542,000  |  
|                                                                                                                                                                                                                                                                                                                                          |  |                   |            |   |              |   |            |  
|Total liabilities and stockholders equity                                                                                                                                                                                                                                                                                                |  | $                 | 19,779,000 |   |              | $ | 22,596,000 |  
|                                                                                                                                                                                                                                                                                                                                          |  |                   |            |   |              |   |            |  

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations



|                                            |  |                                 |            |   |             |   |            |  
|------------------------------------------- |  | ------------------------------- | ---------- | - | ----------- | - | ---------- | -
|                                            |  | Three Months EndedSeptember 30, |           
|                                            |  | 2008                            |            |   | 2007        |  
|                                            |  | (unaudited)                     |            |   | (unaudited) |  
|Revenues:                                   |  |                                 |            |   |             |   |            |  
|Product sales                               |  | $                               | 6,113,000  |   |             | $ | 7,255,000  |  
|Service revenue                             |  |                                 | 2,574,000  |   |             |   | 2,823,000  |  
|Commission revenue                          |  |                                 | 2,127,000  |   |             |   | 2,339,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|                                            |  |                                 | 10,814,000 |   |             |   | 12,417,000 |  
|                                            |  |                                 |            |   |             |   |            |  
|Cost of revenue:                            |  |                                 |            |   |             |   |            |  
|Cost of product sales                       |  |                                 | 4,069,000  |   |             |   | 4,946,000  |  
|Cost of service revenue                     |  |                                 | 1,954,000  |   |             |   | 2,032,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|                                            |  |                                 | 6,023,000  |   |             |   | 6,978,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|Gross margin                                |  |                                 | 4,791,000  |   |             |   | 5,439,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|Other operating expenses:                   |  |                                 |            |   |             |   |            |  
|Selling, general and administrative         |  |                                 | 4,409,000  |   |             |   | 4,621,000  |  
|Depreciation and amortization               |  |                                 | 168,000    |   |             |   | 175,000    |  
|                                            |  |                                 |            |   |             |   |            |  
|                                            |  |                                 | 4,577,000  |   |             |   | 4,796,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|Operating income                            |  |                                 | 214,000    |   |             |   | 643,000    |  
|                                            |  |                                
|Other income                                |  |                                 | 36,000     |   |             |   | 13,000     |  
|                                            |  |                                 |            |   |             |   |            |  
|Income before income taxes                  |  |                                 | 250,000    |   |             |   | 656,000    |  
|Income tax expense                          |  |                                 | 96,000     |   |             |   | 167,000    |  
|                                            |  |                                 |            |   |             |   |            |  
|Net income                                  |  |                                 | 154,000    |   |             |   | 489,000    |  
|Preferred stock dividends                   |  |                                 | (54,000    | ) |             |   | (42,000    | )
|                                            |  |                                 |            |   |             |   |            |  
|Net income available to common stockholders |  | $                               | 100,000    |   |             | $ | 447,000    |  
|                                            |  |                                 |            |   |             |   |            |  
|Earnings per common share, basic            |  | $                               | 0.01       |   |             | $ | 0.03       |  
|                                            |  |                                 |            |   |             |   |            |  
|Earnings per common share, diluted          |  | $                               | 0.01       |   |             | $ | 0.02       |  
|                                            |  |                                 |            |   |             |   |            |  
|Shares used in computation - basic          |  |                                 | 16,656,834 |   |             |   | 15,799,015 |  
|                                            |  |                                 |            |   |             |   |            |  
|Shares used in computation - diluted        |  |                                 | 16,883,805 |   |             |   | 20,007,314 |  
|                                            |  |                                 |            |   |             |   |            |  

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders Equity (Unaudited)



|                                                            |  |                 |   |              |           |                          |                 |            |                    |   |         |       |   |            |   |  |   |            |   |  |   |           |  
|----------------------------------------------------------- |  | --------------- | - | ------------ | --------- | ------------------------ | --------------- | ---------- | ------------------ | - | ------- | ----- | - | ---------- | - |  | - | ---------- | - |  | - | --------- | -
|                                                            |  | Preferred Stock |   | Common Stock |           | AdditionalPaid-InCapital |                 |            | AccumulatedDeficit |   |         | Total |  
|                                                            |  | Number ofShares |   |              | Par Value |                          | Number ofShares |            | Par Value          |   |         |      
|Balance at July 1, 2008                                     |  | 1,090,171       |   |              | $         | 11,000                   |                 | 16,491,244 |                    | $ | 164,000 |       | $ | 12,928,000 |   |  | $ | (3,561,000 | ) |  | $ | 9,542,000 |  
|                                                            |  |                 |   |              |           |                          |                
|Issuance of common stock as compensation                    |  |                |   |              |           |                         |                 | 19,090     |                    |   |        |       |   | 15,000     |   |  |   |           |   |  |   | 15,000    |  
|Issuance of common stock upon the exercise of stock options |  |                |   |              |           |                         |                 | 50,000     |                    |   | 1,000   |       |   | 30,000     |   |  |   |           |   |  |   | 31,000    |  
|Issuance of common stock under Employee Stock Purchase Plan |  |                |   |              |           |                         |                 | 38,327     |                    |   | 1,000   |       |   | 28,000     |   |  |   |           |   |  |   | 29,000    |  
|Issuance of common stock upon the exercise of warrants      |  |                |   |              |           |                         |                 | 140,313    |                    |   | 2,000   |       |   | 79,000     |   |  |   |           |   |  |   | 81,000    |  
|Vesting of stock options issued to employees                |  |                |   |              |           |                         |                 |           |                    |   |        |       |   | 38,000     |   |  |   |            |   |  |   | 38,000    |  
|Conversion of preferred stock into common stock             |  | (21             | ) |              |           |                         |                 | 15,385     |                    |   |        |       |   |           |   |  |   |           |   |  |   |          |  
|Redemption of Preferred Series F shares                     |  |                |   |              |           |                         |                 |           |                    |   |        |       |   | (58,000    | ) |  |   |           |   |  |   | (58,000   | )
|Preferred stock dividends                                   |  |                |   |              |           |                         |                 |           |                    |   |        |       |   | (54,000    | ) |  |   |           |   |  |   | (54,000   | )
|Net income                                                  |  |                |   |              |           |                         |                 |           |                    |   |        |       |   |           |   |  |   | 154,000    |   |  |   | 154,000   |  
|                                                            |  |                 |   |              |           |                          |                 |            |                    |   |         |       |   |            |   |  |   |            |   |  |   |           |  
|Balance at September 30, 2008                               |  | 1,090,150       |   |              | $         | 11,000                   |                 | 16,754,359 |                    | $ | 168,000 |       | $ | 13,006,000 |   |  | $ | (3,407,000 | ) |  | $ | 9,778,000 |  
|                                                            |  |                 |   |              |           |                          |                 |            |                    |   |         |       |   |            |   |  |   |            |   |  |   |           |  

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Cash Flows



|                                                                                               |  |                                 |            |   |             |   |            |  
|---------------------------------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ----------- | - | ---------- | -
|                                                                                               |  | Three Months EndedSeptember 30, |           
|                                                                                               |  | 2008                            |            |   | 2007        |  
|                                                                                               |  | (unaudited)                     |            |   | (unaudited) |  
|Cash flows from operating activities                                                           |  |                                 |            |   |             |   |            |  
|Net income                                                                                     |  | $                               | 154,000    |   |             | $ | 489,000    |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities:    |  |                                 |            |   |             |   |            |  
|Provision for bad debts                                                                        |  |                                 | 15,000     |   |             |   | 26,000     |  
|Depreciation and amortization                                                                  |  |                                 | 168,000    |   |             |   | 175,000    |  
|Non-cash stock compensation expense                                                            |  |                                 | 53,000     |   |             |   | 124,000    |  
|Changes in operating assets and liabilities:                                                   |  |                                 |            |   |             |   |            |  
|Accounts and other receivables                                                                 |  |                                 | 1,526,000  |   |             |   | (545,000   | )
|Inventory                                                                                      |  |                                 | (91,000    | ) |             |   | (16,000    | )
|Prepaid expenses and other current assets                                                      |  |                                 | 83,000     |   |             |   | 34,000     |  
|Other assets                                                                                   |  |                                 |           |   |             |   | 10,000     |  
|Accounts payable and accrued expenses                                                          |  |                                 | (1,627,000 | ) |             |   | 458,000    |  
|Income taxes payable                                                                           |  |                                 | (650,000   | ) |             |   |           |  
|Accrued compensation and related benefits                                                      |  |                                 | (345,000   | ) |             |   | (351,000   | )
|Deferred revenue                                                                               |  |                                 | 15,000     |   |             |   | (41,000    | )
|Deferred tax asset, net                                                                        |  |                                 | 1,000      |   |             |   |           |  
|Other current liabilities                                                                      |  |                                 | (4,000     | ) |             |   | (27,000    | )
|                                                                                               |  |                                 |            |   |             |   |            |  
|Net cash provided by (used in) operating activities                                            |  |                                 | (702,000   | ) |             |   | 336,000    |  
|                                                                                               |  |                                 |            |   |             |   |            |  
|Cash flows from investing activities                                                           |  |                                 |            |   |             |   |            |  
|Purchase of property and equipment                                                             |  |                                 | (84,000    | ) |             |   | (112,000   | )
|                                                                                               |  |                                 |            |   |             |   |            |  
|Net cash used in investing activities                                                          |  |                                 | (84,000    | ) |             |   | (112,000   | )
|                                                                                               |  |                                 |            |   |             |   |            |  
|Cash flows from financing activities                                                           |  |                                 |            |   |             |   |            |  
|Proceeds from borrowings under line of credit                                                  |  |                                 |           |   |             |   | 795,000    |  
|Repayments of borrowings under line of credit                                                  |  |                                 |           |   |             |   | (2,203,000 | )
|Repayments of long-term debt                                                                   |  |                                 |           |   |             |   | (9,000     | )
|Proceeds from issuance of common stock to employees and exercise of stock options and warrants |  |                                 | 141,000    |   |             |   | 152,000    |  
|Payment of preferred stock dividends                                                           |  |                                 | (54,000    | ) |             |   | (42,000    | )
|Redemption of Preferred Series F shares                                                        |  |                                 | (500,000   | ) |             |   |           |  
|                                                                                               |  |                                 |            |   |             |   |            |  
|Net cash used in financing activities                                                          |  |                                 | (413,000   | ) |             |   | (1,307,000 | )
|                                                                                               |  |                                 |            |   |             |   |            |  
|Net change in cash and cash equivalents                                                        |  |                                 | (1,199,000 | ) |             |   | (1,083,000 | )
|Cash and cash equivalents - beginning of period                                                |  |                                 | 5,488,000  |   |             |   | 1,688,000  |  
|                                                                                               |  |                                 |            |   |             |   |            |  
|Cash and cash equivalents - end of period                                                      |  | $                               | 4,289,000  |   |             | $ | 605,000    |  
|                                                                                               |  |                                 |            |   |             |   |            |  



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Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

For the Three Months Ended September 30, 2008

1. Basis of Presentation

Avatech Solutions, Inc. (the Company) provides design automation and facilities and data management software, hardware, training, technical support and
professional services to corporations, government agencies and educational institutions throughout the United States.

The accompanying unaudited
consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Article 8 of Regulation S-X. Accordingly, certain
information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules or regulations. The interim financial
statements are unaudited, but reflect all adjustments (consisting of normal recurring accruals) which are, in managements opinion, necessary to present a fair statement of results of the interim periods presented. These financial statements
should be read in conjunction with the audited financial statements and the notes thereto in the Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2008. Operating results for the three months ended September 30,
2008 are not necessarily indicative of results for the full fiscal year or any future interim period.

The consolidated financial statements include the
accounts of Avatech Solutions, Inc. and its majority owned subsidiaries. All intercompany accounts and transactions between the Company and its consolidated affiliated companies have been eliminated in consolidation.

2. Recent Accounting Pronouncements

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

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

3. Employee Stock
Compensation Plans

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. The effect of applying Statement 123R was a
decrease to net income of $38,000 for the quarter ended September 30, 2008, or less than $0.01 per basic and diluted share.

The Board of Directors
may grant options under the Avatech Solutions, Inc. 2002 Stock Option Plan to purchase shares of the Companys common stock at an exercise price of not less than the fair market value of the common stock on the date of grant. The plan provides
for the granting of either incentive or non-qualified stock options to purchase an aggregate of up to 3,100,000 shares of common stock to eligible



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employees, officers, and directors of the Company. Stock options generally have a maximum term of 10 years. Options generally vest ratably over three or four
years, depending on the specific grant award. Pursuant to its Board compensation plan, for the three months ended September 30, 2008 and 2007, the Company issued 19,090 and 18,783 shares, respectively, of fully vested common stock to members of
the Board of Directors under the Companys Restricted Stock Award Plan, with an aggregate market value of $16,000 and $16,000, respectively. For the three months ended September 30, 2008 and 2007, total stock compensation expense charged
against income for these plans was $53,000 and $124,000, respectively.

There were no stock option awards granted during the three months ended
September 30, 2008. The following are the assumptions made in computing the fair value of stock-based awards for the three months ended September 30, 2007:



|                                               |  |   |           |  
|---------------------------------------------- |  | - | --------- | -
|Average risk-free interest rate                |  |   | 4.18      | %
|Dividend yield                                 |  |   | 0         | %
|Expected term                                  |  |   | 6.6 years |  
|Average expected volatility                    |  |   | 0.96      |  
|Weighted average fair value of granted options |  | $ | 0.70      |  

Expected volatilities are based on historical volatility of the market price for the Companys common stock.
The expected term of options granted represents the period of time that options granted are expected to be outstanding. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The risk-free
rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

A summary of stock
option activity during the three months ended September 30, 2008 and related information is included in the table below:



|                                            |  |           |   |  |                               |      |                         |   |        
|------------------------------------------- |  | --------- | - |  | ----------------------------- | ---- | ----------------------- | - | -------
|                                            |  | Options   |   |  | Weighted-AverageExercisePrice |      | AggregateIntrinsicValue
|Outstanding at July 1, 2008                 |  | 1,678,205 |   |  | $                             | 1.11 |                         |   |        
|Granted                                     |  |          |   |  |                               |     |                         |   |        
|Exercised                                   |  | (50,000   | ) |  |                               | 0.60 |                         |   |        
|Forfeited                                   |  | (25,000   | ) |  |                               | 0.60 |                         |   |        
|                                            |  |           |   |  |                               |      |                         |   |        
|Outstanding at September 30, 2008           |  | 1,603,205 |   |  | $                             | 1.14 |                         | $ | 167,000
|                                            |  |           |   |  |                               |      |                         |   |        
|Exercisable at September 30, 2008           |  | 1,132,412 |   |  | $                             | 1.18 |                         | $ | 157,000
|                                            |  |           |   |  |                               |      |                         |   |        
|Weighted-average remaining contractual life |  | 7.5 Years |   |  |                               |      |                         |   |        
|                                            |  |           |   |  |                               |      |                         |   |        

All options granted have an exercise price equal to the fair market value of the Companys common stock on
the date of grant. Exercise prices for options outstanding as of September 30, 2008 ranged from $0.17 to $63.33 as follows



|                         |  |                    |  |                                                    |      |                                                              |           |                    |           |                                                    |   |                                                              |  |          
|------------------------ |  | ------------------ |  | -------------------------------------------------- | ---- | ------------------------------------------------------------ | --------- | ------------------ | --------- | -------------------------------------------------- | - | ------------------------------------------------------------ |  | ---------
|Range of Exercise Prices |  | OptionsOutstanding |  | WeightedAverageExercisePrices ofOptionsOutstanding |      | WeightedAverageRemainingContractualLife ofOptionsOutstanding |           | OptionsExercisable |           | WeightedAverageExercisePrices ofOptionsExercisable |   | WeightedAverageRemainingContractualLife ofOptionsExercisable
|$ 0.17 - 0.34            |  | 107,997            |  | $                                                  | 0.29 |                                                              | 5.2 years |                    | 107,997   |                                                    | $ | 0.29                                                         |  | 5.2 years
|0.35 - 0.91              |  | 1,023,000          |  |                                                    | 0.78 |                                                              | 7.8 years |                    | 688,458   |                                                    |   | 0.75                                                         |  | 7.2 years
|1.05 - 63.33             |  | 472,208            |  |                                                    | 2.10 |                                                              | 7.5 years |                    | 335,957   |                                                    |   | 2.35                                                         |  | 7.3 years
|                         |  |                    |  |                                                    |      |                                                              |           |                    |           |                                                    |   |                                                              |  |          
|                         |  | 1,603,205          |  |                                                    |      |                                                              |           |                    | 1,132,412 |                                                    |   |                                                              |  |          
|                         |  |                    |  |                                                    |      |                                                              |           |                    |           |                                                    |   |                                                              |  |          



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Assuming that no additional share-based payments are granted after September 30, 2008, unamortized stock
compensation expense of $335,000 will be recognized in the statement of operations over a weighted average period of 5.5 years.

4. Borrowings Under
Line of Credit

The Company maintains a line of credit from a bank which provides for up to $5 million of borrowings limited to 80% of the
Companys aggregate eligible accounts receivable. The loan bears interest at a rate tied to the banks prime rate adjusted for changes in the Companys capital structure. The interest rate ranges from the banks prime rate plus
two percent to a low of the banks prime rate plus 0.25% when the Companys net worth exceeds $4,000,000 at the end of a fiscal quarter. The interest rate as of September 30, 2008 was the banks prime rate plus one-half percent,
or 5.5%. The loan has a December 31, 2008 expiration date and is secured by all of the Companys assets, except inventory. The Company has received a commitment from its Bank to renew its line of credit at similar terms except that the
proposed interest rate is the 30 day London Interbank Offered Rate (LIBOR) plus 2.25%.

The Company had no outstanding borrowings from the bank under this
credit line at September 30, 2008 or June 30, 2008.

5. Income Taxes

Income tax expense during the three months ended September 30, 2008 and 2007 includes both federal and state income taxes. During fiscal year 2008, the Companys taxable income was offset by approximately
$600,000 of net operating loss carryforwards. The Companys remaining federal net operating loss carryforwards total $1.2 million and are subject to a $92,000 annual limitation.

6. Earnings Per Share

Basic earnings per common share is computed by dividing net earnings available to common
stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings 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. As of September 30, 2008, 9,540,367 shares of common stock were issuable upon the conversion or exercise of options, warrants and preferred stock. For the three months ended September 30,
2008, there were 4,849,870 common stock equivalents excluded from the computation of diluted earnings per share because their effect would have been antidilutive.

The following summarizes the computations of basic and diluted earnings per common share for the three months ended September 30, 2008 and 2007:



|                                                    |  |                                 |            |   |      |   |            |  
|--------------------------------------------------- |  | ------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                    |  | Three Months EndedSeptember 30, |           
|                                                    |  | 2008                            |            |   | 2007 |  
|Numerator for basic earnings per share:             |  |                                 |            |   |      |   |            |  
|Net income                                          |  | $                               | 154,000    |   |      | $ | 489,000    |  
|Less: preferred stock dividends                     |  |                                 | (54,000    | ) |      |   | (42,000    | )
|                                                    |  |                                 |            |   |      |   |            |  
|Net income available to common stockholders         |  | $                               | 100,000    |   |      | $ | 447,000    |  
|                                                    |  |                                 |            |   |      |   |            |  
|Denominator:                                        |  |                                 |            |   |      |   |            |  
|Weighted average shares outstanding - basic         |  |                                 | 16,656,834 |   |      |   | 15,799,015 |  
|                                                    |  |                                
|Assumed conversion of preferred stock               |  |                                 |           |   |      |   | 3,783,321  |  
|Effect of outstanding stock options                 |  |                                 | 189,271    |   |      |   | 235,821    |  
|Effect of outstanding stock warrants                |  |                                 | 37,700     |   |      |   | 189,157    |  
|                                                    |  |                                 |            |   |      |   |            |  
|Weighted average shares outstanding - fully diluted |  |                                 | 16,883,805 |   |      |   | 20,007,314 |  
|                                                    |  |                                 |            |   |      |   |            |  
|Earnings per common share - basic                   |  | $                               | 0.01       |   |      | $ | 0.03       |  
|                                                    |  |                                 |            |   |      |   |            |  
|Earnings per common share - diluted                 |  | $                               | 0.01       |   |      | $ | 0.02       |  
|                                                    |  |                                 |            |   |      |   |            |  



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##### Table of Contents

7. Liquidity and Capital Resources

The Company had no outstanding long-term debt at June 30, 2008 and the Company had a working capital surplus of approximately $4,409,000. As a result of its operations, the Companys management believes that
its near-term needs can be met from its available cash resources, cash flows from operations and its line of credit.

8. Subsequent Event

On October 1, 2008, pursuant to the agreements executed as part of its June 2006 offering of its Series F Convertible Preferred Stock (Series F),
the Company redeemed an additional 500 of the original 4,000 Series F shares for payments to the holders of Series F totaling $500,000 plus accumulated dividends of approximately $14,000. The Series F shareholders have the right to request
redemptions of up to $500,000 of the Series F stock each January 1, April 1, July 1 and October 1 and have expressed their intention of requesting the redemptions until their Series F stock has been fully redeemed. The
Company expects to fund these redemptions out of its excess cash balance and does not anticipate that they will have any material effect on the Companys liquidity. Each $500,000 redemption of the Preferred Series F shares will result in a
decrease of the Preferred Series F balance of $442,000 and a reduction of additional paid-in capital of $58,000.



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##### Table of Contents

|ITEM 2. | 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.

This report contains 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 we operate, 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; changes in interest rates, the cost of funds, and demand for the Companys products and services; changes in the Companys competitive position or competitive actions by other companies; the Companys
ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond the Companys control. Consequently, all of the forward-looking statements made in this report 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 our business or operations. Except as required by
applicable laws, the Company does not intend to publish updates or revisions of any forward-looking statements to reflect new information, future events or otherwise.

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 expertise 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.

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



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



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



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

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 subscribers do not participate in the delivery of these subscription products or the web support and eLearning lesson benefits, Avatech records the gross profit from the sale of Autodesk software subscriptions as
commission revenue. Approximately 92% of the Companys total product revenue in the quarter 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 90 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, 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.

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, 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
Expense- Selling, general and administrative expense 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 Expense- 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, and leasehold improvements. The Company computes depreciation and amortization expenses using the straight-line method. The Company 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- Interest expense consists primarily of interest on a revolving line of
credit.

Three Months Ended September 30, 2008 Compared to the Three Months Ended September 30, 2007



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The following tables set forth a comparison of the Companys results of operations for the three
month period ended September 30, 2008 to the three month period ended September 30, 2007. The amounts are derived from selected items reflected in the Companys unaudited Consolidated Statements of Operations included elsewhere in
this report. The three months financial results are not necessarily indicative of future results.

Revenues



|                   |  |                                  |            |      |   |            |  |       |   
|------------------ |  | -------------------------------- | ---------- | ---- | - | ---------- |  | ----- | --
|                   |  | Three Months Ended September 30, |           
|                   |  | 2008                             |            | 2007 |   | %change    | 
|Revenues:          |  |                                  |            |      |   |            |  |       |   
|Product sales      |  | $                                | 6,113,000  |      | $ | 7,255,000  |  | (15.7 | )%
|Service revenue    |  |                                  | 2,574,000  |      |   | 2,823,000  |  | (8.8  | )%
|Commission revenue |  |                                  | 2,127,000  |      |   | 2,339,000  |  | (9.1  | )%
|                   |  |                                  |            |      |   |            |  |       |   
|Total revenues     |  | $                                | 10,814,000 |      | $ | 12,417,000 |  | (12.9 | )%
|                   |  |                                  |            |      |   |            |  |       |   

Revenues. Total revenues for the three months ended September 30, 2008 decreased by
$1.6 million or 12.9% when compared to the same period in the prior fiscal year as a result of a decreased average number of sales professionals and a weakening national economy. The average number of salespeople decreased as a result of the
Companys fiscal year 2008 strategy of limiting hiring to control costs and should increase the likelihood of future profitable results. Management believes that it now has processes in place to help assure consistent profitability and is now
implementing a plan to gradually build its sales force. Despite poor economic conditions, the Company improved sales productivity, increasing the average revenue per salesperson during the three months ended September 30, 2008 compared with the
same period in the prior fiscal year.

Product sales decreased $1,142,000 or 15.7% for the three months ended September 30, 2008 as
compared to the same period in the prior fiscal year. The decrease in product sales is due primarily to the previously discussed decrease in the number of sales professionals as well as the weakened national economy. In addition, the Company also
reported lower Service and Commission revenues when compared to the same period in the prior fiscal year for the same reasons.

Cost of Revenues and
Gross Margin



|                        |  |                                  |           |      |   |           |  |       |   
|----------------------- |  | -------------------------------- | --------- | ---- | - | --------- |  | ----- | --
|                        |  | Three Months Ended September 30, |          
|                        |  | 2008                             |           | 2007 |   | %change   | 
|Cost of revenue:        |  |                                  |           |      |   |           |  |       |   
|Cost of product sales   |  | $                                | 4,069,000 |      | $ | 4,946,000 |  | (17.7 | )%
|Cost of service revenue |  |                                  | 1,954,000 |      |   | 2,032,000 |  | (3.8  | )%
|                        |  |                                  |           |      |   |           |  |       |   
|Total cost of revenue   |  | $                                | 6,023,000 |      | $ | 6,978,000 |  | (13.7 | )%
|                        |  |                                  |           |      |   |           |  |       |   
|Gross margin            |  | $                                | 4,791,000 |      | $ | 5,439,000 |  |       |   
|                        |  |                                  |           |      |   |           |  |       |   

Cost of revenue. The total cost of revenue decreased $955,000, or 13.7%, for the three
months ended September 30, 2008 when compared to the same period in the prior fiscal year.

Cost of product sales decreased 17.7%
while product sales decreased only 15.7% during the three months ended September 30, 2008 as compared with the same period the prior fiscal year. Product costs decreased at a higher rate than revenues as the Company more effectively sold the
higher-end software solutions which generated higher gross margin rates.

Cost of service revenue decreased $78,000, or 3.8%, for the three
months ended September 30, 2008 when compared to the same period in the prior fiscal year, while service revenues decreased $249,000 or 9.1%. Cost of service revenue as a percentage of related revenue increased from 72.0% to 75.9% during the
three months ended September 30, 2008 when compared to the same period in the prior fiscal year. The



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higher cost of service revenue resulted from lowered productivity of the services personnel during the current fiscal quarter due to a reduction in the
volume of services work sold during the period.

Gross margin. For the previously-stated reasons, the Companys gross margin
percentage increased slightly to 44.3% for the three months ended September 30, 2008 as compared to 43.8% for the same period in the prior fiscal year.

Other Operating Expenses



|                                    |  |                                  |           |      |   |           |  |      |   
|----------------------------------- |  | -------------------------------- | --------- | ---- | - | --------- |  | ---- | --
|                                    |  | Three Months Ended September 30, |          
|                                    |  | 2008                             |           | 2007 |   | %change   | 
|Other operating expenses:           |  |                                  |           |      |   |           |  |      |   
|Selling, general and administrative |  | $                                | 4,409,000 |      | $ | 4,621,000 |  | (4.6 | )%
|Depreciation and amortization       |  |                                  | 168,000   |      |   | 175,000   |  | (4.0 | )%
|                                    |  |                                  |           |      |   |           |  |      |   
|Total other operating expenses      |  | $                                | 4,577,000 |      | $ | 4,796,000 |  | (4.6 | )%
|                                    |  |                                  |           |      |   |           |  |      |   

Selling, General and Administrative Expense. Selling, general and administrative expenses
decreased $212,000, or 4.6%, for the three months ended September 30, 2008 when compared to the same period in the prior fiscal year. Selling, general and administrative expense as a percent of total revenues was 40.8% for the three months
ended September 30, 2008, up from 37.2% for the same period in the prior fiscal year. The decrease in selling, general and administrative expenses are primarily the result of decreased commissions due to lower sales, and lower salaries due to
the Company having fewer employees as a result of the Companys fiscal year 2008 strategy of limiting hiring to control costs.

Depreciation and Amortization. Depreciation and amortization expenses decreased $7,000, or 4.0%, for the three months ended September 30, 2008 when compared to the same period in the prior fiscal year.

Other Income



|             |  |                                  |        |      |   |         |  |       |  
|------------ |  | -------------------------------- | ------ | ---- | - | ------- |  | ----- | -
|             |  | Three Months Ended September 30, |       
|             |  | 2008                             |        | 2007 |   | %change | 
|Other income |  | $                                | 36,000 |      | $ | 13,000  |  | 176.9 | %
|             |  |                                  |        |      |   |         |  |       |  

Other Income. The Company earned $36,000 in other income during the three months ended
September 30, 2008 compared to $13,000 in other expense during the same period in the prior fiscal year. The Company had a positive cash balance and no borrowings against its line of credit during the current quarter resulting in net interest
income. During the same period in the prior fiscal year, the Company had borrowings against its line of credit, and earned less interest due to its lower average cash balances.

Income Tax Expense



|                   |  |                                  |        |      |   |         |  |       |   
|------------------ |  | -------------------------------- | ------ | ---- | - | ------- |  | ----- | --
|                   |  | Three Months Ended September 30, |       
|                   |  | 2008                             |        | 2007 |   | %change | 
|Income tax expense |  | $                                | 96,000 |      | $ | 167,000 |  | (42.5 | )%
|                   |  |                                  |        |      |   |         |  |       |   

Income Tax Expense. The Company recorded a tax provision of $96,000 during the three months
ended September 30, 2008, a 42.5% decrease over the $167,000 recorded for the same period in the prior fiscal year. During fiscal year 2008, the Companys taxable income was offset by approximately $600,000 of federal net operating losses.
The Companys remaining federal net operating loss carryforwards total $1.2 million and are subject to a $92,000 annual limitation. Due to the lower amount of available federal net operating loss carryforwards in fiscal year 2009 versus 2008,
income tax is a higher percentage of income before income taxes.



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##### Table of Contents

Liquidity and Capital Resources

The Company has financed its operations and met its capital expenditure requirements primarily through cash flows provided by operations.

The Company has a line of credit which provides for up to $5 million of borrowings limited to 80% of the Companys aggregate eligible accounts receivable. The loan bears interest at a rate tied to the banks
prime rate and changes as the Companys tangible net worth changes. 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 tangible net worth exceeds
$4,000,000 at the end of a fiscal quarter. Based on the Companys current tangible net worth, the interest rate for the quarter ended September 30, 2008 was the banks prime rate plus one-half percent or 5.50%. The loan will expire on
December 31, 2008 and is secured by all of the Companys assets, except inventory. The Company has received a commitment from its Bank to renew its line of credit at similar terms except that the proposed interest rate is the 30 day London
Interbank Offered Rate (LIBOR) plus 2.25%.

There were no outstanding borrowings from the bank under this line of credit as of
September 30, 2008 or September 30, 2007.

The Companys operating assets and liabilities consist primarily of accounts
receivable, inventory and accounts payable. 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 inventory levels through
arrangements with suppliers to ship products with an average delivery period of two days and centralized inventory management. The Company purchases approximately 97% of its product from one principal supplier which provides it with credit to
finance those purchases.

The Companys investing activities consist principally of investments in computer and office equipment.
Capital expenditures for the three months ended September 30, 2008 decreased to $84,000 from $112,000 for the same period in 2007 due to a decreased need for new or upgraded IT equipment and infrastructure due to significant purchases in recent
years.

For the three months ended September 30, 2008, net cash used in operating activities was $702,000, compared with $336,000 cash
provided operating activities during the same period in 2008, resulting primarily from payment of income taxes coupled with decreased net income.

For the three months ended September 30, 2008, the Company used $413,000 in financing activities compared with $1,307,000 for the same period in 2007. Also during the current quarter the Company redeemed $500,000 of Preferred Series F
shares, while in the same quarter of the prior fiscal year, the Company paid down $1,408,000 of the outstanding balance on the line of credit. The $500,000 redemption of the Preferred Series F shares resulted in a decrease of the Preferred Series F
balance of $442,000 and a reduction of additional paid-in capital of $58,000. The Series F shareholders have the right to request redemptions of up to $500,000 of the Series F stock each January 1, April 1, July 1 and
October 1 and have expressed their intention of requesting the redemptions until their Series F stock has been fully redeemed. The Company expects to fund these redemptions out of its excess cash balance and does not anticipate that they will
have any material effect on the Companys liquidity.

The Company had no long-term debt at September 30, 2008, and had working
capital of $4,409,000.

As a result of its profitable operations, the Companys has positive working capital and management believes
the Companys near-term needs can be met from its available cash resources, cash flows from operations and its line of credit.

Because the Company is one of the largest resellers of Autodesk software and because Autodesk has continued to state its intention to continue to strengthen its relationships with its resellers, the Company 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 with Autodesk, which designates the Company as an authorized reseller of Autodesk
products, provides one year performance targets but expires February 1, 2010.



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##### Table of Contents

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



|                        |  |       |           |                 |   |             |  |             |           |                  |   |         |  |   |       
|----------------------- |  | ----- | --------- | --------------- | - | ----------- |  | ----------- | --------- | ---------------- | - | ------- |  | - | ------
|                        |  | Total |           | Less than 1year |   | 1 - 3 years |  | 3 - 5 years |           | More than5 years
|Contractual Obligations |  |       |           |                 |   |             |  |             |           |                  |   |         |  |   |       
|Operating leases        |  | $     | 4,485,000 |                 | $ | 1,308,000   |  | $           | 2,215,000 |                  | $ | 883,000 |  | $ | 79,000
|                        |  |       |           |                 |   |             |  |             |           |                  |   |         |  |   |       
|Total obligations       |  | $     | 4,485,000 |                 | $ | 1,308,000   |  | $           | 2,215,000 |                  | $ | 883,000 |  |   | 79,000
|                        |  |       |           |                 |   |             |  |             |           |                  |   |         |  |   |       



|ITEM 4T. | CONTROLS AND PROCEDURES
|-------- | -----------------------

The Company maintains
disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports filed under the Securities Exchange Act of 1934 with the SEC, such as this Quarterly Report, is recorded, processed, summarized
and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO),
as appropriate, to allow for timely decisions regarding required disclosure. 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 is also 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, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of September 30, 2008 was carried out under the supervision and with the participation of management, including the CEO and the CFO. Based on
that evaluation, management, including the CEO and the CFO, has concluded that the Companys disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the quarter ended September 30, 2008, there was no change in our internal control over financial reporting that has materially affected, or
is reasonably likely to materially affect, the Companys internal control over financial reporting.

PART II. OTHER
INFORMATION



|ITEM 6. | EXHIBITS
|------- | --------

The exhibits filed or furnished with this
report are listed in the Exhibit Index that immediately follows the Signatures to this report, which list is incorporated herein by reference.



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                        |  |                         |  |                                                     
|----------------------- |  | ----------------------- |  | ----------------------------------------------------
|                        |  | AVATECH SOLUTIONS, INC.
|                        |  |                        
|Date: November 14, 2008 |  | By                      |  | /s/ George M. Davis                                 
|                        |  |                         |  | George M. Davis                                     
|                        |  |                         |  | President and Chief Executive Officer               
|                        |  |                        
|Date: November 14, 2008 |  | By                      |  | /s/ Lawrence Rychlak                                
|                        |  |                         |  | Lawrence Rychlak                                    
|                        |  |                         |  | Executive Vice President and Chief Financial Officer
|                        |  |                         |  | (Principal financial and accounting officer)        



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EXHIBIT INDEX



|        |  |                                                                         
|------- |  | ------------------------------------------------------------------------
|Exhibit |  | Description                                                             
|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)                        



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