---



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 March 31, 2004



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.)
|                                                               | 
|11400  A Cronridge Drive, 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 an accelerated filer (as defined in Rule 12b-2 of the 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.



|                                       |  |                            
|-------------------------------------- |  | ---------------------------
|Class                                  |  | Outstanding at May 14, 2004
|Common Stock, par value $.01 per share |  | 9,460,378                  



---



---

AVATECH SOLUTIONS, INC. AND SUBSIDIARIES



INDEX



|           |  |                                                                                                |  |     
|---------- |  | ---------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                |  | Page
|           |  |                                                                                               
|PART I     |  | FINANCIAL INFORMATION                                                                          |  |     
|           |  |                                                                                               
|Item 1.    |  | Consolidated Financial Statements                                                              |  |     
|           |  |                                                                                               
|           |  | Consolidated Balance Sheets  June 30, 2003 (Audited) and March 31, 2004 (Unaudited)           |  | 3   
|           |  |                                                                                               
|           |  | Consolidated Statements of Operations  Three months ended March 31, 2003 and 2004 (Unaudited) |  | 5   
|           |  |                                                                                               
|           |  | Consolidated Statements of Operations  Nine months ended March 31, 2003 and 2004 (Unaudited)  |  | 6   
|           |  |                                                                                               
|           |  | Consolidated Statement of Stockholders Deficit  Nine months ended March 31, 2004 (Unaudited) |  | 7   
|           |  |                                                                                               
|           |  | Consolidated Statements of Cash Flows  Nine months ended March 31, 2003 and 2004 (Unaudited)  |  | 8   
|           |  |                                                                                               
|           |  | Notes to Consolidated Financial Statements  March 31, 2004 (Unaudited)                        |  | 9   
|           |  |                                                                                               
|Item 2.    |  | Managements Discussion and Analysis of Results of Operations and Financial Condition          |  | 18  
|           |  |                                                                                               
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                                     |  | 26  
|           |  |                                                                                               
|Item 4.    |  | Controls and Procedures                                                                        |  | 26  
|           |  |                                                                                               
|PART II    |  | OTHER INFORMATION                                                                              |  |     
|           |  |                                                                                               
|Item 1.    |  | Legal Proceedings                                                                              |  | 27  
|           |  |                                                                                               
|Item 2.    |  | Changes in Securities                                                                          |  | 27  
|           |  |                                                                                               
|Item 3.    |  | Defaults upon Senior Securities                                                                |  | 27  
|           |  |                                                                                               
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                            |  | 27  
|           |  |                                                                                               
|Item 5.    |  | Other Information                                                                              |  | 27  
|           |  |                                                                                               
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                               |  | 28  
|           |  |                                                                                               
|SIGNATURES |  |                                                                                                |  | 31  



2



---

Part I. Financial Information



Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets



|                                                                                                |  |               |           |                |   |          
|----------------------------------------------------------------------------------------------- |  | ------------- | --------- | -------------- | - | ---------
|                                                                                                |  | June 30, 2003 |           | March 31, 2004
|                                                                                                |  | (audited)     |           | (unaudited)   
|Assets                                                                                          |  |               |           |                |   |          
|Current assets:                                                                                 |  |               |           |                |   |          
|Cash and cash equivalents                                                                       |  | $             | 540,384   |                | $ | 680,423  
|Accounts receivable, less allowance of $160,000 at June 30, 2003 and $145,000 at March 31, 2004 |  |               | 3,393,123 |                |   | 4,280,209
|Inventory                                                                                       |  |               | 146,877   |                |   | 314,384  
|Prepaid expenses                                                                                |  |               | 395,189   |                |   | 394,064  
|Other current assets                                                                            |  |               | 94,258    |                |   | 136,551  
|                                                                                                |  |               |           |                |   |          
|Total current assets                                                                            |  |               | 4,569,831 |                |   | 5,805,631
|Property and equipment:                                                                         |  |               |           |                |   |          
|Computer software and equipment                                                                 |  |               | 2,925,159 |                |   | 2,756,422
|Office, furniture and equipment                                                                 |  |               | 760,020   |                |   | 801,829  
|Leasehold improvements                                                                          |  |               | 207,661   |                |   | 210,032  
|                                                                                                |  |               |           |                |   |          
|                                                                                                |  |               | 3,892,840 |                |   | 3,768,283
|Less accumulated depreciation and amortization                                                  |  |               | 3,255,361 |                |   | 3,303,581
|                                                                                                |  |               |           |                |   |          
|                                                                                                |  |               | 637,479   |                |   | 464,702  
|Goodwill                                                                                        |  |               | 52,272    |                |   | 52,272   
|Other assets                                                                                    |  |               | 12,385    |                |   | 56,674   
|                                                                                                |  |               |           |                |   |          
|Total assets                                                                                    |  | $             | 5,271,967 |                | $ | 6,379,279
|                                                                                                |  |               |           |                |   |          



See accompanying notes.



3



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets (Continued)



|                                                                                                                                                                                                           |  |               |            |   |                |   |            |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | - | -------------- | - | ---------- | -
|                                                                                                                                                                                                           |  | June 30, 2003 |            |   | March 31, 2004 |  
|                                                                                                                                                                                                           |  | (audited)     |            |   | (unaudited)    |  
|Liabilities and stockholders deficit                                                                                                                                                                      |  |               |            |   |                |   |            |  
|Current liabilities:                                                                                                                                                                                       |  |               |            |   |                |   |            |  
|Accounts payable and accrued expenses                                                                                                                                                                      |  | $             | 5,089,207  |   |                | $ | 4,380,397  |  
|Accrued compensation and related benefits                                                                                                                                                                  |  |               | 354,555    |   |                |   | 468,385    |  
|Borrowings under line-of-credit                                                                                                                                                                            |  |               | 1,634,709  |   |                |   | 1,800,831  |  
|Current portion of long-term debt                                                                                                                                                                          |  |               | 250,000    |   |                |   | 26,250     |  
|Deferred revenue                                                                                                                                                                                           |  |               | 736,963    |   |                |   | 754,473    |  
|Other current liabilities                                                                                                                                                                                  |  |               | 325,920    |   |                |   | 322,742    |  
|                                                                                                                                                                                                           |  |               |            |   |                |   |            |  
|Total current liabilities                                                                                                                                                                                  |  |               | 8,391,354  |   |                |   | 7,753,078  |  
|Long-term debt                                                                                                                                                                                             |  |               |           |   |                |   | 1,666,438  |  
|Notes payable to related parties subject to refinancing                                                                                                                                                    |  |               | 966,503    |   |                |   | 893,795    |  
|Other long-term liabilities                                                                                                                                                                                |  |               | 363,307    |   |                |   | 296,320    |  
|Commitments and contingencies                                                                                                                                                                              |  |               |           |   |                |   |           |  
|Minority interest                                                                                                                                                                                          |  |               | 1,525,000  |   |                |   | 1,525,000  |  
|Stockholders deficit:                                                                                                                                                                                     |  |               |            |   |                |   |            |  
|Series C Convertible Preferred Stock, $0.01 par value; 1,000,000 shares authorized and 172,008 issued and outstanding at June 30, 2003 and -0-
shares authorized, issued and outstanding at March 31, 2004 |  |               | 1,720      |   |                |   |           |  
|Series D Convertible Preferred Stock, $0.01 par value; -0- shares authorized, issued and outstanding at June 30, 2003 and 1,297,537 shares
authorized, issued and outstanding at March 31, 2004            |  |               |           |   |                |   | 12,975     |  
|Common stock, $0.01 par value; 22,500,000 shares authorized; 8,897,874 and 9,492,812 shares issued and outstanding at June 30, 2003 and March
31, 2004, respectively                                       |  |               | 88,980     |   |                |   | 94,928     |  
|Additional paid-in capital                                                                                                                                                                                 |  |               | 3,242,454  |   |                |   | 3,771,272  |  
|Accumulated deficit                                                                                                                                                                                        |  |               | (9,307,351 | ) |                |   | (9,634,527 | )
|                                                                                                                                                                                                           |  |               |            |   |                |   |            |  
|Total stockholders deficit                                                                                                                                                                                |  |               | (5,974,197 | ) |                |   | (5,755,352 | )
|                                                                                                                                                                                                           |  |               |            |   |                |   |            |  
|Total liabilities and stockholders deficit                                                                                                                                                                |  | $             | 5,271,967  |   |                | $ | 6,379,279  |  
|                                                                                                                                                                                                           |  |               |            |   |                |   |            |  



See accompanying notes.



4



---

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations



|                                                                     |  |                              |           |   |             |   |           |  
|-------------------------------------------------------------------- |  | ---------------------------- | --------- | - | ----------- | - | --------- | -
|                                                                     |  | Three Months Ended March 31, |          
|                                                                     |  | 2003                         |           |   | 2004        |  
|                                                                     |  | (unaudited and restated)     |           |   | (unaudited) |  
|Revenues:                                                            |  |                              |           |   |             |   |           |  
|Product sales                                                        |  | $                            | 3,289,161 |   |             | $ | 5,086,415 |  
|Service revenue                                                      |  |                              | 1,452,621 |   |             |   | 1,336,533 |  
|Commission revenue                                                   |  |                              | 1,326,651 |   |             |   | 1,413,097 |  
|                                                                     |  |                              |           |   |             |   |           |  
|                                                                     |  |                              | 6,068,433 |   |             |   | 7,836,045 |  
|                                                                     |  |                              |           |   |             |   |           |  
|Cost of revenue:                                                     |  |                              |           |   |             |   |           |  
|Cost of product sales                                                |  |                              | 2,247,821 |   |             |   | 3,472,919 |  
|Cost of service revenue                                              |  |                              | 898,995   |   |             |   | 912,379   |  
|                                                                     |  |                              |           |   |             |   |           |  
|                                                                     |  |                              | 3,146,816 |   |             |   | 4,385,298 |  
|                                                                     |  |                              |           |   |             |   |           |  
|Gross margin                                                         |  |                              | 2,921,617 |   |             |   | 3,450,747 |  
|Other expenses:                                                      |  |                              |           |   |             |   |           |  
|Selling, general and administrative                                  |  |                              | 3,222,012 |   |             |   | 2,970,289 |  
|Depreciation and amortization                                        |  |                              | 60,516    |   |             |   | 81,691    |  
|                                                                     |  |                              |           |   |             |   |           |  
|                                                                     |  |                              | 3,282,528 |   |             |   | 3,051,980 |  
|                                                                     |  |                              |           |   |             |   |           |  
|Operating income (loss)                                              |  |                              | (360,911  | ) |             |   | 398,767   |  
|                                                                     |  |                              |           |   |             |   |           |  
|Other income (expense):                                              |  |                              |           |   |             |   |           |  
|Minority interest                                                    |  |                              | (38,125   | ) |             |   | (38,125   | )
|Interest and other income                                            |  |                              | 3,907     |   |             |   | 5,260     |  
|Interest expense                                                     |  |                              | (59,989   | ) |             |   | (98,158   | )
|                                                                     |  |                              |           |   |             |   |           |  
|                                                                     |  |                              | (94,207   | ) |             |   | (131,023  | )
|                                                                     |  |                              |           |   |             |   |           |  
|Income (loss) from continuing operations before income taxes         |  |                              | (455,118  | ) |             |   | 267,744   |  
|Income tax expense                                                   |  |                              |          |   |             |   | 10,828    |  
|                                                                     |  |                              |           |   |             |   |           |  
|Income (loss) from continuing operations                             |  |                              | (455,118  | ) |             |   | 256,916   |  
|Loss from operations of discontinued operating segments              |  |                              | (303,674  | ) |             |   | (86,554   | )
|                                                                     |  |                              |           |   |             |   |           |  
|Net income (loss)                                                    |  |                              | (758,792  | ) |             |   | 170,362   |  
|Preferred stock dividends                                            |  |                              |          |   |             |   | 19,463    |  
|                                                                     |  |                              |           |   |             |   |           |  
|Earnings (loss) attributable to common stockholders                  |  | $                            | (758,792  | ) |             | $ | 150,899   |  
|                                                                     |  |                              |           |   |             |   |           |  
|Earnings (loss) from continuing operations per common share, basic   |  | $                            | (0.05     | ) |             | $ | 0.03      |  
|                                                                     |  |                              |           |   |             |   |           |  
|Earnings (loss) per common share, basic                              |  | $                            | (0.08     | ) |             | $ | 0.02      |  
|                                                                     |  |                              |           |   |             |   |           |  
|Earnings (loss) from continuing operations per common share, diluted |  | $                            | (0.05     | ) |             | $ | 0.02      |  
|                                                                     |  |                              |           |   |             |   |           |  
|Earnings (loss) per common share, diluted                            |  | $                            | (0.08     | ) |             | $ | 0.01      |  
|                                                                     |  |                              |           |   |             |   |           |  



See accompanying notes.



5



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations



|                                                                     |  |                             |            |   |             |   |            |  
|-------------------------------------------------------------------- |  | --------------------------- | ---------- | - | ----------- | - | ---------- | -
|                                                                     |  | Nine Months Ended March 31, |           
|                                                                     |  | 2003                        |            |   | 2004        |  
|                                                                     |  | (unauditedand restated)     |            |   | (unaudited) |  
|Revenues:                                                            |  |                             |            |   |             |   |            |  
|Product sales                                                        |  | $                           | 9,344,490  |   |             | $ | 13,774,812 |  
|Service revenue                                                      |  |                             | 4,488,949  |   |             |   | 4,096,710  |  
|Commission revenue                                                   |  |                             | 3,254,079  |   |             |   | 3,697,908  |  
|                                                                     |  |                             |            |   |             |   |            |  
|                                                                     |  |                             | 17,087,518 |   |             |   | 21,569,430 |  
|                                                                     |  |                             |            |   |             |   |            |  
|Cost of revenue:                                                     |  |                             |            |   |             |   |            |  
|Cost of product sales                                                |  |                             | 6,386,221  |   |             |   | 9,887,768  |  
|Cost of service revenue                                              |  |                             | 2,708,834  |   |             |   | 3,019,153  |  
|                                                                     |  |                             |            |   |             |   |            |  
|                                                                     |  |                             | 9,095,055  |   |             |   | 12,906,921 |  
|                                                                     |  |                             |            |   |             |   |            |  
|Gross margin                                                         |  |                             | 7,992,463  |   |             |   | 8,662,509  |  
|Other expenses:                                                      |  |                             |            |   |             |   |            |  
|Selling, general and administrative                                  |  |                             | 8,989,109  |   |             |   | 8,135,275  |  
|Depreciation and amortization                                        |  |                             | 290,705    |   |             |   | 231,317    |  
|                                                                     |  |                             |            |   |             |   |            |  
|                                                                     |  |                             | 9,279,814  |   |             |   | 8,366,592  |  
|                                                                     |  |                             |            |   |             |   |            |  
|Operating income (loss)                                              |  |                             | (1,287,351 | ) |             |   | 295,917    |  
|                                                                     |  |                             |            |   |             |   |            |  
|Other income (expense):                                              |  |                             |            |   |             |   |            |  
|Gain on the extinguishment of debt                                   |  |                             | 1,960,646  |   |             |   |           |  
|Minority interest                                                    |  |                             | (56,016    | ) |             |   | (114,375   | )
|Interest and other income                                            |  |                             | 13,232     |   |             |   | 9,553      |  
|Interest expense                                                     |  |                             | (217,222   | ) |             |   | (258,642   | )
|                                                                     |  |                             |            |   |             |   |            |  
|                                                                     |  |                             | 1,700,640  |   |             |   | (363,464   | )
|                                                                     |  |                             |            |   |             |   |            |  
|Income (loss) from continuing operations before income taxes         |  |                             | 413,289    |   |             |   | (67,547    | )
|Income tax expense                                                   |  |                             | 400,365    |   |             |   | 31,828     |  
|                                                                     |  |                             |            |   |             |   |            |  
|Income (loss) from continuing operations                             |  |                             | 12,924     |   |             |   | (99,375    | )
|Loss from operations of discontinued operating segments              |  |                             | (599,369   | ) |             |   | (227,801   | )
|                                                                     |  |                             |            |   |             |   |            |  
|Net loss                                                             |  |                             | (586,445   | ) |             |   | (327,176   | )
|Preferred stock dividends                                            |  |                             |           |   |             |   | 36,842     |  
|                                                                     |  |                             |            |   |             |   |            |  
|Net loss attributable to common stockholders                         |  | $                           | (586,445   | ) |             | $ | (364,018   | )
|                                                                     |  |                             |            |   |             |   |            |  
|Earnings (loss) from continuing operations per common share, basic   |  | $                           | 0.00       |   |             | $ | (0.02      | )
|                                                                     |  |                             |            |   |             |   |            |  
|Loss per common share, basic                                         |  | $                           | (0.08      | ) |             | $ | (0.04      | )
|                                                                     |  |                             |            |   |             |   |            |  
|Earnings (loss) from continuing operations per common share, diluted |  | $                           | 0.00       |   |             | $ | (0.02      | )
|                                                                     |  |                             |            |   |             |   |            |  
|Loss per common share, diluted                                       |  | $                           | (0.08      | ) |             | $ | (0.04      | )
|                                                                     |  |                             |            |   |             |   |            |  



See accompanying notes.



6



---

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders Deficit (Unaudited)



|                                                                                             |  |                             |   |  |          |        |              |                 |           |          |   |                  |  |           |  |                          |        |  |                    |           |   |       |   |            |   |  |   |            |  
|-------------------------------------------------------------------------------------------- |  | --------------------------- | - |  | -------- | ------ | ------------ | --------------- | --------- | -------- | - | ---------------- |  | --------- |  | ------------------------ | ------ |  | ------------------ | --------- | - | ----- | - | ---------- | - |  | - | ---------- | -
|                                                                                             |  | Convertible Preferred Stock |   |  |          |        |              |                 |           |          |   |                  |  |           | 
|                                                                                             |  | Series C                    |   |  | Series D |        | Common Stock |                 |           |          |   |                  |  |           |  |                         
|                                                                                             |  | Numberof Shares             |   |  | ParValue |        |              | Number ofShares |           | ParValue |   | Number of Shares |  | ParValue  |  | AdditionalPaid-InCapital |        |  | AccumulatedDeficit |           |   | Total |  
|Balance at July 1, 2003                                                                      |  | 172,008                     |   |  | $        | 1,720  |              |                 |          |          | $ |                 |  | 8,897,874 |  | $                        | 88,980 |  | $                  | 3,242,454 |   |       | $ | (9,307,351 | ) |  | $ | (5,974,197 | )
|Issuance of common stock as compensation                                                     |  |                             |   |  |          |        |              |                 |           |          |   |                  |  | 594,938   |  |                          | 5,948  |  |                    | 74,169    |   |       |   |            |   |  |   | 80,117     |  
|Conversion of Series C Convertible Preferred Stock into Series D Convertible Preferred Stock |  | (172,008                    | ) |  |          | (1,720 | )            |                 | 484,487   |          |   | 4,845            |  |           |  |                          |        |  |                    | (3,125    | ) |       |   |            |   |  |   |           |  
|Issuance of Series D Convertible Preferred Stock and warrants to purchase common stock       |  |                             |   |  |          |        |              |                 | 813,050   |          |   | 8,130            |  |           |  |                          |        |  |                    | 479,700   |   |       |   |            |   |  |   | 487,830    |  
|Preferred stock dividends                                                                    |  |                             |   |  |          |        |              |                 |           |          |   |                  |  |           |  |                          |        |  |                    | (36,842   | ) |       |   |            |   |  |   | (36,842    | )
|Issuance of warrants                                                                         |  |                             |   |  |          |        |              |                 |           |          |   |                  |  |           |  |                          |        |  |                    | 14,916    |   |       |   |            |   |  |   | 14,916     |  
|Net loss                                                                                     |  |                             |   |  |          |        |              |                 |           |          |   |                  |  |           |  |                          |        |  |                    |           |   |       |   | (327,176   | ) |  |   | (327,176   | )
|                                                                                             |  |                             |   |  |          |        |              |                 |           |          |   |                  |  |           |  |                          |        |  |                    |           |   |       |   |            |   |  |   |            |  
|Balance at March 31, 2004                                                                    |  |                            |   |  | $        |       |              |                 | 1,297,537 |          | $ | 12,975           |  | 9,492,812 |  | $                        | 94,928 |  | $                  | 3,771,272 |   |       | $ | (9,634,527 | ) |  | $ | (5,755,352 | )
|                                                                                             |  |                             |   |  |          |        |              |                 |           |          |   |                  |  |           |  |                          |        |  |                    |           |   |       |   |            |   |  |   |            |  



See accompanying notes.



7



---

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Cash Flows



|                                                                                     |  |                             |             |   |      |   |             |  
|------------------------------------------------------------------------------------ |  | --------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                                     |  | Nine Months Ended March 31, |            
|                                                                                     |  | 2003                        |             |   | 2004 |  
|                                                                                     |  | (unaudited)                 |            
|Cash flows from operating activities                                                 |  |                             |             |   |      |   |             |  
|Net income (loss)                                                                    |  | $                           | (586,445    | ) |      | $ | (327,176    | )
|Adjustments to reconcile net income (loss) to net cash used in operating activities: |  |                             |             |   |      |   |             |  
|Provision for bad debts                                                              |  |                             | 57,390      |   |      |   | 74,349      |  
|Gain on extinguishment of debt                                                       |  |                             | (1,960,646  | ) |      |   |            |  
|Depreciation and amortization                                                        |  |                             | 483,734     |   |      |   | 231,317     |  
|Deferred income taxes                                                                |  |                             | 373,000     |   |      |   |            |  
|Write-off of in-process research and development                                     |  |                             | 282,000     |   |      |   |            |  
|Non-cash stock compensation expense                                                  |  |                             |            |   |      |   | 80,117      |  
|(Gain) loss on disposal of property and equipment                                    |  |                             | (3,532      | ) |      |   | (1,291      | )
|Non-cash interest expense                                                            |  |                             | 2,883       |   |      |   | 52,073      |  
|Changes in operating assets and liabilities:                                         |  |                             |             |   |      |   |             |  
|Accounts receivable                                                                  |  |                             | 520,376     |   |      |   | (961,435    | )
|Inventory                                                                            |  |                             | 80,396      |   |      |   | (167,507    | )
|Prepaid expenses and other current assets                                            |  |                             | (300,273    | ) |      |   | (41,168     | )
|Accounts payable and accrued expenses                                                |  |                             | 200,434     |   |      |   | (708,810    | )
|Accrued compensation and related benefits                                            |  |                             | (27,376     | ) |      |   | 113,830     |  
|Deferred revenue                                                                     |  |                             | 53,774      |   |      |   | 17,510      |  
|Other current liabilities                                                            |  |                             | (36,597     | ) |      |   | (3,178      | )
|Other long-term liabilities                                                          |  |                             |            |   |      |   | (66,987     | )
|                                                                                     |  |                             |             |   |      |   |             |  
|Net cash used in operating activities                                                |  |                             | (860,882    | ) |      |   | (1,708,356  | )
|                                                                                     |  |                             |             |   |      |   |             |  
|Cash flows from investing activities                                                 |  |                             |             |   |      |   |             |  
|Cash received in merger, net of acquisition costs                                    |  |                             | 382,643     |   |      |   |            |  
|Purchase of property and equipment                                                   |  |                             | (179,453    | ) |      |   | (103,426    | )
|Proceeds from sale of property and equipment                                         |  |                             | 3,532       |   |      |   | 46,177      |  
|                                                                                     |  |                             |             |   |      |   |             |  
|Net cash provided by (used in) investing activities                                  |  |                             | 206,722     |   |      |   | (57,249     | )
|                                                                                     |  |                             |             |   |      |   |             |  
|Cash flows from financing activities                                                 |  |                             |             |   |      |   |             |  
|Proceeds from borrowings under line-of-credit                                        |  |                             | 18,689,709  |   |      |   | 23,946,775  |  
|Repayments of borrowings under line-of-credit                                        |  |                             | (18,469,591 | ) |      |   | (23,775,559 | )
|Proceeds from issuance of debt                                                       |  |                             | 1,800,000   |   |      |   | 1,500,000   |  
|Proceeds from issuance of preferred stock                                            |  |                             |            |   |      |   | 389,999     |  
|Payment of preferred stock dividends                                                 |  |                             | (17,891     | ) |      |   | (36,842     | )
|Repayments of long-term debt                                                         |  |                             | (1,000,000  | ) |      |   | (51,250     | )
|Change in other long-term liabilities                                                |  |                             | 221,895     |   |      |   |            |  
|Change in other assets related to financing costs                                    |  |                             |            |   |      |   | (67,479     | )
|                                                                                     |  |                             |             |   |      |   |             |  
|Net cash provided by financing activities                                            |  |                             | 1,224,122   |   |      |   | 1,905,644   |  
|                                                                                     |  |                             |             |   |      |   |             |  
|Net change in cash and cash equivalents                                              |  |                             | 569,962     |   |      |   | 140,039     |  
|Cash and cash equivalents - beginning of period                                      |  |                             | 222,562     |   |      |   | 540,384     |  
|                                                                                     |  |                             |             |   |      |   |             |  
|Cash and cash equivalents - end of period                                            |  | $                           | 792,524     |   |      | $ | 680,423     |  
|                                                                                     |  |                             |             |   |      |   |             |  



See accompanying notes.



8



---

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2004



1. Basis of Presentation



Avatech Solutions, Inc. (the Company) provides design automation 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 10 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 financial statements and the notes thereto in the Companys Annual
Report on Form 10-K for the fiscal year ended June 30, 2003. Operating results for the three and nine months ended March 31, 2004 are not necessarily indicative of results for any future period.



The consolidated financial statements include the accounts of Avatech Solutions, Inc. and its
majority owned subsidiaries. One of the Companys subsidiaries has issued and outstanding preferred stock, which is accounted for as minority interest. All intercompany accounts and transactions between the Company and its consolidated
affiliated companies have been eliminated in consolidation.



2. Discontinued
Operations of Certain Operating Segments



In June 2003, due to poor
operating results, the Company closed a total of three offices located in New York, Michigan and Ohio. These locations were authorized software dealers subject to the Companys channel partner agreement with its principal supplier. By virtue of
these closings, the Company is no longer authorized to market or distribute software products subject to the channel partner agreements in those areas.



Additionally, the Company closed another office located in California in August 2003, which was also an authorized software dealer for which the Company is no longer
authorized to market or distribute software products subject to the channel partner agreement with its principal supplier. In connection with the closing of the California office in August 2003, the Company did not incur a gain or loss.



The discontinued operations were components of the Company as the operations and cash
flows were clearly distinguished, operationally and for financial reporting purposes, from the rest of the Company. The operations and cash flows of the components have been eliminated from the ongoing operations of the Company, and the Company will
not have any significant continuing involvement in the operations of the components. Accordingly, the historical results of operations of these components are presented in the accompanying consolidated statements of operations as a separate
component of operations classified as discontinued operations. All interim periods in fiscal year 2003 have been restated accordingly.



9



---

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2004 (continued)



2.
Discontinued Operations of Certain Operating Segments (continued)



Summarized operating results of the discontinued operations are as follows:



|                  |  |                              |          |   |                             |   |         |      |  |   |           |   |  |   |          |  
|----------------- |  | ---------------------------- | -------- | - | --------------------------- | - | ------- | ---- |  | - | --------- | - |  | - | -------- | -
|                  |  | Three months ended March 31, |          |   | Nine months ended March 31, |  
|                  |  | 2003                         |          |   | 2004                        |   |         | 2003 |  |   | 2004      |  
|Revenue           |  | $                            | 584,191  |   |                             | $ | 1,284   |      |  | $ | 1,865,865 |   |  | $ | 73,005   |  
|Net income (loss) |  | $                            | (303,674 | ) |                             | $ | (86,554 | )    |  | $ | (599,369  | ) |  | $ | (227,801 | )



3. Debt, Commitments and Gain on
Extinguishment of Debt



On September 11, 2003, the Company entered into a
revolving line-of-credit agreement with a financial institution which expires September 2006, but is payable within 60 days of demand by the lender. This line of credit replaced the borrowing facility for $2.0 million that previously existed. The
credit extended under this financing agreement is limited to the lesser of $2.0 million or 75% of the Companys aggregate outstanding eligible accounts receivable. Borrowings under this line-of-credit bear interest at the higher of 7.5% or the
prime rate plus 2.0% and are secured by the accounts receivable of the Company. In addition, the bank has the right to restrict any prepayment of other indebtedness by the Company.



In November 2003, the lender temporarily raised the credit limits to the lesser of $2.5 million or 75% of the Companys eligible
accounts receivable. These credit terms reverted back to the original $2.0 million limit in February 2004. The balance outstanding under this line-of-credit was $1.8 million at March 31, 2004.



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



The terms of the loan agreement provide for a loan of $1,500,000 funded in two payments. Initial funding of $1,000,000 occurred on July 25,
2003 and the remaining $500,000 was provided on February 5, 2004. The loan agreement provides for repayment of principal plus interest at 6% per annum in thirty-five equal quarterly installments commencing in January 2005. The Company is required to
meet certain financial and non-financial covenants in connection with this agreement.



At June 30, 2002, the Company was obligated to one of its suppliers under a note agreement in the amount of $2.96 million, bearing interest at 6.5% per annum. In August 2002, the Company entered into an agreement to extinguish the
outstanding $2.96 million debt for a cash payment of $1.0 million and compliance with certain non-financial covenants. The gain on the extinguishment of the debt of $1.96 million was recorded in August 2002.



On January 1, 2004, the Company retired or refinanced $250,000 of subordinated notes payable.
The Company paid $51,000 in cash to retire certain notes and issued new subordinated notes totaling $199,000. The new notes mature on July 1, 2005, with installment payments totaling $26,000 due on July 1, 2004. In conjunction with this refinancing,
the Company issued 45,000 warrants to purchase common stock for $0.21 per share. These warrants expire on July 1, 2005 and were valued at $7,275.



10



---

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2004 (continued)



3. Debt,
Commitments and Gain on Extinguishment of Debt (continued)



On April 1, 2004, the Company refinanced a note payable to a director and shareholder. A $902,000 note was issued in
satisfaction of the $893,795 aggregate balance outstanding on two $500,000 notes issued on May 28, 2003. The note accrues interest at a rate of 12% per annum, with quarterly interest payments due commencing July 1, 2004. Payment of the principle is
due when the note matures on July 1, 2005.



Below is a summary of our
contractual obligations and commitments at March 31, 2004:



|                                  |  |                               |           |      |   |           |  |      |           |      |   |                    |  |   |         |  |   |          
|--------------------------------- |  | ----------------------------- | --------- | ---- | - | --------- |  | ---- | --------- | ---- | - | ------------------ |  | - | ------- |  | - | ---------
|                                  |  | Payments due by Fiscal Period
|                                  |  | Total                         |           | 2004 |   | 2005      |  | 2006 |           | 2007 |   | 2008 andthereafter
|Contractual Obligations           |  |                               |           |      |   |           |  |      |           |      |   |                    |  |   |         |  |   |          
|Long-term debt and line-of-credit |  | $                             | 4,387,314 |      | $ | 1,800,831 |  | $    | 111,964   |      | $ | 1,231,661          |  | $ | 171,428 |  | $ | 1,071,430
|Operating leases                  |  |                               | 4,313,464 |      |   | 244,697   |  |      | 901,546   |      |   | 837,874            |  |   | 726,720 |  |   | 1,602,627
|                                  |  |                               |           |      |   |           |  |      |           |      |   |                    |  |   |         |  |   |          
|Total obligations                 |  | $                             | 8,700,778 |      | $ | 2,045,528 |  | $    | 1,013,510 |      | $ | 2,069,535          |  | $ | 898,148 |  | $ | 2,674,057
|                                  |  |                               |           |      |   |           |  |      |           |      |   |                    |  |   |         |  |   |          



4. Employee Stock Compensation
Plans



The Company records compensation expense for all stock-based
compensation plans using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25). Under APB No. 25, compensation expense is recorded over the vesting period to the extent
that the fair value of the underlying stock on the date of grant exceeds the exercise or acquisition price of the stock or stock-based award. Financial Accounting Standards Board Statement No. 123, Accounting for Stock Based Compensation
(Statement 123) encourages companies to recognize expense for stock-based awards based on their estimated fair value on the date of grant. Statement 123 requires the disclosure of pro forma income and earnings per share data in the notes
to the financial statement if the fair value method is not adopted.



The
following table illustrates the effect on net income (loss) and earnings (loss) per common share if the Company had applied the fair value recognition provisions of Statement 123 to stock-based employee compensation.



|                                                                                                                              |  |                              |          |   |                             |   |          |      |  |   |          |   |  |   |          |  
|----------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | -------- | - | --------------------------- | - | -------- | ---- |  | - | -------- | - |  | - | -------- | -
|                                                                                                                              |  | Three Months Ended March 31, |          |   | Nine Months Ended March 31, |  
|                                                                                                                              |  | 2003                         |          |   | 2004                        |   |          | 2003 |  |   | 2004     |  
|Net income (loss), as reported                                                                                                |  | $                            | (758,792 | ) |                             | $ | 170,362  |      |  | $ | (586,445 | ) |  | $ | (327,176 | )
|Add: Stock-based employee compensation cost included in net income (loss), net of taxes                                       |  |                              |         |   |                             |   | 9,725    |      |  |   |         |   |  |   | 77,104   |  
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of taxes |  |                              | (32,222  | ) |                             |   | (124,940 | )    |  |   | (124,337 | ) |  |   | (182,198 | )
|                                                                                                                              |  |                              |          |   |                             |   |          |      |  |   |          |   |  |   |          |  
|Pro forma net income (loss)                                                                                                   |  |                              | (791,014 | ) |                             |   | 55,147   |      |  |   | (710,782 | ) |  |   | (432,270 | )
|Preferred stock dividends                                                                                                     |  |                              |         |   |                             |   | 9,463    |      |  |   |         |   |  |   | 36,842   |  
|                                                                                                                              |  |                              |          |   |                             |   |          |      |  |   |          |   |  |   |          |  
|Pro forma net income (loss) attributable to common stockholders                                                               |  | $                            | (791,014 | ) |                             | $ | 35,684   |      |  | $ | 710,782  |   |  | $ | (469,112 | )
|                                                                                                                              |  |                              |          |   |                             |   |          |      |  |   |          |   |  |   |          |  
|Net income (loss) per common share:                                                                                           |  |                              |          |   |                             |   |          |      |  |   |          |   |  |   |          |  
|Basic  as reported                                                                                                           |  | $                            | (0.08    | ) |                             | $ | 0.02     |      |  | $ | (0.08    | ) |  | $ | (0.04    | )
|                                                                                                                              |  |                              |          |   |                             |   |          |      |  |   |          |   |  |   |          |  
|Basic  pro forma                                                                                                             |  | $                            | (0.09    | ) |                             | $ | 0.00     |      |  | $ | (0.09    | ) |  | $ | (0.05    | )
|                                                                                                                              |  |                              |          |   |                             |   |          |      |  |   |          |   |  |   |          |  
|Diluted  as reported                                                                                                         |  | $                            | (0.08    | ) |                             | $ | 0.00     |      |  | $ | (0.08    | ) |  | $ | (0.04    | )
|                                                                                                                              |  |                              |          |   |                             |   |          |      |  |   |          |   |  |   |          |  
|Diluted  pro forma                                                                                                           |  | $                            | (0.09    | ) |                             | $ | 0.00     |      |  | $ | (0.09    | ) |  | $ | (0.05    | )
|                                                                                                                              |  |                              |          |   |                             |   |          |      |  |   |          |   |  |   |          |  



11



---

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2004 (continued)



4.
Employee Stock Compensation Plans (continued)



A summary of stock option activity during the nine months ended March 31, 2004 and related information is included in
the table below:



|                                            |  |           |   |  |                                |     
|------------------------------------------- |  | --------- | - |  | ------------------------------ | ----
|                                            |  | Options   |   |  | Weighted-AverageExercise Price
|Outstanding at July 1, 2003                 |  | 554,386   |   |  | $                              | 1.88
|Granted                                     |  | 862,866   |   |  |                                | 0.41
|Forfeited                                   |  | (217,677  | ) |  |                                | 3.80
|                                            |  |           |   |  |                                |     
|Outstanding at March 31, 2004               |  | 1,199,575 |   |  | $                              | 0.72
|                                            |  |           |   |  |                                |     
|Exercisable at March 31, 2004               |  | 519,213   |   |  | $                              | 1.37
|                                            |  |           |   |  |                                |     
|Weighted-average remaining contractual life |  | 8.6 Years |   |  |                                |     
|                                            |  |           |   |  |                                |     



Stock Option Cancellation Program
and Fiscal Year 2004 Grants



In April 2003, the Company offered its
employees a voluntary option to surrender and cancel certain outstanding stock option agreements. Under the terms of the arrangement, the employee, if still employed, was eligible to receive an equivalent number of stock options six months and a day
after the specific cancellation periods with an exercise price equal to the market value of the common stock on the grant date. On November 4, 2003, the Company issued 274,486 options under this cancellation program that will vest over periods up to
twenty-four months.



Employee Stock Purchase Plan



On September 24, 2003 the Company amended the Employee Stock Purchase Plan. The Plan allows
for the board to provide offering periods, not to exceed 27 months in duration, to employees owning less than 5% of the total combined voting power or value of all classes of stock of the Company. Common shares sold under the Plan shall not exceed
in the aggregate 450,000 shares. As of March 31, 2004, common stock sold under the Plan totaled 265,932 shares.



The Company initiated a six-month offering commencing January 1, 2004. Employees eligible to participate under the plan can accumulate funds, up to 15% of their
compensation, to purchase common stock through payroll deductions. At the conclusion of the offering, shares will be purchased on behalf of the employees at a price per share equal to the lower of 85% of the quoted market value of the common stock
on the first or last day of the offering.



12



---

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2004 (continued)



4.
Employee Stock Compensation Plans (continued)



Restricted Stock Award Plan



In July 2003, the Company issued 540,000 shares of restricted common stock with a quoted market value of $0.163 share, to certain officers
as compensation. The common stock is restricted based on various vesting periods ranging from twelve to twenty-four months. Compensation expense for these awards of $93,000 is being recognized over the vesting period. The issuance resulted in
compensation expense totaling $62,000 for the nine months ended March 31, 2004.



5. Stock Dividend



The Companys Board of Directors
authorized a three-for-one stock split in the form of a stock dividend, which was distributed to stockholders of record as of September 15, 2003 on October 1, 2003. All share and per share data included in the consolidated financial statements have
been restated to reflect the stock split.



6. Preferred Stock



In the second quarter of fiscal year 2004, in connection with a Series D
Convertible Preferred Stock (Series D) issuance, shareholders of Series C Convertible Preferred Stock were given the option to convert their shares to Series D Convertible Preferred Stock. On December 31, 2003, 172,008 shares of Series C
Convertible Preferred Stock, representing all outstanding shares, were converted into 484,487 shares of Series D.



The Company also issued 813,050 shares of Series D for cash proceeds totaling $390,000 and a reduction in notes payable to a related party of $98,000. In connection with
the issuance of Series D, 1.7 million warrants were granted to preferred shareholders. The warrants entitle the holder to purchase common stock at an exercise price of $0.45 per share during the warrant exercise period, not to exceed one year after
the date of issuance.



The Series D Convertible Preferred shares outstanding at
March 31, 2004 totaled 1,297,537, and were issued 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 $0.60 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.



13



---

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2004 (continued)



6.
Preferred Stock (continued)



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 in such market.



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 approximately two shares of common stock for each share of Series D; however, this rate may be further adjusted due
to stock splits, dividends, and other events defined in the Certificate of Designation of Rights and Preferences of the Series D Convertible Preferred Stock.



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.



7. Stock Purchase Warrants



As of March 31, 2004, the Company has outstanding warrants to purchase common stock. A summary of the warrants is as follows:



|                 |  |                |       |                 |              
|---------------- |  | -------------- | ----- | --------------- | -------------
|Number of Shares |  | Exercise Price |       | Expiration Date
|45,000           |  | $              | 0.01  |                 | August 2013  
|97,200           |  | $              | 0.27  |                 | June 2008    
|45,000           |  | $              | 0.21  |                 | July 2005    
|180,000          |  | $              | 43.33 |                 | February 2005
|1,007,823        |  | $              | 0.45  |                 | December 2004
|722,220          |  | $              | 0.45  |                 | November 2004
|37,500           |  | $              | 83.33 |                 | June 2004    
|18,750           |  | $              | 6.67  |                 | June 2004    
|                 |  |                |       |                 |              
|2,153,493        |  |                |       |                 |              
|                 |  |                |       |                 |              



14



---

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2004 (continued)



8. Earnings Per Share



Basic earnings (loss) per common share is computed as net income (loss) less preferred stock dividends divided 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.



The following summarizes the computations of basic and
diluted earnings (loss) per share:



|                                                                                                    |  |                              |          |   |                             |   |         |      |  |   |          |   |  |   |          |  
|--------------------------------------------------------------------------------------------------- |  | ---------------------------- | -------- | - | --------------------------- | - | ------- | ---- |  | - | -------- | - |  | - | -------- | -
|                                                                                                    |  | Three Months Ended March 31, |          |   | Nine Months Ended March 31, |  
|                                                                                                    |  | 2003                         |          |   | 2004                        |   |         | 2003 |  |   | 2004     |  
|Numerator used in basic earnings (loss) per common share:                                           |  |                              |          |   |                             |   |         |      |  |   |          |   |  |   |          |  
|Income (loss) from continuing operations                                                            |  | $                            | (455,118 | ) |                             | $ | 256,916 |      |  | $ | 12,924   |   |  | $ | (99,375  | )
|Less: preferred stock dividends                                                                     |  |                              |         |   |                             |   | (19,463 | )    |  |   |         |   |  |   | (36,842  | )
|                                                                                                    |  |                              |          |   |                             |   |         |      |  |   |          |   |  |   |          |  
|Income (loss) from continuing operations available to common stockholders                           |  |                              | (455,118 | ) |                             |   | 237,453 |      |  |   | 12,924   |   |  |   | (136,217 | )
|Income (loss) from discontinued operations, net of income taxes                                     |  |                              | (303,674 | ) |                             |   | (86,554 | )    |  |   | (599,369 | ) |  |   | (227,801 | )
|                                                                                                    |  |                              |          |   |                             |   |         |      |  |   |          |   |  |   |          |  
|Net income (loss) attributable to common stockholders                                               |  | $                            | (758,792 | ) |                             | $ | 150,899 |      |  | $ | (586,445 | ) |  | $ | (364,018 | )
|                                                                                                    |  |                              |          |   |                             |   |         |      |  |   |          |   |  |   |          |  
|Numerator used in diluted earnings (loss) per common share:                                         |  |                              |          |   |                             |   |         |      |  |   |          |   |  |   |          |  
|Income (loss) from continuing operations available to common stockholders                           |  | $                            | (455,118 | ) |                             | $ | 237,453 |      |  | $ | 12,924   |   |  | $ | (136,217 | )
|Effect of assumed conversion:                                                                       |  |                              |          |   |                             |   |         |      |  |   |          |   |  |   |          |  
|Preferred stock dividends                                                                           |  |                              |         |   |                             |   | 19,463  |      |  |   |         |   |  |   | 36,842   |  
|Income (loss) from continuing operations available to common stockholders, plus assumed conversions |  |                              | (455,118 | ) |                             |   | 256,916 |      |  |   | 12,924   |   |  |   | (99,375  | )
|Income (loss) from discontinued operations, net of income taxes                                     |  |                              | (303,674 | ) |                             |   | (86,554 | )    |  |   | (599,369 | ) |  |   | (227,801 | )
|                                                                                                    |  |                              |          |   |                             |   |         |      |  |   |          |   |  |   |          |  
|Income (loss) available to common stockholders, plus assumed conversions                            |  | $                            | (758,792 | ) |                             | $ | 170,362 |      |  | $ | (586,445 | ) |  | $ | (327,176 | )
|                                                                                                    |  |                              |          |   |                             |   |         |      |  |   |          |   |  |   |          |  



15



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Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2004 (continued)



8.
Earnings Per Share (continued)



|                                                                                                   |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|-------------------------------------------------------------------------------------------------- |  | ---------------------------- | --------- | - | --------------------------- | - | ---------- | ---- |  | - | --------- | - |  | - | ---------- | -
|                                                                                                   |  | Three Months Ended March 31, |           |   | Nine Months Ended March 31, |  
|                                                                                                   |  | 2003                         |           |   | 2004                        |   |            | 2003 |  |   | 2004      |  
|Denominators used in earnings (loss) per share calculations:                                       |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Denominator for basic earnings (loss) per share-weighted average shares outstanding                |  |                              | 8,897,874 |   |                             |   | 9,304,794  |      |  |   | 7,739,142 |   |  |   | 9,225,241  |  
|                                                                                                   |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Effect of dilutive securities:                                                                     |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Stock options                                                                                      |  |                              |          |   |                             |   | 170,923    |      |  |   |          |   |  |   | 89,399     |  
|Warrants                                                                                           |  |                              |          |   |                             |   | 92,084     |      |  |   |          |   |  |   | 51,999     |  
|Restricted stock                                                                                   |  |                              |          |   |                             |   | 212,500    |      |  |   |          |   |  |   | 233,773    |  
|Convertible preferred stock                                                                        |  |                              |          |   |                             |   | 2,597,236  |      |  |   |          |   |  |   | 980,417    |  
|                                                                                                   |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Denominator for diluted earnings (loss)-weighted average shares outstanding and assumed conversion |  |                              | 8,897,874 |   |                             |   | 12,377,537 |      |  |   | 7,739,142 |   |  |   | 10,580,829 |  
|                                                                                                   |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Basic earnings (loss) per common share:                                                            |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Income (loss) from continuing operations                                                           |  | $                            | (0.05     | ) |                             | $ | 0.03       |      |  | $ | 0.00      |   |  | $ | (0.02      | )
|Income(loss) from operations of discontinued operations, net of income taxes                       |  |                              | (0.03     | ) |                             |   | (0.01      | )    |  |   | (0.08     | ) |  |   | (0.02      | )
|                                                                                                   |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Earnings (loss) per common share, basic                                                            |  | $                            | (0.08     | ) |                             | $ | 0.02       |      |  | $ | (0.08     | ) |  | $ | (0.04      | )
|                                                                                                   |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Diluted earnings (loss) per common share:                                                          |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Income (loss) from continuing operations                                                           |  | $                            | (0.05     | ) |                             | $ | 0.02       |      |  | $ | 0.00      |   |  | $ | (0.02      | )
|Income(loss) from operations of discontinued operations, net of income taxes                       |  |                              | (0.03     | ) |                             |   | (0.01      | )    |  |   | (0.08     | ) |  |   | (0.02      | )
|                                                                                                   |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  
|Earnings (loss) per common share, diluted                                                          |  | $                            | (0.08     | ) |                             | $ | 0.01       |      |  | $ | (0.08     | ) |  | $ | (0.04      | )
|                                                                                                   |  |                              |           |   |                             |   |            |      |  |   |           |   |  |   |            |  



16



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Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2004 (continued)



9. Income Taxes



Income tax expense for the nine months ended March 31, 2003 and 2004 was approximately $400,000 and $32,000, respectively. In August 2002, the Company realized a $1.96
million taxable gain from the extinguishment of certain debt, which resulted in a net deferred tax asset of $373,000 being recorded at June 30, 2002. During the nine months ended March 31, 2003, the Company recorded deferred income tax expense of
$373,000 related to the estimated reduction in deferred tax assets in fiscal year 2003. This increase in deferred income tax expense, coupled with certain state tax expense, resulted in the income tax expense for the nine months ended March 31,
2003. For the nine months ended March 31, 2004, income tax expense related solely to estimated state tax expense for the period.



10. Liquidity and Capital Resources



During fiscal year 2003, the Company incurred significant losses from its operations that depleted its capital resources. These losses were incurred primarily due to
unexpected declines in revenue and losses and costs related to the acquisition of PlanetCAD Inc. In response, management has taken actions to close under-performing offices, significantly reduce overhead to improve operational efficiency, initiate
new revenue programs and obtain additional financing. Management believes that the actions it has taken will allow the Company to aggressively pursue its business plan and return to profitability in the near term.



Based on an evaluation of the likely cash to be generated from operations in the near term
and available capital resources, management believes that it has sufficient sources of working capital to fund its operations in the normal course of business through at least December 31, 2004.



11. Contingencies



The Company is a defendant in a lawsuit filed by a vendor for alleged breach of contract. The suit asks for actual damages totaling
$178,000. Legal counsel engaged by the Company has advised that at this stage in the proceedings, they cannot offer an opinion as to the probable outcome, and accordingly, no amounts have been accrued at March 31, 2004. The Company believes the suit
is without merit and is vigorously defending its position.



17



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|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.



Certain statements set forth below constitute forward-looking statements. Such forward-looking statements involve known and unknown risk,
uncertainties and other factors including, but not limited to, those discussed in our annual and quarterly reports, that may cause our actual results, performance or achievements to be materially different from any future results, performance or
achievements implied by such forward-looking statements. These forward-looking statements may generally be identified by the use of the words may, will, believe, should, expects,
anticipates, estimates, and similar expressions. Given these uncertainties, investors and prospective investors are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligation to
update information contained in any forward-looking statement.



Overview



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



During the fall of 2003, we revised our growth strategy and began to focus on new ways of expanding our people resources, product offerings, and geographic footprint. We are accomplishing this strategy by:



| |  | restructuring our company to focus on three product groups: Design Automation (DA); Facility and Asset Management (F/AM); and Product Lifecycle Management (PLM),
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | employing highly qualified professionals in specialized areas,
| | - | --------------------------------------------------------------



| |  | expanding our product offerings to include SmarTeam PLM software, various F/AM software packages, and new internally-developed proprietary software to support our PLM solutions,
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | focusing on solutions and service selling.
| | - | ------------------------------------------



This diversification strategy is intended to match our product and service offerings more precisely with the needs of our customers. In July 2003, we
entered into an Authorized Reseller Agreement with Dassault Systèmes Corp., an international developer and distributor of PLM application software and services, whereby we will market and distribute Dassaults SmarTeam PLM products in
the United States. In connection with this agreement, Dassault provided us with certain financial assistance to create a dedicated PLM sales force and to conduct related marketing efforts. We plan to continue this strategy by expanding
geographically through targeted mergers and acquisitions, opening new locations, and expanding international product distribution relationships.



Beginning in June 2003, we instituted a number of cost containment measures to align our selling, general and administrative expenses with our current
revenue levels. We accomplished this plan by:



| |  | closing four underperforming offices;
| | - | -------------------------------------



| |  | terminating approximately 30 employees in June 2003; and
| | - | --------------------------------------------------------



| |  | reducing our professional fees, telephone, supplies, marketing, and travel expenses.
| | - | ------------------------------------------------------------------------------------



In August 2003, we closed an additional office in California. In accordance with Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the results of operations of these operating units are treated as discontinued operations, and reported as a separate component of operating results in our
consolidated statements of operations.



18



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We considered these expense reduction measures necessary to help us reduce operating losses arising from
the prolonged impact of economic recession on the software industry and also to help us achieve our revised strategy. Our consolidated financial statements for all interim periods and the fiscal years ended June 30, 2001, 2002 and 2003 have been
restated to consistently present these operations as discontinued operations. Unless otherwise indicated, all amounts included in Managements Discussion and Analysis of Financial Condition and Results of Operations are from continuing
operations.



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



| |  | Autodesk design automation software for mechanical, architectural, civil, and discreet products;
| | - | ------------------------------------------------------------------------------------------------



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



| |  | Cyco engineering data management solutions using meridian software; and
| | - | -----------------------------------------------------------------------



| |  | Dassaults SmarTeam PLM software.
| | - | ---------------------------------



We also offer Autodesks subscription programs, which entitle subscribers to receive software upgrades, web support and eLearning lessons directly from Autodesk.
Because we do not participate in the delivery of these subscription products or the web support and eLearning lesson benefits, we record the net fee we earn from the sale of Autodesk software subscriptions as revenue. Approximately 92% of our total
product revenues are related to the resale of Autodesk products.



Service Revenue. We provide services in the form of training, consulting services, professional services and technical support to our design automation, PLM and Facilities/Asset Management customers. We employ a technical staff of 44
personnel associated with these types of services. In the third quarter of fiscal year 2004, we revised our sales commission plan to focus on increasing service sales while achieving higher service margins. Additionally, we also offer our customers
an assessment tool to analyze the ability and knowledge of current and potential employees in computer aided design.



Commission Revenue. We generate 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. We are responsible for managing and reselling Autodesk
products to a number of these major account customers. Autodesk determines the price the customer pays for the product and ships the product directly to the customer. We then receive commissions upon shipment of the product from Autodesk to the
customer based on the product sales price.



Cost of Product
Sales. Our cost of product sales consists of the cost of purchasing products from software suppliers or hardware manufacturers. We also include the associated shipping and handling costs in cost of product sales.



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 us. Our cost of service revenue does not include an allocation of overhead costs.



Selling, General and Administrative Expense. Selling, general and administrative expense consists primarily of compensation and other expenses associated with management, finance, human resources, and
information systems. We also include advertising and public relations expenses, as well as expenses for facilities such as rent and utilities, in selling, general and administrative expense.



Depreciation and Amortization Expense. Depreciation and amortization
expense represents the period costs associated with our investment in property and equipment, consisting principally of computer equipment, software, furniture and fixtures, and leasehold improvements. We compute depreciation and amortization
expense using the straight-line method over estimated useful lives. We lease all of our facilities and depreciate leasehold improvements over the lesser of the lease term or the useful life of the asset.



19



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Interest Expense. Interest expense consists primarily of interest on our revolving line-of-credit
and subordinated debt, which we incurred to fund operations over the past three years.



Critical Accounting Policies



General.
Our consolidated financial statements are impacted by the accounting policies used and the estimates and assumptions made by management during their preparation. Critical accounting policies and estimates that impact the consolidated financial
statements are those that relate to software revenue recognition and estimates of bad debts. We discuss all of these critical accounting policies with our Audit Committee on a periodic basis. Presented below is a description of the accounting
policies that are most critical to an understanding of our consolidated financial statements.



Software Revenue Recognition. We derive most of our revenue from the resale of packaged software products. Our product sales may also include hardware that we may purchase for the convenience of our customers.
Historically, we have not experienced significant customer returns. We earn service revenue from training and other professional services, which often are related to the products that we sell but are not essential to the functionality of the
software. We offer annual support contracts to our customers for the software products that we sell, or we offer maintenance and support services under hourly billing arrangements.



We recognize revenue from software arrangements 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. We determine whether criteria (3) and (4) have
been satisfied based on our 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 us to determine these criteria are not met. In the past, we have not needed to adjust our reported revenue due to changes in conditions, and we continue to evaluate current conditions that may
affect the nature and timing of our revenue recognition.



Our
customer arrangements can involve the sale of one or more elements. When this occurs, we allocate revenue to each element based on the relative fair value of each element. We limit the assessment of fair value to the price that we charge when the
element is sold separately. All of the elements included in the multiple element arrangements have been analyzed by management, which may include products that are resold, training and other professional services, and support services. We have
determined that sufficient evidence of the fair value based on these separate sales exists to allocate revenue to the specified elements. We recognize training and other professional services revenue as services are delivered and recognize support
revenue ratably over the respective contract term. We include all unrecognized fees that have been billed in our deferred revenue.



Bad Debts. We maintain an allowance for doubtful accounts for estimated losses which may result from the inability of our customers to pay for
purchased products and services or for disputes that affect our ability to fully collect our accounts receivable. We estimate this allowance by reviewing the status of our past-due accounts and record general reserves based on our historical bad
debt expense. Our actual experience has not varied significantly from our estimates; however, if the financial condition of our customers were to deteriorate, resulting in their inability to pay for products or services, we may need to record
additional allowances in future periods. To mitigate this risk, we perform ongoing credit evaluations of our customers.



20



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Three and Nine Months Ended March 31, 2003 Compared to the Three and Nine Months Ended March 31, 2004



The following table sets forth a comparison of three and
nine month selected item totals in the year 2004 compared to the same periods in the year 2003. These totals are represented by selected items reflected in our unaudited Consolidated Statements of Operations included elsewhere in this report. The
three and nine months financial results are not necessarily indicative of future results.



Revenues. Our total revenues include product sales, service revenue and commission revenue.



|                   |  |                              |            |      |   |            |  |      |   
|------------------ |  | ---------------------------- | ---------- | ---- | - | ---------- |  | ---- | --
|                   |  | Three Months Ended March 31, |           
|                   |  | 2003                         |            | 2004 |   | %          | 
|Revenue:           |  |                              |            |      |   |            |  |      |   
|Product sales      |  | $                            | 3,289,161  |      | $ | 5,086,415  |  | 54.6 | % 
|Service revenue    |  |                              | 1,452,621  |      |   | 1,336,533  |  | (8.0 | )%
|Commission revenue |  |                              | 1,326,651  |      |   | 1,413,097  |  | 6.5  | % 
|                   |  |                              |            |      |   |            |  |      |   
|Total revenue      |  | $                            | 6,068,433  |      | $ | 7,836,045  |  | 29.1 | % 
|                   | 
|                   |  | Nine Months Ended March 31,  |           
|                   |  | 2003                         |            | 2004 |   | %          | 
|Revenue:           |  |                              |            |      |   |            |  |      |   
|Product sales      |  | $                            | 9,344,490  |      | $ | 13,774,812 |  | 47.4 | % 
|Service revenue    |  |                              | 4,488,949  |      |   | 4,096,710  |  | (8.7 | )%
|Commission revenue |  |                              | 3,254,079  |      |   | 3,697,908  |  | 13.6 | % 
|                   |  |                              |            |      |   |            |  |      |   
|Total revenue      |  | $                            | 17,087,518 |      | $ | 21,569,430 |  | 26.2 | % 



Revenues. Total
revenue for the three months ended March 31, 2004 increased $1.8 million, or 29.1% to $7.8 million, compared to $6.1 million for the same period in 2003. Total revenue for the nine months ended March 31, 2004 increased $4.5 million, or 26.2% to
$21.6 million, compared to $17.1 million for the same period in 2003.



Product sales for the three months ended March 31, 2004 increased $1.8 million, or 54.6% to $5.1 million, compared to $3.3 million for the same period in 2003. Product sales for the nine months ended March 31, 2004 increased $4.4 million,
or 47.4% to $13.8 million, compared to $9.3 million for the same period in 2003. Our product sales have increased due to increased sales volume caused by several factors. During fiscal year 2004, demand for Autodesk products increased, caused in
part by product upgrades required by our customers in order to continue to receive product maintenance services and an overall improvement in economic conditions. Also, during the month of October 2003, we reduced prices when Autodesk reduced the
price we pay for products by 20% under a short-term promotional program which increased our volume of units delivered. Product retirement and price reduction has contributed to our increase in product sales.



Service revenue for the three months ended March 31, 2004 decreased $116,000,
or 8.0% to $1.3 million, compared to $1.5 million for the same period in 2003. Service revenue for the nine months ended March 31, 2004 decreased $392,000 to $4.1 million, compared to $4.5 million for the same period in 2003. These decreases in
service revenue are the result of the market focusing on product upgrades from discontinued products and a reduction in the number of service employees dedicated to service activities.



Commission revenue for the three months ended March 31, 2004 increased $86,000, or 6.5% to $1.4 million, compared to $1.3
million for the same period in 2003. Commission revenue for the nine months ended March 31, 2004 increased $444,000, or 13.6% to $3.7 million, compared to $3.3 million for the same period in 2003. The increase in commission revenues is consistent
with the revenue increases we experienced in product sales resulting from an improved economy, Autodesks promotional activities, and demand caused by customers upgrading their software.



21



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Cost of Revenue.



|                        |  |                              |           |      |   |            |  |      |  
|----------------------- |  | ---------------------------- | --------- | ---- | - | ---------- |  | ---- | -
|                        |  | Three Months Ended March 31, |          
|                        |  | 2003                         |           | 2004 |   | %          | 
|Cost of revenue:        |  |                              |           |      |   |            |  |      |  
|Cost of product sales   |  | $                            | 2,247,821 |      | $ | 3,472,919  |  | 54.5 | %
|Cost of service revenue |  |                              | 898,995   |      |   | 912,379    |  | 1.5  | %
|                        |  |                              |           |      |   |            |  |      |  
|Total cost of revenue   |  | $                            | 3,146,816 |      | $ | 4,385,298  |  | 39.4 | %
|                        |  |                              |           |      |   |            |  |      |  
|                        | 
|                        |  | Nine Months Ended March 31,  |          
|                        |  | 2003                         |           | 2004 |   | %          | 
|Cost of revenue:        |  |                              |           |      |   |            |  |      |  
|Cost of product sales   |  | $                            | 6,386,221 |      | $ | 9,887,768  |  | 54.8 | %
|Cost of service revenue |  |                              | 2,708,834 |      |   | 3,019,153  |  | 11.5 | %
|                        |  |                              |           |      |   |            |  |      |  
|Total cost of revenue   |  | $                            | 9,095,055 |      | $ | 12,906,921 |  | 41.9 | %
|                        |  |                              |           |      |   |            |  |      |  



Cost of Product
Sales. Cost of product sales for the three months ended March 31, 2004 increased $1.2 million, or 54.5%, to $3.5 million, compared to $2.2 million for the same period in 2003. Cost of product sales for the nine months ended March 31, 2004
increased $3.5 million, or 54.8%, to $9.9 million, compared to $6.4 million for the same period in 2003. Although our revenues have increased in fiscal year 2004, our product margins have declined from 31.7% for the nine months ended March 31, 2003
to 28.2% for the nine months ended March 31, 2004. Our product margins decreased as a result of several factors. Our major vendor, Autodesk, changed our cooperative advertising program to increase the price we pay for Autodesk products, while
increasing the payments we receive from Autodesk. This program is a supplemental marketing plan designed to help support our selling opportunities and develop increased Autodesk product sales. In addition, we have strategically reduced the price we
charge our customers for certain products to obtain additional sales volume in the first nine months of fiscal year 2004.



Cost of Service Revenue. Cost of service revenue for three months ended March 31, 2004 remained consistent with the corresponding quarter in fiscal
2003. However, as a percentage of related service revenue, cost of service revenue increased to 68% from 62% in the same period last year. The decline in our service revenue margins is the direct result of an 8% reduction in service revenue, while
our direct labor costs, the largest component of cost of service revenues, remained constant. For the nine months ended March 31, 2004 our cost of service revenue as a percentage of revenue increased to 74% from 60%. This decrease in service revenue
margin is the result of a 9% decrease in service revenues from the same period in 2003 and our strategy of redirecting some service employees to our new lines of business. We are currently focused on developing our PLM and F/AM markets for products
and related services, and until such time as we generate significant revenue from these new product and service offerings, our margins will be affected by our investment in a professional, well-trained service staff. We expect that as our service
revenues from F/AM and PLM services increase, our margins will likely return to historical levels.



Other Expenses.



|                                    |  |                              |           |      |   |           |  |       |   
|----------------------------------- |  | ---------------------------- | --------- | ---- | - | --------- |  | ----- | --
|                                    |  | Three Months Ended March 31, |          
|                                    |  | 2003                         |           | 2004 |   | %         | 
|Other expenses:                     |  |                              |           |      |   |           |  |       |   
|Selling, general and administrative |  | $                            | 3,222,012 |      | $ | 2,970,289 |  | (7.8  | )%
|Depreciation and amortization       |  |                              | 60,516    |      |   | 81,691    |  | 35.0  | % 
|                                    |  |                              |           |      |   |           |  |       |   
|Total other expenses                |  | $                            | 3,282,528 |      | $ | 3,051,980 |  | (7.0  | )%
|                                    |  |                              |           |      |   |           |  |       |   
|                                    | 
|                                    |  | Nine Months Ended March 31,  |          
|                                    |  | 2003                         |           | 2004 |   | %         | 
|Other expenses:                     |  |                              |           |      |   |           |  |       |   
|Selling, general and administrative |  | $                            | 8,989,109 |      | $ | 8,135,275 |  | (9.5  | )%
|Depreciation and amortization       |  |                              | 290,705   |      |   | 231,317   |  | (20.4 | )%
|                                    |  |                              |           |      |   |           |  |       |   
|Total other expenses                |  | $                            | 9,279,814 |      | $ | 8,366,592 |  | (9.8  | )%
|                                    |  |                              |           |      |   |           |  |       |   



22



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Selling, General and Administrative. Selling, general and administrative expenses for the three
months ended March 31, 2004 decreased $252,000 or 7.8%, to $3.0 million, compared to $3.2 million for the same period in 2003. Selling, general and administrative expenses for the nine months ended March 31, 2004 decreased $854,000 or 9.5%, to $8.1
million, compared to $9.0 million for the same period in 2003. We attribute this decrease in selling, general and administrative expenses to our restructuring efforts in the fourth quarter of 2003, as discussed more fully in our 2003 Annual Report
on Form 10-K. Although we had increases in our insurance and professional fees of approximately $150,000, our decreases in other areas such as travel, facilities and maintenance, salaries and commissions, and marketing expenses significantly reduced
our selling general and administrative expenses. The decrease in travel expenses was a result of our focusing on controlling travel expenses by contracting with a travel agency. Also, vendor cooperative marketing program credits are now being off
set against marketing expenses.



Depreciation and
Amortization. Depreciation and amortization expense for the three months ended March 31, 2004 increased $21,000 or 35%, to $82,000, compared to $61,000 for the same period in 2003. Depreciation and amortization expense for the nine months ended
March 31, 2004 decreased $59,000, or 20.4%, to $231,000, compared to $291,000 for the same period in 2003. Depreciation and amortization of property and equipment for the three month period ending March 31, 2004 increased as a result of investing in
our infrastructure. We increased capital expenditures for computer equipment and application software by $85,000. Depreciation and amortization of property and equipment for the nine month period ending March 31, 2003 decreased because of an
increase in the number of fully depreciated assets compared to the prior period.



Other Income Expense.



|                                    |  |                              |           |   |      |   |          |   |  |        |   
|----------------------------------- |  | ---------------------------- | --------- | - | ---- | - | -------- | - |  | ------ | --
|                                    |  | Three Months Ended March 31, |          
|                                    |  | 2003                         |           |   | 2004 |   |          | % | 
|Other income (expense)              |  |                              |           |   |      |   |          |   |  |        |   
|Minority Interest                   |  | $                            | (38,125   | ) |      | $ | (38,125  | ) |  |       |   
|Interest and other income (expense) |  |                              | 3,907     |   |      |   | 5,260    |   |  | 34.6   | % 
|Interest expense                    |  |                              | (59,989   | ) |      |   | (98,158  | ) |  | 59.6   | % 
|                                    |  |                              |           |   |      |   |          |   |  |        |   
|                                    |  | $                            | (94,207   | ) |      | $ | (131,023 | ) |  | 39.1   | % 
|                                    |  |                              |           |   |      |   |          |   |  |        |   
|                                    | 
|                                    |  | Nine Months Ended March 31,  |          
|                                    |  | 2003                         |           |   | 2004 |   |          | % | 
|Other income (expense)              |  |                              |           |   |      |   |          |   |  |        |   
|Gain on extinguishment of debt      |  | $                            | 1,960,646 |   |      | $ |         |   |  | (100.0 | )%
|Minority interest                   |  |                              | (56,016   | ) |      |   | (114,375 | ) |  | 104.2  | % 
|Interest and other income (expense) |  |                              | 13,232    |   |      |   | 9,553    |   |  | (27.8  | )%
|Interest expense                    |  |                              | (217,222  | ) |      |   | (258,642 | ) |  | 18.5   | % 
|                                    |  |                              |           |   |      |   |          |   |  |        |   
|                                    |  | $                            | 1,700,640 |   |      | $ | (363,464 | ) |  | (121.3 | )%
|                                    |  |                              |           |   |      |   |          |   |  |        |   



Other Income
(Expense). Other income (expense) for the three months ended March 31, 2004 decreased $37,000, or 39.1%, to $(131,000) compared to $(94,000) for the same period in 2003. Other income (expense) for the nine months ended March 31, 2004 decreased
$2.1 million, to $(363,000), compared to $1.7 million for the same period in 2003. Included in other income for the nine month period ended March 31, 2003 was a $2.0 million gain from the extinguishment of debt resulting from the payment to a
significant supplier of $1.0 million in full satisfaction of a $3.0 million loan made to us by that supplier in 1999. Due to an increase in our outstanding borrowings, we expect our interest expense to increase in 2004. As discussed more fully in
Note 3 to the consolidated financial statements, we have borrowed $1.5 million with interest at 6% per annum to assist us with working capital needs, $500,000 of which was received in February 2004.



23



---

Income Tax Expense.



|                             |  |                              |         |      |   |        |  |       |   
|---------------------------- |  | ---------------------------- | ------- | ---- | - | ------ |  | ----- | --
|                             |  | Three Months Ended March 31, |        
|                             |  | 2003                         |         | 2004 |   | %      | 
|Income tax expense (benefit) |  | $                            |        |      | $ | 10,828 |  | 100   | % 
|                             |  |                              |         |      |   |        |  |       |   
|                             | 
|                             |  | Nine Months Ended March 31,  |        
|                             |  | 2003                         |         | 2004 |   | %      | 
|Income tax expense (benefit) |  | $                            | 400,365 |      | $ | 31,828 |  | (92.1 | )%
|                             |  |                              |         |      |   |        |  |       |   



Income Tax
Expense. Income tax expense for the three months ended March 31, 2004 increased $11,000, compared to $0 for the same period in 2003. Income tax expense for the nine months ended March 31, 2004 decreased $369,000, or 92.1% to $32,000, compared to
$400,000 for the same period in 2003. In August 2002, we realized a $2.0 million taxable gain from the extinguishment of certain debt (described above), which resulted in us recording a net deferred tax asset of $373,000 at June 30, 2002. In fiscal
year 2003, we recorded deferred income tax expense of $373,000 related to the estimated reduction in deferred tax assets in 2003. Our income tax expense in fiscal year 2004 is expected to relate solely to state income tax expense, which we expect to
be approximately $40,000 for the full year.



Discontinued Operations.



|                        |  |                              |          |   |      |   |          |   |  |       |   
|----------------------- |  | ---------------------------- | -------- | - | ---- | - | -------- | - |  | ----- | --
|                        |  | Three Months Ended March 31, |         
|                        |  | 2003                         |          |   | 2004 |   |          | % | 
|Discontinued Operations |  | $                            | (303,674 | ) |      | $ | (86,554  | ) |  | (71.5 | )%
|                        | 
|                        |  | Nine Months Ended March 31,  |         
|                        |  | 2003                         |          |   | 2004 |   |          | % | 
|Discontinued Operations |  | $                            | (599,369 | ) |      | $ | (227,801 | ) |  | (62.0 | )%



Discontinued
Operations. Discontinued operations for the three months ended March 31, 2004 decreased $217,000, or 71.5%, to $(87,000), compared to $(304,000) for the same period in 2003. Discontinued operations for the nine months ended March 31, 2004
decreased $372,000, or 62%, to $(228,000), compared to $(599,000) for the same period in 2003. All operating results for the offices closed in June of 2003 are included in discontinued operations. Also, in August of 2003, we closed the California
office and the results from operations were included in discontinued operations. For the three and nine months period ended March 31, 2004, the results of discontinued operations consist primarily of the cost of closing offices, and legal costs and
maintenance fees associated with PlanetCAD operations. We do not anticipate additional material expenses.



Liquidity and Capital Resources



Historically, we have financed our operations and met our capital expenditure requirements primarily through cash flows provided by operations, borrowings under short-term and long-term debt arrangements and sales of preferred stock. Our
outstanding debt totaled $4.4 million at March 31, 2004, and we had a deficiency of working capital of $2.0 million.



Our deficiency of working capital is in large part caused by the classification of our line of credit as a current liability due to its demand provisions.
Our line of credit with K Bank allows us to borrow up to $2.0 million (on November 24, 2003, this line of credit was temporarily increased to $2.5 million through January 31, 2004), limited to 75% of eligible accounts receivable. At March 31, 2004,
our outstanding balance under this line-of-credit totaled $1.8 million. The line-of-credit expires in three years and is payable within 60 days of demand. Despite the existence of the 60-day demand provision on this line-of-credit, we do not believe
it is likely that the bank will exercise the demand provisions of the agreement. In the event that the bank does so, we believe that other lenders would provide us with a line of credit with similar terms, as long as our financial position and
results of operations have not significantly declined.



During
the nine month period ended March 31, 2004, we used $1.7 million of cash in operations primarily as a result of our loss of $327,000 and working capital needs of $1.7 million. Our working capital needs increased as a result of increases in accounts
receivable caused by higher revenues. During the nine month period ended March 31, 2004, our revenues increased about $4.3 million to $21.6 million compared



24



---

to $17.2 million recognized in the nine month period ended June 30, 2003, which led to a corresponding increase in our accounts receivable balance of about
$961,000 between June 30, 2003 and March 31, 2004. In addition, our accounts payable and accrued expenses decreased by $706,000 since June 30, 2003, principally because we paid certain expenses related to our 2003 merger with PlanetCAD. We financed
these operating cash requirements through borrowings of $1.5 million from a software developer and vendor, and the cash proceeds of $390,000 from the sale of preferred stock and stock purchase warrants. We purchase over 90% of the products we sell
from Autodesk, which provides us with the ability to purchase up to $3.0 million of inventory under 60 to 90 day payment terms. Historically, we have been able to manage our average days sales outstanding in a range from 50 to 60 days. Our customary
collection terms range from 30 to 60 days for all of our customers.



Prior to the merger with PlanetCAD, Inc., we had outstanding $1.7 million of 10% subordinated notes. The notes were to mature on July 1, 2003 and interest was payable quarterly until maturity or prepayment. On November 19, 2002, with the
completion of the merger with PlanetCAD, subordinated note holders owning an aggregate of $1.5 million of subordinated notes exchanged their notes for preferred stock in Avatech Solutions, Inc. Subsidiary.



On July 22, 2003, we entered into a loan agreement with a software developer
to borrow up to $1.5 million for working capital purposes. The loan was received in two payments, with the initial funding of $1.0 million occurring on July 25, 2003 and the remaining $500,000 provided on February 5, 2004. The loan agreement
requires repayment of principal plus interest at 6% per annum in thirty-five equal quarterly installments beginning in January 2005. We must meet certain financial and non-financial covenants in connection with this agreement.



Additionally, we have outstanding borrowings of approximately $894,000 at
March 31, 2004 that are payable to a director and shareholder. On April 1, 2004, the maturity date of these borrowings was extended to July 1, 2005. Currently, we expect to be able to pay down this outstanding debt as of the maturity date.



Our investment activities consist principally of investments
in computer and office equipment. Our capital expenditures for the nine months ended March 31, 2004 were approximately $184,000 compared to $168,000 for the same period in 2003. In order to maintain current operations, we believe that our average
annual outlay for investments in computer and office equipment will be consistent with the previous year.



As described more fully above, our financing activities in all periods have consisted principally of borrowings and repayments under our lines of credit.
Net borrowings (repayments) under lines of credit were $220,000 in 2003 and $171,000 for nine months ended March 31, 2004.



We expect to generate income from our operations before non-cash charges for the remaining three months of fiscal year 2004. Our working capital needs are
expected to stabilize, and we believe our needs can be met from the $500,000 of borrowings that we made in February 2004, as well as our available cash resources and line of credit. We do not have any material commitments to acquire property and
equipment, and our capital equipment needs for the next twelve months are expected to be insignificant. Because of our reliance on Autodesk to supply us with the products that we sell, and due to the concentration of our revenues from the sale of
Autodesk products, we cannot readily predict our ability to generate sufficient cash from our operations to meet our obligations beyond December 31, 2004. In the event that our operating results decline and we are unable to generate cash flows from
our operations in the near term, then we may be unable to meet our existing obligations in the normal course of business and expand our operations to allow for continued long-term improvement in operating results.



25



---

Below is a summary of our contractual obligations and commitments at March 31, 2004:



|                                  |  |                               |           |      |   |           |  |      |           |      |   |                    |  |   |         |  |   |          
|--------------------------------- |  | ----------------------------- | --------- | ---- | - | --------- |  | ---- | --------- | ---- | - | ------------------ |  | - | ------- |  | - | ---------
|                                  |  | Payments due by Fiscal Period
|                                  |  | Total                         |           | 2004 |   | 2005      |  | 2006 |           | 2007 |   | 2008 andthereafter
|Contractual Obligations           |  |                               |           |      |   |           |  |      |           |      |   |                    |  |   |         |  |   |          
|Long-term debt and line-of-credit |  | $                             | 4,387,314 |      | $ | 1,800,831 |  | $    | 111,964   |      | $ | 1,231,661          |  | $ | 171,428 |  | $ | 1,071,430
|Operating leases                  |  |                               | 4,313,464 |      |   | 244,697   |  |      | 901,546   |      |   | 837,874            |  |   | 726,720 |  |   | 1,602,627
|                                  |  |                               |           |      |   |           |  |      |           |      |   |                    |  |   |         |  |   |          
|Total obligations                 |  | $                             | 8,700,778 |      | $ | 2,045,528 |  | $    | 1,013,510 |      | $ | 2,069,535          |  | $ | 898,148 |  | $ | 2,674,057
|                                  |  |                               |           |      |   |           |  |      |           |      |   |                    |  |   |         |  |   |          



|ITEM 3. | 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 March 31, 2004,
approximately 41% of the Companys outstanding debt bears interest at variable rates. Accordingly, the Companys earnings and cash flow are affected by changes in interest rates. Assuming the current level of borrowings at variable rates
and assuming a 100 basis point changes in the 2004 average interest rate under these borrowings, it is estimated that the Companys 2004 interest expense and net income would have changed by less than $20,000. In the event of an adverse change
in interest rates, management would likely take actions to further mitigate its exposure. However, due to the uncertainty of the actions that would be taken and their possible effects, the analysis assumes no such actions. Further, the analysis does
not consider the effects of the change in the level of overall economic activity that could exist in such an environment.



|ITEM 4. | 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 reports that it files or submits under the Securities and Exchange Act of 1934, as amended, is accumulated and communicated to management in a timely manner. The Companys Chief Executive Officer and Interim
Chief Financial Officer have evaluated this system of disclosure controls and procedures as of the end of the period covered by this quarterly report, and believe that the system is operating effectively to ensure appropriate disclosure. There have
been no changes in the Companys internal controls over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Companys internal controls over financial
reporting.



26



---

Part II. OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------



On October 15, 2003, we were sued by Inter-Tel Leasing, Inc. in the District Court in Harris County, Texas (Case No. 03-57866). The suit claims that we
defaulted on the lease of equipment from Inter-Tel and demands $149,617 for the rental of the equipment, immediate possession of the leased property, and attorney fees estimated at $29,923.



We filed an answer, a verified denial and an affirmative defense on December
5, 2003 and have demanded that Inter-Tel dismiss the claim against Avatech because Inter-Tel has named the wrong party in this action. Although Spatial Technology, Inc. (Spatial Technology), a predecessor of Avatech, on June 2, 2000,
entered into a Lease Agreement with Inter-Tel, Inter-Tel agreed on September 9, 2000 to Spatial Technologys assignment of the Lease Agreement to Spatial Components, LLC (Spatial Components). Spatial Components was a wholly owned
subsidiary of Spatial Technology, and was sold to Dassault Systemes Corporation in November of 2000. Spatial Components has since changed its name to Spatial Corp.



Inter-Tel is investigating adding Spatial Corp; as a defendant, but has not yet taken any action. If Inter-Tel does not
dismiss the suit against us, we may file a cross-claim against Spatial Corp. We believe that we have meritorious defenses to this claim, but we are unable to assess our potential liability at this time.



|Item 2. | Changes in Securities
|------- | ---------------------



On January 1, 2004, a consolidated subsidiary issued 10% subordinated notes for an aggregate total of $135,000 due on July 1, 2005 to three
accredited investors in exchange for these investors agreement to cancel existing 10% subordinated notes for an aggregate total of $150,000 due on December 31, 2003 and cash totaling $15,000 in aggregate. Two of these 10% notes
require an interim payment of $15,000 in aggregate, due on July 1, 2004. Each of these investors also received warrants to purchase 15,000 shares of our common stock at $0.21 per share, which expire on July 1, 2005.



Also on January 1, 2004, the same subsidiary issued 12% subordinated notes
for an aggregate total of $63,750 due on July 1, 2005 to three accredited investors in exchange for those investors agreement to cancel existing 12% subordinated notes for an aggregate total of $75,000 due on December 31, 2003 and
cash in the aggregate amount of $11,250. These 12% notes require an interim payment of $11,250 in aggregate, due on July 1, 2004.



Because these issuances were to accredited investors within the meaning of Rule 501 under the Securities Act, the offer and sale of these
securities was exempt from registration under Rule 506 of the Securities Act.



On April 1, 2004, the Company issued a senior subordinated note in principal amount of $902,169 to an accredited investor in satisfaction of the balance outstanding on certain notes issued to that investor in May
2003. The new note accrues interest at a rate of 12% per annum, with quarterly interest payments due commencing July 1, 2004, and matures on July 1, 2005. Because this note was issued by the Company in exchange for notes originally issued by the
Company to the note holder, and no commission or other remuneration was paid or given for soliciting the exchange, the offer and sale of this note was exempt from registration under Section 3(a)(9) of the Securities Act.



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------



None



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------



None



|Item 5. | Other Information
|------- | -----------------



None



27



---

|Item 6. | Exhibits and Reports on Form 8-K
|------- | --------------------------------



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



|            |  |                                                                                                                                                                                                                                                                                        
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                                                                                                                                                                 
|            | 
|2.1         |  | Agreement and Plan of Mergera                                                                                                                                                                                                                                                          
|            | 
|3.1         |  | Restated Certificate of Incorporationb                                                                                                                                                                                                                                                 
|            | 
|3.2         |  | First Amendment to Restated Certificate of Incorporationb                                                                                                                                                                                                                              
|            | 
|3.3         |  | Reverse Split Amendment to Restated Certificate of Incorporationa                                                                                                                                                                                                                      
|            | 
|3.4         |  | Amendment of PlanetCADs Certificate of Incorporation to change the name of PlanetCAD, Inc. to Avatech Solutions, Inc.a                                                                                                                                                                
|            | 
|3.5         |  | Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stockc                                                                                                                                                                                   
|            | 
|3.6         |  | Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stockd                                                                                                                                                                                            
|            | 
|3.7         |  | Certificate of Designation, Preferences and Rights of Series C Convertible Preferred Stocke                                                                                                                                                                                            
|            | 
|3.8         |  | Certificate of Amendment to Certificate of Designation of Series C Convertible Preferred Stockh                                                                                                                                                                                        
|            | 
|3.9         |  | Certificate of Designation, Preferences and Rights of Series D Convertible Preferred Stockh                                                                                                                                                                                            
|            | 
|3.10        |  | Certificate of Elimination of Series A Junior Participating Preferred Stockh                                                                                                                                                                                                           
|            | 
|3.11        |  | Certificate of Elimination of Series C Convertible Preferred Stockh                                                                                                                                                                                                                    
|            | 
|3.12        |  | Certificate of Amendment to Certificate of Designation of Series D Convertible Preferred Stockh                                                                                                                                                                                        
|            | 
|3.13        |  | By-Lawsb                                                                                                                                                                                                                                                                               
|            | 
|10.01       |  | Autodesk Authorized Channel Partner Agreement by and among Avatech Solutions, Inc. and Autodesk, Inc. effective as of February 1, 2003h                                                                                                                                                
|            | 
|10.02       |  | Autodesk Authorized Channel Partner Agreement by and among Avatech Solutions, Inc. and Autodesk, Inc. effective as of February 1, 2004h                                                                                                                                                
|            | 
|10.03       |  | Loan Agreement by and between Avatech Solutions Subsidiary, Inc. and a Strategic Partner dated July 22, as amended (portions of this exhibit have been omitted and filed separately with the
U.S. Securities and Exchange Commission pursuant to a request for confidential treatment)f
|            | 
|10.04       |  | Security Agreement by and between Avatech Solutions Subsidiary, Inc. and a Strategic Partner dated July 22, 2003 (portions of this exhibit have been omitted and filed separately with the U.S.
Securities and Exchange Commission pursuant to a request for confidential treatment)f  
|            | 
|10.05       |  | Demand Promissory Note by and between Avatech Solutions Subsidiary, Inc. and Key Bank and Trust in the amount of $2,000,000 dated September 11, 2003f                                                                                                                                  
|            | 
|10.06       |  | Loan and Security Agreement by and between Avatech Solutions Subsidiary, Inc. and Key Bank and Trust dated September 11, 2003f                                                                                                                                                         
|            | 
|10.07       |  | Master Lease Agreement by and between Allstate Leasing, Inc. and Avatech Solutions, Inc. dated July 17, 2001a                                                                                                                                                                          
|            | 
|10.08       |  | Form of Promissory Note, principal amount $500,000.00, issued by Avatech Solutions, Inc. in favor of W. James Hindman dated May 28, 2003f                                                                                                                                              
|            | 
|10.09       |  | Warrants to purchase up to 32,400 shares of Common Stock issued by Avatech to W. James Hindman dated May 28, 2003f                                                                                                                                                                     
|            | 
|10.10       |  | Affidavit and Discharge of Indebtedness by W. James Hindmanf                                                                                                                                                                                                                           



28



---

|            |  |                                                                                                                                                                                                                                         
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description of Exhibit                                                                                                                                                                                                                  
|            | 
|10.11       |  | Form of 10% Subordinated Note with attached Warrant issued by Avatech Solutions, Inc. to certain note holders in connection with Avatech Solutions Subsidiary, Inc.s 1998 $2,600,000
Subordinated Debt Offering, dated January 1, 2004h
|            | 
|10.12       |  | Form of 12 % Subordinated Note issued by Avatech Solutions, Inc. to certain note holders in connection with Avatech Solutions Subsidiary, Inc.s 1998 $2,600,000 Subordinated Debt
Offering dated January 1, 2004h                      
|            | 
|10.13       |  | Form of Purchase Agreement for Series D Convertible Preferred Stockh                                                                                                                                                                    
|            | 
|10.14       |  | 2002 Stock Option Plana                                                                                                                                                                                                                 
|            | 
|10.15       |  | Restricted Stock Award Plane                                                                                                                                                                                                            
|            | 
|10.16       |  | Employment Agreement by and between Debra Keith and Avatech Solutions, Inc. dated as of April 4, 2003f                                                                                                                                  
|            | 
|10.17       |  | Employment Agreement by and between Eric L. Pratt and Avatech Solutions, Inc. dated April 15, 2003g                                                                                                                                     
|            | 
|10.18       |  | Employment Agreement by and between Scott N. Fischer and Avatech Solutions, Inc. dated as of March 17, 2003f                                                                                                                            
|            | 
|10.19       |  | Consulting Agreement by and between V. Joel Nicholson and Avatech Solutions, Inc. effective as of June 1, 2003g                                                                                                                         
|            | 
|10.20       |  | Employment Agreement by and between Donald R. Scotty Walsh and Avatech Solutions, Inc. dated July 1, 2003f                                                                                                                            
|            | 
|10.21       |  | Letter Agreement by and between Henry D. Felton and Avatech Solutions, Inc. dated August 21, 2003f                                                                                                                                      
|            | 
|10.22       |  | Form of Promissory Note, principal amount $902,168.80, issued by Avatech Solutions, Inc. in favor of W. James Hindman dated April 1, 2004 *                                                                                             
|            | 
|10.23       |  | Separation Agreement between Scott Fischer and Avatech Solutions, Inc. dated as of March 10, 2004 *                                                                                                                                     
|            | 
|31.1        |  | Certification of Donald R. Scotty Walsh, Chief Executive Officer *                                                                                                                                                                    
|            | 
|31.2        |  | Certification of Beth O. MacLaughlin, Chief Financial Officer *                                                                                                                                                                         
|            | 
|32.1        |  | Section 1350 Certifications *                                                                                                                                                                                                           

---

|* | Filed herewith
|- | --------------



|a. | Incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386.
|-- | --------------------------------------------------------------------------------------------------------------



|b. | Incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426.
|-- | --------------------------------------------------------------------------------------------------------------------



|c. | Incorporated by reference to our Registration Statement on form 8-A filed on March 11, 2002, File No. 001-31265.
|-- | ----------------------------------------------------------------------------------------------------------------



|d. | Incorporated by reference to our Current Report on form 8-K, filed on May 28, 2002, File No. 001-31265.
|-- | -------------------------------------------------------------------------------------------------------



|e. | Incorporated by reference to our Amended Registration Statement on form S-1, filed on April 11, 2003, File No. 333-104035.
|-- | --------------------------------------------------------------------------------------------------------------------------



|f. | Incorporated by reference to our Annual Report on form 10-K, filed on October 3, 2003, File No. 001-31265.
|-- | ----------------------------------------------------------------------------------------------------------



|g. | Incorporated by reference to our Amended Registration Statement on form S-1, filed on June 4, 2003, File No. 333-104035.
|-- | ------------------------------------------------------------------------------------------------------------------------



|h. | Incorporated by reference to our Quarterly Report on form 10-Q, filed on February 13, 2004, File No. 001-31265.
|-- | ---------------------------------------------------------------------------------------------------------------



(b) Reports on Form 8-K



Registrant filed Current Reports on Form 8-K during the quarter for which this report is filed:



On February 17, 2003, we filed a Report on Form 8-K to announce the filing of
our Quarterly Report on Form 10-Q for the three-month period ended December 31, 2003.



29



---

On January 21, 2004, we filed a Report on Form 8-K to announce the closing of the private placement of
Series D Convertible Preferred Stock and warrants.



30



---

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. AND SUBSIDIARIES
|                   |  |  | 
|Date: May 17, 2004 |  |  |  | By                                       |  | /s/ Donald R. Scotty Walsh                                                                 
|                   |  |  |  |                                          |  |                                                                                              
|                   |  |  |  |                                          |  | Donald R. Scotty Walsh Chief Executive Officer                                             
|                   |  |  | 
|Date: May 17, 2004 |  |  |  | By                                       |  | /s/ Beth MacLaughlin                                                                         
|                   |  |  |  |                                          |  |                                                                                              
|                   |  |  |  |                                          |  | Beth MacLaughlin Interim Chief Financial Officer (principal financial and accounting officer)



31