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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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

For the quarterly period ended December 31, 2006

OR



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

Commission file number: 001-31265



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Avatech Solutions, Inc.

(Exact Name
of Registrant as Specified in its Charter)



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



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

(410) 5818080

(Registrants telephone number, including area code)



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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No ̈

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

Large accelerated
filer ̈Accelerated filer ̈Non-accelerated filer  x

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

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 February 1, 2007
|Common Stock, par value $.01 per share |  | 14,811,702                     



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AVATECH SOLUTIONS, INC. AND SUBSIDIARIES

INDEX



|           |  |                                                                                                   |  |     
|---------- |  | ------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                   |  | Page
|PART I     |  | FINANCIAL INFORMATION                                                                             |  |     
|           |  |                                                                                                  
|ITEM 1.    |  | Consolidated Financial Statements                                                                 |  |     
|           |  |                                                                                                  
|           |  | Consolidated Balance Sheets  December 31, 2006 (Unaudited) and June 30, 2006                     |  | 3   
|           |  |                                                                                                  
|           |  | Consolidated Statements of Operations  Three months ended December 31, 2006 and 2005 (Unaudited) |  | 5   
|           |  |                                                                                                  
|           |  | Consolidated Statements of Operations  Six months ended December 31, 2006 and 2005 (Unaudited)   |  | 6   
|           |  |                                                                                                  
|           |  | Consolidated Statement of Stockholders Equity  Six months ended December 31, 2006 (Unaudited)   |  | 7   
|           |  |                                                                                                  
|           |  | Consolidated Statements of Cash Flows  Six months ended December 31, 2006 and 2005 (Unaudited)   |  | 8   
|           |  |                                                                                                  
|           |  | Notes to Consolidated Financial Statements (Unaudited)                                            |  | 9   
|           |  |                                                                                                  
|ITEM 2.    |  | Managements Discussion and Analysis of Results of Operations and Financial Condition             |  | 14  
|           |  |                                                                                                  
|ITEM 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                        |  | 21  
|           |  |                                                                                                  
|ITEM 4.    |  | Controls and Procedures                                                                           |  | 23  
|           |  |                                                                                                  
|PART II    |  | OTHER INFORMATION                                                                                 |  | 23  
|           |  |                                                                                                  
|ITEM 1A.   |  | Risk Factors                                                                                      |  | 23  
|           |  |                                                                                                  
|ITEM 4.    |  | Submission of Matters to a Vote of Security Holders                                               |  | 23  
|           |  |                                                                                                  
|ITEM 6.    |  | Exhibits                                                                                          |  | 23  
|           |  |                                                                                                  
|SIGNATURES |  |                                                                                                   |  | 25  



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PART I. FINANCIAL INFORMATION

Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets



|                                                                                                                    |  |                  |            |               |   |           
|------------------------------------------------------------------------------------------------------------------- |  | ---------------- | ---------- | ------------- | - | ----------
|                                                                                                                    |  | December 31,2006 |            | June 30, 2006
|                                                                                                                    |  | (unaudited)      |            |              
|Assets                                                                                                              |  |                  |            |               |   |           
|Current assets:                                                                                                     |  |                  |            |               |   |           
|Cash and cash equivalents                                                                                           |  | $                | 341,000    |               | $ | 581,000   
|Accounts receivable, less allowance of $133,000 as of December 31, 2006 and $112,000 as of June 30, 2006            |  |                  | 8,229,000  |               |   | 5,471,000 
|Other receivables                                                                                                   |  |                  | 318,000    |               |   | 320,000   
|Inventory                                                                                                           |  |                  | 1,342,000  |               |   | 1,414,000 
|Prepaid expenses and other current assets                                                                           |  |                  | 323,000    |               |   | 305,000   
|                                                                                                                    |  |                  |            |               |   |           
|Total current assets                                                                                                |  |                  | 10,553,000 |               |   | 8,091,000 
|                                                                                                                    |  |                 
|Property and equipment:                                                                                             |  |                  |            |               |   |           
|Computer software and equipment                                                                                     |  |                  | 2,824,000  |               |   | 2,649,000 
|Office furniture and equipment                                                                                      |  |                  | 1,066,000  |               |   | 1,048,000 
|Leasehold improvements                                                                                              |  |                  | 170,000    |               |   | 133,000   
|                                                                                                                    |  |                  |            |               |   |           
|                                                                                                                    |  |                  | 4,060,000  |               |   | 3,830,000 
|Less accumulated depreciation and amortization                                                                      |  |                  | 3,145,000  |               |   | 2,960,000 
|                                                                                                                    |  |                  |            |               |   |           
|                                                                                                                    |  |                  | 915,000    |               |   | 870,000   
|Customer list, net of accumulated amortization of $243,000 as of December 31, 2006 and $100,000 as of June 30, 2006 |  |                  | 1,944,000  |               |   | 1,900,000 
|Goodwill                                                                                                            |  |                  | 5,864,000  |               |   | 5,864,000 
|Other assets                                                                                                        |  |                  | 104,000    |               |   | 125,000   
|                                                                                                                    |  |                  |            |               |   |           
|Total assets                                                                                                        |  | $                | 19,380,000 |               | $ | 16,850,000
|                                                                                                                    |  |                  |            |               |   |           

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets (continued)



|                                                                                                                                                                                                                                                                  |  |                  |            |   |               |   |            |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | ---------- | - | ------------- | - | ---------- | -
|                                                                                                                                                                                                                                                                  |  | December 31,2006 |            |   | June 30, 2006 |  
|                                                                                                                                                                                                                                                                  |  | (unaudited)      |            |   |               |  
|Liabilities and stockholders equity                                                                                                                                                                                                                              |  |                  |            |   |               |   |            |  
|Current liabilities:                                                                                                                                                                                                                                              |  |                  |            |   |               |   |            |  
|Accounts payable and accrued expenses                                                                                                                                                                                                                             |  | $                | 4,216,000  |   |               | $ | 5,097,000  |  
|Accrued compensation and related benefits                                                                                                                                                                                                                         |  |                  | 810,000    |   |               |   | 725,000    |  
|Borrowings under lines-of-credit                                                                                                                                                                                                                                  |  |                  | 3,916,000  |   |               |   | 1,409,000  |  
|Current portion of long-term debt                                                                                                                                                                                                                                 |  |                  | 50,000     |   |               |   | 43,000     |  
|Deferred revenue                                                                                                                                                                                                                                                  |  |                  | 1,131,000  |   |               |   | 1,022,000  |  
|Other current liabilities                                                                                                                                                                                                                                         |  |                  | 250,000    |   |               |   | 156,000    |  
|                                                                                                                                                                                                                                                                  |  |                  |            |   |               |   |            |  
|Total current liabilities                                                                                                                                                                                                                                         |  |                  | 10,373,000 |   |               |   | 8,452,000  |  
|                                                                                                                                                                                                                                                                  |  |                 
|Long-term debt                                                                                                                                                                                                                                                    |  |                  | 13,000     |   |               |   | 51,000     |  
|Other long-term liabilities                                                                                                                                                                                                                                       |  |                  | 2,000      |   |               |   | 67,000     |  
|Commitments and contingencies                                                                                                                                                                                                                                     |  |                  |           |   |               |   |           |  
|                                                                                                                                                                                                                                                                  |  |                 
|Series F Convertible Preferred Stock                                                                                                                                                                                                                              |  |                  | 3,629,000  |   |               |   | 3,629,000  |  
|                                                                                                                                                                                                                                                                  |  |                 
|Stockholders equity:                                                                                                                                                                                                                                             |  |                  |            |   |               |   |            |  
|Convertible Preferred Stock, $0.01 par value; 1,300,537 shares authorized and 1,298,728 issued at December 31, 2006 and June 30,
2006; 1,190,387 shares outstanding with an aggregate liquidation preference of $1,892,000 at December 31, 2006 and June 30, 2006 |  |                  | 12,000     |   |               |   | 12,000     |  
|Common stock, $0.01 par value; 80,000,000 shares authorized; issued and outstanding shares of 13,632,074 at December 31, 2006 and
13,517,296 at June 30, 2006                                                                                                     |  |                  | 136,000    |   |               |   | 135,000    |  
|Additional paid-in capital                                                                                                                                                                                                                                        |  |                  | 10,769,000 |   |               |   | 10,601,000 |  
|Accumulated deficit                                                                                                                                                                                                                                               |  |                  | (5,554,000 | ) |               |   | (6,097,000 | )
|                                                                                                                                                                                                                                                                  |  |                  |            |   |               |   |            |  
|Total stockholders equity                                                                                                                                                                                                                                        |  |                  | 5,363,000  |   |               |   | 4,651,000  |  
|                                                                                                                                                                                                                                                                  |  |                  |            |   |               |   |            |  
|Total liabilities and stockholders equity                                                                                                                                                                                                                        |  | $                | 19,380,000 |   |               | $ | 16,850,000 |  
|                                                                                                                                                                                                                                                                  |  |                  |            |   |               |   |            |  

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations



|                                            |  |                                 |            |   |             |   |            |  
|------------------------------------------- |  | ------------------------------- | ---------- | - | ----------- | - | ---------- | -
|                                            |  | Three Months Ended December 31, |           
|                                            |  | 2006                            |            |   | 2005        |  
|                                            |  | (unaudited)                     |            |   | (unaudited) |  
|Revenues:                                   |  |                                 |            |   |             |   |            |  
|Product sales                               |  | $                               | 7,266,000  |   |             | $ | 5,734,000  |  
|Service revenue                             |  |                                 | 2,346,000  |   |             |   | 1,864,000  |  
|Commission revenue                          |  |                                 | 2,800,000  |   |             |   | 1,853,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|                                            |  |                                 | 12,412,000 |   |             |   | 9,451,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|Cost of revenue:                            |  |                                 |            |   |             |   |            |  
|Cost of product sales                       |  |                                 | 4,506,000  |   |             |   | 3,382,000  |  
|Cost of service revenue                     |  |                                 | 1,736,000  |   |             |   | 1,171,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|                                            |  |                                 | 6,242,000  |   |             |   | 4,553,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|Gross margin                                |  |                                 | 6,170,000  |   |             |   | 4,898,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|Other operating expenses:                   |  |                                 |            |   |             |   |            |  
|Selling, general and administrative         |  |                                 | 5,372,000  |   |             |   | 3,860,000  |  
|Depreciation and amortization               |  |                                 | 164,000    |   |             |   | 99,000     |  
|                                            |  |                                 |            |   |             |   |            |  
|                                            |  |                                 | 5,536,000  |   |             |   | 3,959,000  |  
|                                            |  |                                 |            |   |             |   |            |  
|Operating income                            |  |                                 | 634,000    |   |             |   | 939,000    |  
|                                            |  |                                 |            |   |             |   |            |  
|Other income (expense):                     |  |                                 |            |   |             |   |            |  
|Interest and other income                   |  |                                 | 19,000     |   |             |   | 2,000      |  
|Interest expense                            |  |                                 | (85,000    | ) |             |   | (124,000   | )
|                                            |  |                                 |            |   |             |   |            |  
|                                            |  |                                 | (66,000    | ) |             |   | (122,000   | )
|                                            |  |                                 |            |   |             |   |            |  
|Income before income taxes                  |  |                                 | 568,000    |   |             |   | 817,000    |  
|Income tax expense                          |  |                                 | 61,000     |   |             |   | 12,000     |  
|                                            |  |                                 |            |   |             |   |            |  
|Net income                                  |  |                                 | 507,000    |   |             |   | 805,000    |  
|Preferred stock dividends                   |  |                                 | (167,000   | ) |             |   | (50,000    | )
|                                            |  |                                 |            |   |             |   |            |  
|Net income available to common stockholders |  | $                               | 340,000    |   |             | $ | 755,000    |  
|                                            |  |                                 |            |   |             |   |            |  
|                                            |  |                                
|Earnings per common share, basic            |  | $                               | 0.02       |   |             | $ | 0.07       |  
|                                            |  |                                 |            |   |             |   |            |  
|Earnings per common share, diluted          |  | $                               | 0.02       |   |             | $ | 0.05       |  
|                                            |  |                                 |            |   |             |   |            |  
|                                            |  |                                
|Shares used in computation - basic          |  |                                 | 13,627,309 |   |             |   | 11,231,627 |  
|                                            |  |                                 |            |   |             |   |            |  
|Shares used in computation - diluted        |  |                                 | 19,261,073 |   |             |   | 17,051,497 |  
|                                            |  |                                 |            |   |             |   |            |  

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations



|                                            |  |                               |            |   |             |   |            |  
|------------------------------------------- |  | ----------------------------- | ---------- | - | ----------- | - | ---------- | -
|                                            |  | Six Months Ended December 31, |           
|                                            |  | 2006                          |            |   | 2005        |  
|                                            |  | (unaudited)                   |            |   | (unaudited) |  
|Revenues:                                   |  |                               |            |   |             |   |            |  
|Product sales                               |  | $                             | 14,520,000 |   |             | $ | 11,945,000 |  
|Service revenue                             |  |                               | 4,965,000  |   |             |   | 3,727,000  |  
|Commission revenue                          |  |                               | 4,972,000  |   |             |   | 3,007,000  |  
|                                            |  |                               |            |   |             |   |            |  
|                                            |  |                               | 24,457,000 |   |             |   | 18,679,000 |  
|                                            |  |                               |            |   |             |   |            |  
|Cost of revenue:                            |  |                               |            |   |             |   |            |  
|Cost of product sales                       |  |                               | 9,182,000  |   |             |   | 7,202,000  |  
|Cost of service revenue                     |  |                               | 3,565,000  |   |             |   | 2,398,000  |  
|                                            |  |                               |            |   |             |   |            |  
|                                            |  |                               | 12,747,000 |   |             |   | 9,600,000  |  
|                                            |  |                               |            |   |             |   |            |  
|Gross margin                                |  |                               | 11,710,000 |   |             |   | 9,079,000  |  
|                                            |  |                               |            |   |             |   |            |  
|Other operating expenses:                   |  |                               |            |   |             |   |            |  
|Selling, general and administrative         |  |                               | 10,596,000 |   |             |   | 7,588,000  |  
|Depreciation and amortization               |  |                               | 335,000    |   |             |   | 193,000    |  
|                                            |  |                               |            |   |             |   |            |  
|                                            |  |                               | 10,931,000 |   |             |   | 7,781,000  |  
|                                            |  |                               |            |   |             |   |            |  
|Operating income                            |  |                               | 779,000    |   |             |   | 1,298,000  |  
|                                            |  |                               |            |   |             |   |            |  
|Other income (expense):                     |  |                               |            |   |             |   |            |  
|Interest and other income                   |  |                               | 31,000     |   |             |   | 7,000      |  
|Interest expense                            |  |                               | (152,000   | ) |             |   | (263,000   | )
|                                            |  |                               |            |   |             |   |            |  
|                                            |  |                               | (121,000   | ) |             |   | (256,000   | )
|                                            |  |                               |            |   |             |   |            |  
|Income before income taxes                  |  |                               | 658,000    |   |             |   | 1,042,000  |  
|Income tax expense                          |  |                               | 115,000    |   |             |   | 32,000     |  
|                                            |  |                               |            |   |             |   |            |  
|Net income                                  |  |                               | 543,000    |   |             |   | 1,010,000  |  
|Preferred stock dividends                   |  |                               | (215,000   | ) |             |   | (89,000    | )
|                                            |  |                               |            |   |             |   |            |  
|Net income available to common stockholders |  | $                             | 328,000    |   |             | $ | 921,000    |  
|                                            |  |                               |            |   |             |   |            |  
|                                            |  |                              
|Earnings per common share, basic            |  | $                             | 0.02       |   |             | $ | 0.08       |  
|                                            |  |                               |            |   |             |   |            |  
|Earnings per common share, diluted          |  | $                             | 0.02       |   |             | $ | 0.06       |  
|                                            |  |                               |            |   |             |   |            |  
|                                            |  |                              
|Shares used in computation - basic          |  |                               | 13,621,915 |   |             |   | 11,058,411 |  
|                                            |  |                               |            |   |             |   |            |  
|Shares used in computation - diluted        |  |                               | 19,307,760 |   |             |   | 16,539,757 |  
|                                            |  |                               |            |   |             |   |            |  

See accompanying notes.





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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders Equity (Unaudited)



|                                                            |  |                 |  |              |        |                  |            |           |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  
|----------------------------------------------------------- |  | --------------- |  | ------------ | ------ | ---------------- | ---------- | --------- | - | ------------------------ |  | - | ------------------ | - |  | ----- | ---------- | - |  | - | --------- | -
|                                                            |  | Preferred Stock |  | Common Stock |        |                  |            |           |   |                          |  |   |                   
|                                                            |  | Number ofShares |  | Par Value    |        | Number of Shares |            | Par Value |   | AdditionalPaid-InCapital |  |   | AccumulatedDeficit |   |  | Total |           
|Balance at July 1, 2006                                     |  | 1,190,387       |  | $            | 12,000 |                  | 13,517,296 |           | $ | 135,000                  |  | $ | 10,601,000         |   |  | $     | (6,097,000 | ) |  | $ | 4,651,000 |  
|Issuance of common stock as compensation                    |  |                |  |              |       |                  | 20,893     |           |   |                         |  |   | 34,000             |   |  |       |           |   |  |   | 34,000    |  
|Issuance of common stock upon the exercise of stock options |  |                |  |              |       |                  | 10,502     |           |   |                         |  |   | 4,000              |   |  |       |           |   |  |   | 4,000     |  
|Issuance of common stock under Employee Stock Purchase Plan |  |                |  |              |       |                  | 83,383     |           |   | 1,000                    |  |   | 92,000             |   |  |       |           |   |  |   | 93,000    |  
|Vesting of stock options issued to employees                |  |                |  |              |       |                  |           |           |   |                         |  |   | 253,000            |   |  |       |            |   |  |   | 253,000   |  
|Preferred stock dividends                                   |  |                |  |              |       |                  |           |           |   |                         |  |   | (215,000           | ) |  |       |           |   |  |   | (215,000  | )
|Net income                                                  |  |                |  |              |       |                  |           |           |   |                         |  |   |                   |   |  |       | 543,000    |   |  |   | 543,000   |  
|                                                            |  |                 |  |              |        |                  |            |           |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  
|Balance at December 31, 2006                                |  | 1,190,387       |  | $            | 12,000 |                  | 13,632,074 |           | $ | 136,000                  |  | $ | 10,769,000         |   |  | $     | (5,554,000 | ) |  | $ | 5,363,000 |  
|                                                            |  |                 |  |              |        |                  |            |           |   |                          |  |   |                    |   |  |       |            |   |  |   |           |  

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Cash Flows



|                                                                                            |  |                               |             |   |      |   |             |  
|------------------------------------------------------------------------------------------- |  | ----------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                                            |  | Six Months Ended December 31, |            
|                                                                                            |  | 2006                          |             |   | 2005 |  
|                                                                                            |  | (unaudited)                   |            
|Cash flows from operating activities                                                        |  |                               |             |   |      |   |             |  
|Net income                                                                                  |  | $                             | 543,000     |   |      | $ | 1,010,000   |  
|Adjustments to reconcile net income to net cash (used in) provided by operating activities: |  |                               |             |   |      |   |             |  
|Provision for (recovery) of bad debts                                                       |  |                               | 33,000      |   |      |   | (3,000      | )
|Depreciation and amortization                                                               |  |                               | 335,000     |   |      |   | 193,000     |  
|Non-cash stock compensation expense                                                         |  |                               | 287,000     |   |      |   | 107,000     |  
|Amortization of debt discount charged to interest expense                                   |  |                               |            |   |      |   | 1,000       |  
|Loss on disposal of assets                                                                  |  |                               |            |   |      |   | 2,000       |  
|Changes in operating assets and liabilities:                                                |  |                               |             |   |      |   |             |  
|Accounts and other receivables                                                              |  |                               | (2,756,000  | ) |      |   | 254,000     |  
|Inventory                                                                                   |  |                               | 72,000      |   |      |   | (392,000    | )
|Prepaid expenses and other current assets                                                   |  |                               | (18,000     | ) |      |   | 42,000      |  
|Other assets                                                                                |  |                               | 21,000      |   |      |   | 30,000      |  
|Accounts payable and accrued expenses                                                       |  |                               | (881,000    | ) |      |   | (641,000    | )
|Accrued compensation and related benefits                                                   |  |                               | 85,000      |   |      |   | 277,000     |  
|Deferred revenue                                                                            |  |                               | 109,000     |   |      |   | 318,000     |  
|Other current liabilities                                                                   |  |                               | 94,000      |   |      |   | 91,000      |  
|                                                                                            |  |                               |             |   |      |   |             |  
|Net cash (used in) provided by operating activities                                         |  |                               | (2,076,000  | ) |      |   | 1,289,000   |  
|                                                                                            |  |                               |             |   |      |   |             |  
|                                                                                            |  |                              
|Cash flows from investing activities                                                        |  |                               |             |   |      |   |             |  
|Purchase of property and equipment                                                          |  |                               | (233,000    | ) |      |   | (112,000    | )
|Acquisition of customer list                                                                |  |                               | (200,000    | ) |      |   |            |  
|                                                                                            |  |                               |             |   |      |   |             |  
|Net cash used in investing activities                                                       |  |                               | (433,000    | ) |      |   | (112,000    | )
|                                                                                            |  |                               |             |   |      |   |             |  
|                                                                                            |  |                              
|Cash flows from financing activities                                                        |  |                               |             |   |      |   |             |  
|Proceeds from borrowings under line-of-credit                                               |  |                               | 32,607,000  |   |      |   | 24,070,000  |  
|Repayments of borrowings under line-of-credit                                               |  |                               | (30,100,000 | ) |      |   | (25,973,000 | )
|Repayments of long-term debt                                                                |  |                               | (31,000     | ) |      |   | (379,000    | )
|Proceeds from sale of preferred stock                                                       |  |                               |            |   |      |   | 1,191,000   |  
|Proceeds from sale of common stock to employees and exercise of stock options               |  |                               | 97,000      |   |      |   | 102,000     |  
|Payment of preferred stock dividends                                                        |  |                               | (215,000    | ) |      |   | (89,000     | )
|Change in accounts payable and accrued expenses related to financing                        |  |                               | (24,000     | ) |      |   |            |  
|Change in other long-term liabilities                                                       |  |                               | (65,000     | ) |      |   | (93,000     | )
|                                                                                            |  |                               |             |   |      |   |             |  
|Net cash provided by (used in) financing activities                                         |  |                               | 2,269,000   |   |      |   | (1,171,000  | )
|                                                                                            |  |                               |             |   |      |   |             |  
|Net change in cash and cash equivalents                                                     |  |                               | (240,000    | ) |      |   | 6,000       |  
|Cash and cash equivalents - beginning of period                                             |  |                               | 581,000     |   |      |   | 295,000     |  
|                                                                                            |  |                               |             |   |      |   |             |  
|Cash and cash equivalents - end of period                                                   |  | $                             | 341,000     |   |      | $ | 301,000     |  
|                                                                                            |  |                               |             |   |      |   |             |  

See accompanying notes.



---

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

December 31, 2006

1. Basis of Presentation

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

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for
interim financial information and in accordance with the instructions to Article 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, 2006. Operating results for the three and six months ended December 31, 2006 are not necessarily indicative of results for the full fiscal year or any future interim period.

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

2. Recent Accounting Pronouncements

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

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No.157). This statement provides a single definition of fair
value, a framework for measuring fair value, and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements creating inconsistencies in measurement and disclosures.
SFAS No. 157 applies under those previously issued pronouncements that prescribe fair value as the relevant measure of value, except SFAS No. 123(R) and related interpretations and pronouncements that require or permit measurement similar
to fair value but are not intended to measure fair value. This pronouncement is effective for fiscal years beginning after November 15, 2007. The Company is evaluating the impact of this new standard, but currently believes that adoption will
not have a material impact on its financial position, results of operations, or cash flows.

3. Employee Stock Compensation Plans



---

During fiscal year 2006, the Company adopted Financial Accounting Standards Board Statement No. 123R,
Share-Based Payment (Statement 123R), which requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Previously, the Company
accounted for stock-based compensation plans and the employee stock purchase plan in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and related Interpretations and provided
the required pro forma disclosures of Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation. On July 1, 2005, the Company elected to adopt the modified prospective transition method as
provided by Statement 123R. Under this transition method, compensation cost recognized during fiscal year 2006 includes (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 1, 2005, based on
the grant-date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to July 1, 2005, based on the grant-date fair value estimated in
accordance with the provisions of Statement 123R. The effect of applying Statement 123R was a decrease to net income of $136,000 for the quarter ended December 31, 2006, or less than $0.01 per basic and diluted share. For the six months ended
December 31, 2006, the effect of applying this Statement was $253,000, or less $0.02 per basic and $0.01 per diluted share. Results for prior periods have not been restated.

The Board of Directors may grant options under the Avatech Solutions, Inc. 2002 Stock Option Plan to purchase shares of the Companys common stock at an exercise price of not less than the fair market value of
the common stock on the date of grant. The plan provides for the granting of either incentive or non-qualified stock options to purchase an aggregate of up to 3,100,000 shares of common stock to eligible employees, officers, and directors of the
Company. Stock options generally have a maximum term of 10 years. Options generally vest ratably over three or four years, depending on the specific grant award. For the three and six months ended December 31, 2006, the Company also issued
11,334 and 20,893 shares, respectively, of fully vested common stock to members of the Board of Directors under the Companys Restricted Stock Award Plan, with an aggregate market value of $17,000 and $34,000, respectively. For the three months
three and six months ended December 31, 2006, total stock compensation expense charged against income for these plans was $153,000 and $287,000, respectively.

The minimum value method calculates the fair value of options as the excess of the estimated fair value of the underlying stock at the date of grant over the present value of both the exercise price and the expected dividend payments, each
discounted at the risk-free rate, over the expected life of the option. For all stock options granted prior to November 19, 2002, the date the Companys common stock became publicly traded and had a readily determinable market value, the
Company used the minimum value method to calculate pro forma stock compensation expense. For all stock options granted after this date, the Company used the Black-Scholes option pricing model. The Black-Scholes option pricing model was developed for
estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility.
Because the Companys stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in managements opinion,
the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards.

The following are the assumptions
made in computing the fair value of stock-based awards:



|                                               |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|---------------------------------------------- |  | ------------------------------ | --------- | - | ---------------------------- | - | --------- | ---- |  | - | --------- | - |  | - | --------- | -
|                                               |  | Three months endedDecember 31, |           |   | Six months endedDecember 31, |  
|                                               |  | 2006                           |           |   | 2005                         |   |           | 2006 |  |   | 2005      |  
|Average risk-free interest rate                |  |                                | 4.57      | % |                              |   | 4.47      | %    |  |   | 4.62      | % |  |   | 4.13      | %
|Dividend yield                                 |  |                                | 0         | % |                              |   | 0         | %    |  |   | 0         | % |  |   | 0         | %
|Expected term                                  |  |                                | 5.8 years |   |                              |   | 6.1 years |      |  |   | 5.9 years |   |  |   | 6.1 years |  
|Average expected volatility                    |  |                                | 1.03      |   |                              |   | 1.29      |      |  |   | 1.05      |   |  |   | 1.38      |  
|Weighted average fair value of granted options |  | $                              | 1.29      |   |                              | $ | 1.08      |      |  | $ | 1.39      |   |  | $ | 0.77      |  

Expected volatilities are based on historical volatility of the Companys stock. The expected term of options
granted represents the period of time that options granted are expected to be outstanding. The Company uses historical data to estimate option exercise and employee termination within the valuation



---

model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

A summary of stock option activity during the three months ended December 31, 2006 and related information is included in the table below:



|                                            |  |           |   |  |                                |      |                           |   |          
|------------------------------------------- |  | --------- | - |  | ------------------------------ | ---- | ------------------------- | - | ---------
|                                            |  | Options   |   |  | Weighted-AverageExercise Price |      | Aggregate Intrinsic Value
|Outstanding at July 1, 2006                 |  | 2,001,588 |   |  | $                              | 0.92 |                           |   |          
|Granted                                     |  | 328,000   |   |  |                                | 1.59 |                           |   |          
|Exercised                                   |  | (10,502   | ) |  |                                | 0.30 |                           |   |          
|Forfeited                                   |  | (30,000   | ) |  |                                | 1.76 |                           |   |          
|                                            |  |           |   |  |                                |      |                           |   |          
|Outstanding at December 31, 2006            |  | 2,289,086 |   |  | $                              | 1.01 |                           | $ | 1,122,000
|                                            |  |           |   |  |                                |      |                           |   |          
|Exercisable at December 31, 2006            |  | 1,359,525 |   |  | $                              | 0.80 |                           | $ | 952,000  
|                                            |  |           |   |  |                                |      |                           |   |          
|Weighted-average remaining contractual life |  | 7.6 Years |   |  |                                |      |                           |   |          
|                                            |  |           |   |  |                                |      |                           |   |          

The weighted average grant date fair value of options granted during the quarter ended December 31, 2006 was
$1.29 per share. All options granted have an exercise price equal to the fair market value of the Companys common stock on the date of grant. Exercise prices for options outstanding as of December 31, 2006 ranged from $0.12 to $63.33 as
follows:



|                         |              |                    |           |                                                    |   |                                                               |  |                    |  |                                                    |  |                                                               |      |  |          
|------------------------ | ------------ | ------------------ | --------- | -------------------------------------------------- | - | ------------------------------------------------------------- |  | ------------------ |  | -------------------------------------------------- |  | ------------------------------------------------------------- | ---- |  | ---------
|Range of Exercise Prices |              | OptionsOutstanding |           | WeightedAverageExercisePrices ofOptionsOutstanding |   | WeightedAverageRemainingContractual Lifeof OptionsOutstanding |  | OptionsExercisable |  | WeightedAverageExercisePrices ofOptionsExercisable |  | WeightedAverageRemainingContractual Lifeof OptionsExercisable
|$                        | 0.12  0.34  |                    | 590,632   |                                                    | $ | 0.17                                                          |  | 6.5 years          |  | 576,632                                            |  | $                                                             | 0.17 |  | 6.5 years
|                         | 0.35  0.91  |                    | 809,667   |                                                    |   | 0.65                                                          |  | 7.9 years          |  | 602,168                                            |  |                                                               | 0.65 |  | 7.9 years
|                         | 1.05  63.33 |                    | 892,787   |                                                    |   | 1.90                                                          |  | 9.1 years          |  | 180,725                                            |  |                                                               | 3.30 |  | 8.4 years
|                         |              |                    |           |                                                    |   |                                                               |  |                    |  |                                                    |  |                                                               |      |  |          
|                         |              |                    | 2,289,086 |                                                    |   |                                                               |  |                    |  | 1,359,525                                          |  |                                                               |      |  |          
|                         |              |                    |           |                                                    |   |                                                               |  |                    |  |                                                    |  |                                                               |      |  |          

Assuming that no additional share-based payments are granted after December 31, 2006, unamortized stock
compensation expense of $861,000 will be recognized in the statement of operations over a weighted average period of 2.7 years.

4. Borrowings Under
Line-of-Credit

The Company maintains a line of credit from a bank which provides for up to $5 million of borrowings limited to 80% of the
Companys aggregate eligible accounts receivable. The loan bears interest at a rate tied to the banks prime rate adjusted for changes in the Companys capital structure. The interest rate ranges from the banks prime rate plus
two percent to a low of the banks prime rate plus 0.25%. Based on the Companys capital structure, the interest rate for the quarter ended December 31, 2006 was the banks prime rate plus one and one-half percent. The loan was
renewed prior to its December 31, 2006 expiration date with a two year extension through December 31, 2008 and is secured by all of the Companys assets, except inventory.

The aggregate outstanding borrowings from the bank under this credit line were $3,916,000 and $1,409,000 at December 31, 2006 and June 30, 2006, respectively.



---

5. Long-Term Debt

The Company entered into two loans in connection with its April 2005 acquisition of Comtrex Corporation which totaled $50,000 as of December 31, 2006. Additionally, the Company assumed the automotive loans of Sterling Systems which
totaled $13,000 as of December 31, 2006.

6. Income Taxes

Income tax expense relates to the recordation of state income taxes and a federal alternative minimum tax provision as a result of the Companys profitable results. The Company, however, has significant net operating loss carry
forwards and does not expect to pay significant federal income taxes for the foreseeable future. For all periods presented, valuation allowances have been provided for the full amount of all net deferred tax assets.

7. Earnings Per Share

Basic earnings per common share is computed as
net earnings available to common stockholders 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 stocks. As of December 31, 2006, 10,787,432 shares of common stock were issuable upon the conversion or exercise of options, warrants and preferred stock. For
the three and six months ended December 31, 2006, there were 3,982,361 and 3,882,361, respectively, of common stock equivalents excluded from the computation of diluted earnings per share because their effect would have been antidilutive.

The following summarizes the computations of basic and diluted earnings per common share for the three months ended December 31, 2006 and 2005:



|                                                                     |  |                                 |            |   |      |   |            |  
|-------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                     |  | Three Months Ended December 31, |           
|                                                                     |  | 2006                            |            |   | 2005 |  
|Numerator for basic earnings per share:                              |  |                                 |            |   |      |   |            |  
|Net income                                                           |  | $                               | 507,000    |   |      | $ | 805,000    |  
|Less: preferred stock dividends                                      |  |                                 | (167,000   | ) |      |   | (50,000    | )
|                                                                     |  |                                 |            |   |      |   |            |  
|Net income available to common stockholders - basic                  |  | $                               | 340,000    |   |      | $ | 755,000    |  
|                                                                     |  |                                 |            |   |      |   |            |  
|Numerator for fully diluted earnings per share:                      |  |                                 |            |   |      |   |            |  
|Net income                                                           |  | $                               | 507,000    |   |      | $ | 805,000    |  
|Less: preferred stock dividends on dilutive common stock equivalents |  |                                 | (119,000   | ) |      |   | (50,000    | )
|                                                                     |  |                                 |            |   |      |   |            |  
|Net income available to common stockholders - fully diluted          |  | $                               | 388,000    |   |      | $ | 755,000    |  
|                                                                     |  |                                 |            |   |      |   |            |  
|Denominator:                                                         |  |                                 |            |   |      |   |            |  
|Weighted average shares outstanding - basic                          |  |                                 | 13,627,309 |   |      |   | 11,231,627 |  
|                                                                     |  |                                
|Assumed conversion of preferred stock                                |  |                                 | 4,192,708  |   |      |   | 4,382,843  |  
|Effect of outstanding stock options                                  |  |                                 | 1,072,796  |   |      |   | 1,105,407  |  
|Effect of outstanding stock warrants                                 |  |                                 | 368,260    |   |      |   | 331,621    |  
|                                                                     |  |                                 |            |   |      |   |            |  
|Weighted average shares outstanding - fully diluted                  |  |                                 | 19,261,073 |   |      |   | 17,051,497 |  
|                                                                     |  |                                 |            |   |      |   |            |  
|                                                                     |  |                                
|Earnings per common share - basic                                    |  | $                               | 0.02       |   |      | $ | 0.07       |  
|                                                                     |  |                                 |            |   |      |   |            |  
|Earnings per common share - diluted                                  |  | $                               | 0.02       |   |      | $ | 0.05       |  
|                                                                     |  |                                 |            |   |      |   |            |  



---

|                                                                     |  |                              |            |   |      |   |            |  
|-------------------------------------------------------------------- |  | ---------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                     |  | Six Months EndedDecember 31, |           
|                                                                     |  | 2006                         |            |   | 2005 |  
|Numerator for basic earnings per share:                              |  |                              |            |   |      |   |            |  
|Net income                                                           |  | $                            | 543,000    |   |      | $ | 1,010,000  |  
|Less: preferred stock dividends                                      |  |                              | (215,000   | ) |      |   | (89,000    | )
|                                                                     |  |                              |            |   |      |   |            |  
|Net income available to common stockholders - basic                  |  | $                            | 328,000    |   |      | $ | 921,000    |  
|                                                                     |  |                              |            |   |      |   |            |  
|Numerator for fully diluted earnings per share:                      |  |                              |            |   |      |   |            |  
|Net income                                                           |  | $                            | 543,000    |   |      | $ | 1,010,000  |  
|Less: preferred stock dividends on dilutive common stock equivalents |  |                              | (119,000   | ) |      |   | (89,000    | )
|                                                                     |  |                              |            |   |      |   |            |  
|Net income available to common stockholders - fully diluted          |  | $                            | 424,000    |   |      | $ | 921,000    |  
|                                                                     |  |                              |            |   |      |   |            |  
|Denominator:                                                         |  |                              |            |   |      |   |            |  
|Weighted average shares outstanding - basic                          |  |                              | 13,621,915 |   |      |   | 11,058,411 |  
|                                                                     |  |                             
|Assumed conversion of preferred stock                                |  |                              | 4,192,708  |   |      |   | 4,382,843  |  
|Effect of outstanding stock options                                  |  |                              | 1,112,966  |   |      |   | 878,979    |  
|Effect of outstanding stock warrants                                 |  |                              | 380,171    |   |      |   | 219,524    |  
|                                                                     |  |                              |            |   |      |   |            |  
|Weighted average shares outstanding - fully diluted                  |  |                              | 19,307,760 |   |      |   | 16,539,757 |  
|                                                                     |  |                              |            |   |      |   |            |  
|                                                                     |  |                             
|Earnings per common share - basic                                    |  | $                            | 0.02       |   |      | $ | 0.08       |  
|                                                                     |  |                              |            |   |      |   |            |  
|Earnings per common share - diluted                                  |  | $                            | 0.02       |   |      | $ | 0.06       |  
|                                                                     |  |                              |            |   |      |   |            |  

8. Liquidity and Capital Resources

The Companys operations have significantly improved over the last twelve months and it has generated sufficient capital to fund its operations and strengthen its balance sheet. As of December 31, 2006, the
stockholders equity was $5,363,000. Based on an evaluation of likely cash to be generated from operations in the near term and other available capital resources, management believes that it has sufficient sources of working capital to fund its
operations in the normal course of business.

9. Subsequent Event

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



---

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

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

This report contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995.
Readers of this report should be aware of the speculative nature of forward-looking statements. Statements that are not historical in nature, including those that include the words anticipate, estimate,
should, expect, believe, intend, and similar expressions, are based on current expectations, estimates and projections about, among other things, the industry and the markets in which we operate, and
they are not guarantees of future performance. Whether actual results will conform to expectations and predictions is subject to known and unknown risks and uncertainties, including risks and uncertainties discussed in this report; general economic,
market, or business conditions; changes in interest rates, the cost of funds, and demand for the Companys products and services; changes in the Companys competitive position or competitive actions by other companies; the Companys
ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond the Companys control. Consequently, all of the forward-looking statements made in this report are
qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on our business or operations. These and other risk
factors are discussed in detail the Companys periodic reports that it files with the Securities and Exchange Commission (the SEC) (see Item 1A of Part II of this report for further information). Except as required by
applicable laws, the Company does not intend to publish updates or revisions of any forward-looking statements to reflect new information, future events or otherwise.

Overview

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

The Company has a growth strategy which focuses on new ways of expanding its human
resources, product offerings, and geographic presence. This strategy includes-



| |  |  | focusing on three product groups: Design Automation (DA), Facilities Management (FM), and Data Management (DM);
| | - |  | ---------------------------------------------------------------------------------------------------------------



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



| |  |  | expanding our product offerings to include various FM and DM software packages, and new, internally-developed proprietary software; and,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



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

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



| |  |  | Autodesk design automation software for mechanical, architectural and civil engineering sectors and the Discreet product line for animation;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



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



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



---

| |  |  | Autodesk data management software.
| | - |  | ----------------------------------

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

Service Revenue- Avatech provides services in the form of training, consulting
services, professional services, and technical support to its customers. The Company also offers its customers an assessment tool to analyze the ability and knowledge of current and potential employees in computer aided design. The Company employs a
technical staff of approximately 69 personnel associated with these types of services.

Commission Revenue- The Company generates
commission revenue from the resale of Autodesk software to various customers, a number of which Autodesk considers major accounts. Autodesk designates these customers as major accounts based on specific criteria, primarily sales volume,
and typically gives these customers volume discounts. The Company is responsible for managing and reselling Autodesk products to a number of these major account customers; however, software products are shipped directly from Autodesk to the
customers. The Company receives commissions upon shipment of the products from Autodesk to the customer based on the product sales price. In addition, the Company sells technology upgrades to existing Autodesk customers through the Autodesk
Subscription program where the customers receive the latest releases of Autodesk software, incremental product enhancements, personalized web support direct from Autodesk technical experts, and self-paced training to help extend its customers
skills. Based on the Companys analysis of the Autodesk Subscription program, it records the net proceeds that it receives from Autodesk for subscription sales in accordance with the provisions of EITF 99-19, Reporting Revenue Gross as a
Principal versus Net as an Agent.

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

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

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

Depreciation and Amortization Expense- Depreciation and amortization expenses represent the period costs associated with our investment in
property and equipment, consisting principally of computer equipment, software, furniture and fixtures, and leasehold improvements. The Company computes depreciation and amortization expenses using the straight-line method. The Company leases all of
its facilities and depreciates leasehold improvements over the lesser of the lease term or the estimated useful life of the asset.

Interest Expense- Interest expense consists primarily of interest on a revolving line-of-credit.



---

Three Months Ended December 31, 2006 Compared to the Three Months Ended December 31, 2005

The following tables set forth a comparison of the Companys results of operations for the three-month period ended December 31, 2006 to the
three-month period ended December 31, 2005. The amounts are derived from selected items reflected in our unaudited Consolidated Statements of Operations included elsewhere in this report. The three months financial results are not necessarily
indicative of future results.

Revenues



|                   |  |                                 |            |      |   |            |  |      |  
|------------------ |  | ------------------------------- | ---------- | ---- | - | ---------- |  | ---- | -
|                   |  | Three Months Ended December 31, |           
|                   |  | 2006                            |            | 2005 |   | % increase | 
|Revenues:          |  |                                 |            |      |   |            |  |      |  
|Product sales      |  | $                               | 7,266,000  |      | $ | 5,734,000  |  | 26.7 | %
|Service revenue    |  |                                 | 2,346,000  |      |   | 1,864,000  |  | 25.9 | %
|Commission revenue |  |                                 | 2,800,000  |      |   | 1,853,000  |  | 51.1 | %
|                   |  |                                 |            |      |   |            |  |      |  
|Total revenues     |  | $                               | 12,412,000 |      | $ | 9,451,000  |  | 31.3 | %
|                   |  |                                 |            |      |   |            |  |      |  

Revenues. Total revenues for the three months ended December 31, 2006 increased
$2,961,000, or 31.3 %, when compared to the same period last year due to growth in all revenue categories. Subsequent to the May 2006 acquisition of Sterling Systems & Consulting, Inc. (Sterling), the Company integrated all
Sterling personnel into a reorganized organization and as a result, lost the ability to accurately track the revenues from the pre-acquisition Sterling. However, the offices that were previously owned, managed and staffed with all Sterling personnel
accounted for product sales of approximately $1,174,000, service revenue of $278,000 and commission revenue of $267,000 for the three months ended December 31, 2006.

Product sales increased to $7,266,000 for the quarter, an increase of $1,532,000 from the quarter ended December 31, 2005, or 26.7%. Excluding the effects of the offices acquired in the Sterling acquisition,
product sales increased by approximately $358,000, or 6.2%.

Service revenues increased $482,000, or 25.9%, for the three months ended
December 31, 2006 when compared to the same period in the prior fiscal year. Service revenues from the offices acquired in the Sterling acquisition accounted for approximately 58% of the increase with the remainder due to organic growth.

Commission revenues showed the largest growth of all of the revenue categories, increasing by 51.1%, or $947,000, for the three months
ended December 31, 2006 when compared to the same period in the prior fiscal year. Approximately 28% of the increase in commission revenues was a result of the Sterling acquisition. The remaining increase was a result of a significant increase
in the sales volume due to the fact that a larger percentage of subscriptions are renewed in the month of December compared with other periods and the continued focus by the Company to increase this type of business.

Cost of Revenues and Gross Margin



|                        |  |                                 |           |      |   |           |  |      |  
|----------------------- |  | ------------------------------- | --------- | ---- | - | --------- |  | ---- | -
|                        |  | Three Months Ended December 31, |          
|                        |  | 2006                            |           | 2005 |   | %increase | 
|Cost of revenue:        |  |                                 |           |      |   |           |  |      |  
|Cost of product sales   |  | $                               | 4,506,000 |      | $ | 3,382,000 |  | 33.2 | %
|Cost of service revenue |  |                                 | 1,736,000 |      |   | 1,171,000 |  | 48.2 | %
|                        |  |                                 |           |      |   |           |  |      |  
|Total cost of revenue   |  | $                               | 6,242,000 |      | $ | 4,553,000 |  | 37.1 | %
|                        |  |                                 |           |      |   |           |  |      |  
|Gross margin            |  | $                               | 6,170,000 |      | $ | 4,898,000 |  |      |  
|                        |  |                                 |           |      |   |           |  |      |  



---

Cost of revenue. The total cost of revenue increased $1,689,000, or 37.1%, for the three months
ended December 31, 2006 when compared to the same period in the prior fiscal year.

Cost of product sales for the second quarter of
the current fiscal year increased $1,124,000, or 33.2%, when compared to the second quarter of last year despite the fact that product sales increased by only 26.7% between periods. The cost of product sales as a percentage of related revenue for
the three months ended December 31, 2006 was 62.0%, compared to 59.0% in the same period in 2005. The increase in the cost of product sales as a percentage of sales is due to the fact that on October 1, 2006, the Companys main
supplier increased the cost of certain of its lower end products and the Company was unable to pass the full amounts of the increases onto its customers due to market pressures. In addition, the Company sold some hardware during the quarter ended
December 31, 2006 and hardware has a lower margin than software, thus contributing to the lower overall product margin.

Cost of
service revenue increased $565,000, or 48.2%, for the three months ended December 31, 2006 when compared to the same period in the prior fiscal year, while service revenues increased only 25.9%. Cost of service revenue as a percentage of
related revenue for the three months ended December 31, 2006 increased to 74.0% from 62.8% for the same period in the prior fiscal year. The Company hired a number of technical personnel during its first and second quarters of the current
fiscal year and it has taken longer than expected to increase the billable utilization of these new hires. The Company expects that its service revenue will increase once these personnel are fully trained and increase their billable hours resulting
in a increase to the service gross margin percentage.

Gross margin. Overall, the gross margin percentage decreased slightly from
51.8% for the three months ended December 31, 2005 to 49.7% for the same period in the current fiscal year. The decrease in the gross margin percentage was due to the factors noted above offset to a large degree by higher commission revenue as
a percentage of total revenue.

Other Operating Expenses



|                                    |      |                                 |           |  |           |           |  |      |  
|----------------------------------- | ---- | ------------------------------- | --------- |  | --------- | --------- |  | ---- | -
|                                    |      | Three Months Ended December 31, |          
|                                    | 2006 |                                 | 2005      |  | %increase |          
|Other operating expenses:           |      |                                 |           |  |           |           |  |      |  
|Selling, general and administrative |      | $                               | 5,372,000 |  | $         | 3,860,000 |  | 39.2 | %
|Depreciation and amortization       |      |                                 | 164,000   |  |           | 99,000    |  | 65.7 | %
|                                    |      |                                 |           |  |           |           |  |      |  
|Total other operating expenses      |      | $                               | 5,536,000 |  | $         | 3,959,000 |  | 39.8 | %
|                                    |      |                                 |           |  |           |           |  |      |  

Selling, General and Administrative Expense. Selling, general and administrative expenses
increased $1,512,000, or 39.2%, for the three months ended December 31, 2006 when compared to the same period in the prior fiscal year due to higher salary expense and sales commissions due to the acquisition of Sterling in May 2006 and new
sales personnel hired in the past twelve months. Selling, general and administrative expense as a percent of total revenues was 43.3% for the three months ended December 31, 2006, up from 40.8% for the same period in the prior fiscal year.

Depreciation and Amortization. Depreciation and amortization expenses increased $65,000, or 65.7%, for the three months ended
December 31, 2006 when compared to the same period in the prior fiscal year. The increase was due to the additional depreciation of the Sterling assets and the amortization of the intangible asset, the Sterling customer list, recorded in the
three months ended December 31, 2006.

Other Income (Expense)



|                             |      |                                 |          |  |           |           |  |        
|---------------------------- | ---- | ------------------------------- | -------- |  | --------- | --------- |  | -------
|                             |      | Three Months Ended December 31,
|                             | 2006 |                                 | 2005     |  | %increase
|Other income (expense):      |      |                                 |          |  |           |           |  |        
|Interest and other income    |      | $                               | 19,000   |  | $         | 2,000     |  | 850.0% 
|Interest expense             |      |                                 | (85,000) |  |           | (124,000) |  | (31.5)%
|                             |      |                                 |          |  |           |           |  |        
|Total other income (expense) |      | $                               | (66,000) |  | $         | (122,000) |  | (45.9)%
|                             |      |                                 |          |  |           |           |  |        



---

Other Income (Expense). Other income (expense) decreased $56,000 for the three months ended
December 31, 2006 when compared to the same period in the prior fiscal year. Interest expense decreased due to the payoff of virtually all long-term debt that occurred in fiscal year 2006.

Income Tax Expense



|                   |      |                                 |        |  |           |        |  |       |  
|------------------ | ---- | ------------------------------- | ------ |  | --------- | ------ |  | ----- | -
|                   |      | Three Months Ended December 31, |       
|                   | 2006 |                                 | 2005   |  | %increase |       
|Income tax expense |      | $                               | 61,000 |  | $         | 12,000 |  | 408.3 | %
|                   |      |                                 |        |  |           |        |  |       |  

Income Tax Expense. Income tax expense increased $49,000 for the three months ended
December 31, 2006 when compared to the same period in the prior fiscal year. The increase in tax expense relates to the recordation of state income taxes and a federal alternative minimum tax provision as a result of the Companys
profitable results. The Company, however, has significant net operating loss carry forwards and does not expect to pay significant federal income taxes for the foreseeable future. As the Company continues to demonstrate its ability to consistently
earn net income, some portion of the deferred tax asset valuation allowance may need to be reversed in future periods. The Company will continue to evaluate the likelihood of this asset being realized and will adjust the valuation allowance when
circumstances warrant its recordation. Any future reversal of the valuation allowance could have a material, non-cash effect on reported earnings.

Six
Months Ended December 31, 2006 Compared to the Six Months Ended December 31, 2005

The following tables set forth a comparison
of the Companys results of operations for the six month period ended December 31, 2006 to the six month period ended December 31, 2005. The amounts are derived from selected items reflected in our unaudited Consolidated Statements of
Operations included elsewhere in this report. The six months financial results are not necessarily indicative of future results.

Revenues



|                   |      |                               |            |  |   |            |  |      
|------------------ | ---- | ----------------------------- | ---------- |  | - | ---------- |  | -----
|                   |      | Six Months Ended December 31,
|                   | 2006 |                               | 2005       |  | %
|Revenues:          |      |                               |            |  |   |            |  |      
|Product sales      |      | $                             | 14,520,000 |  | $ | 11,945,000 |  | 21.6%
|Service revenue    |      |                               | 4,965,000  |  |   | 3,727,000  |  | 33.2%
|Commission revenue |      |                               | 4,972,000  |  |   | 3,007,000  |  | 65.3%
|                   |      |                               |            |  |   |            |  |      
|Total revenues     |      | $                             | 24,457,000 |  | $ | 18,679,000 |  | 30.9%
|                   |      |                               |            |  |   |            |  |      

Revenues. The Company realized significant revenue growth over the same period in the prior
fiscal year. Total revenues increased $5,778,000, or 30.9%, between periods and all three categories of revenues showed large increases. As noted above, the Company integrated all Sterling personnel into a reorganized organization and as a result,
lost the ability to accurately track the revenues from the pre-acquisition Sterling. However, the offices that were previously owned, managed and staffed with all Sterling personnel accounted for product sales of approximately $2,848,000, service
revenue of $648,000 and commission revenue of $669,000 for the six months ended December 31, 2006, or a total of $4,165,000.

Product
sales increased to $14,520,000 for the six months ended December 31, 2006, an increase of $2,575,000 over the same period in 2005, or 21.6% due to the Sterling acquisition.

Service revenues increased $1,238,000, or 33.2%, for the six months ended December 31, 2006 as compared to the same period in the prior fiscal year.
The Company continued its strategy of investing in its services business by adding personnel and expanding its training, support and consulting capabilities. This strategy, coupled with the Sterling acquisition, resulted in the large growth in its
services revenues.



---

Commission revenues increased $1,965,000, or 65.3% for the six months ended December 31, 2006, when
compared to the same period in the prior fiscal year. Approximately 34% of the increase in commission revenues was a result of the Sterling acquisition. The remaining increase in commission revenues was a result of a significant industry-wide
increase in sales volume and a continued focus by the Company and Autodesk to increase this category of business.

Cost of Revenues and Gross Margin



|                        |  |                               |            |      |   |           |  |      |  
|----------------------- |  | ----------------------------- | ---------- | ---- | - | --------- |  | ---- | -
|                        |  | Six Months Ended December 31, |           
|                        |  | 2006                          |            | 2005 |   | %         | 
|Cost of revenue:        |  |                               |            |      |   |           |  |      |  
|Cost of product sales   |  | $                             | 9,182,000  |      | $ | 7,202,000 |  | 27.5 | %
|Cost of service revenue |  |                               | 3,565,000  |      |   | 2,398,000 |  | 48.7 | %
|                        |  |                               |            |      |   |           |  |      |  
|Total cost of revenue   |  | $                             | 12,747,000 |      | $ | 9,600,000 |  | 32.8 | %
|                        |  |                               |            |      |   |           |  |      |  
|Gross margin            |  | $                             | 11,710,000 |      | $ | 9,079,000 |  |      |  
|                        |  |                               |            |      |   |           |  |      |  

Costs of revenue. Total cost of revenue increased $3,147,000, or 32.8%, for the six months
ended December 31, 2006 as compared to the same period in the prior fiscal year.

Cost of product sales increased $1,980,000, or
27.5%, despite only a 21.6% increase in product revenues. The cost of product sales as a percentage of related revenue for the six months ended December 31, 2006 was 63.2%, compared to 60.3% in the same period in 2005. The increase in the cost
of product sales as a percentage of sales is due to the fact that the Company sold some hardware during the six months ended December 31, 2006 and hardware has a lower margin than software, thus contributing to the lower overall product margin.
In addition, on October 1, 2006, the Companys main supplier increased the cost of certain of its lower end products and the Company was unable to pass the full amounts of these increases onto its customers due to market pressures.

Cost of service revenue increased $1,167,000, or 48.7%, for the six months ended December 31, 2006 compared to the same period in the
prior fiscal year, but service revenues increased by 33.2%. As a result, cost of service revenue as a percentage of related revenue for the six months ended December 31, 2006 increased to 71.8% from 64.3% for the same period in the prior fiscal
year. The Company hired a number of technical personnel during its first and second quarter of the current fiscal year and it has taken longer than expected to increase the billable utilization of these new hires. The Company expects that its
service revenue will increase once these personnel are fully trained and increase their billable hours resulting in a increase to the service gross margin percentage.

Gross margin. For the previously-stated reasons, the Companys gross margin percentage decreased from 48.6% for the six months ended December 31, 2005 to 47.9% for the same period in the current
fiscal year.

Other Operating Expenses



|                                    |  |                               |            |      |   |           |  |      |  
|----------------------------------- |  | ----------------------------- | ---------- | ---- | - | --------- |  | ---- | -
|                                    |  | Six Months Ended December 31, |           
|                                    |  | 2006                          |            | 2005 |   | %         | 
|Other operating expenses:           |  |                               |            |      |   |           |  |      |  
|Selling, general and administrative |  | $                             | 10,596,000 |      | $ | 7,588,000 |  | 39.7 | %
|Depreciation and amortization       |  |                               | 335,000    |      |   | 193,000   |  | 73.6 | %
|                                    |  |                               |            |      |   |           |  |      |  
|Total other operating expenses      |  | $                             | 10,931,000 |      | $ | 7,781,000 |  | 40.5 | %
|                                    |  |                               |            |      |   |           |  |      |  

Selling, General and Administrative Expense. Selling, general and administrative expenses
increased $3,008,000, or 39.7%, for the six months ended December 31, 2006 compared to the same period in the prior fiscal year due to higher salary expense and sales commissions due to new sales personnel hired in the past twelve months.
Selling, general and administrative expense as a percent of total revenues was 43.3% for the six months ended December 31, 2006, compared to 40.6% for the same period in the prior fiscal



---

year due to the acquisition of Sterling in May 2006 and new sales personnel hired in the past twelve months.

Depreciation and Amortization. Depreciation and amortization expenses increased $142,000, or 73.6%, for the six months ended December 31,
2006 when compared to the same period in the prior fiscal year. These expenses increased due to the Companys investment in upgrading its information technology infrastructure, purchases of new, upgraded computers for several of the
Companys training centers as well as for new personnel that were hired during the last twelve months and the amortization of a customer list, recorded as a result of the Companys purchase of Sterling in May 2006.

Other income (expense)



|                             |      |                               |          |      |  |   |          |   |  |       |   
|---------------------------- | ---- | ----------------------------- | -------- | ---- |  | - | -------- | - |  | ----- | --
|                             |      | Six Months Ended December 31, |         
|                             | 2006 |                               |          | 2005 |  |   | %        |  
|Other income (expense):      |      |                               |          |      |  |   |          |   |  |       |   
|Interest and other income    |      | $                             | 31,000   |      |  | $ | 7,000    |   |  | 342.9 | % 
|Interest expense             |      |                               | (152,000 | )    |  |   | (263,000 | ) |  | (42.2 | )%
|                             |      |                               |          |      |  |   |          |   |  |       |   
|Total other income (expense) |      | $                             | (121,000 | )    |  | $ | (256,000 | ) |  | (52.8 | )%
|                             |      |                               |          |      |  |   |          |   |  |       |   

Other Income (Expense). Other income (expense) decreased $135,000 for the six months ended
December 31, 2006 when compared to the same period in the prior fiscal year. Interest expense decreased due to the payoff of virtually all long-term debt that occurred in fiscal year 2006.

Income tax expense



|                   |      |                               |         |  |   |        |  |       |  
|------------------ | ---- | ----------------------------- | ------- |  | - | ------ |  | ----- | -
|                   |      | Six Months Ended December 31, |        
|                   | 2006 |                               | 2005    |  | % |       
|Income tax expense |      | $                             | 115,000 |  | $ | 32,000 |  | 259.4 | %
|                   |      |                               |         |  |   |        |  |       |  

Income Tax Expense. Income tax expense increased $83,000 for the six months ended
December 31, 2006 when compared to the same period in the prior fiscal year. The increase in tax expense relates to the recordation of state income taxes and a federal alternative minimum tax provision as a result of the Companys
profitable results. The Company, however, has significant net operating loss carry forwards and does not expect to pay significant federal income taxes for the foreseeable future. As the Company continues to demonstrate its ability to consistently
earn net income, some portion of the deferred tax asset valuation allowance may need to be reversed in future periods. The Company will continue to evaluate the likelihood of this asset being realized and will adjust the valuation allowance when
circumstances warrant its recordation.

Liquidity and Capital Resources

Historically, the Company has financed its operations and met its capital expenditure requirements primarily through cash flows provided by operations,
borrowings under short-term and long-term debt arrangements, and sales of its securities. See Note 9 to the Companys consolidated financial statements contained elsewhere in this report for information about the recent sale of securities.

The Companys operating assets and liabilities consist primarily of accounts receivable, inventory and accounts payable. Changes in
these balances are affected principally by the timing of sales and investments in inventory based on expected customer demand. The Company attempts to minimize inventory levels through arrangements with suppliers to ship products with an average
delivery period of two days and centralized inventory management but has increased inventories at times to take advantage of special pricing and rebates offered by its main supplier. The Company purchases approximately 90% of its product from one
principal supplier which provides between $4 million and $5 million of available credit to finance those purchases, depending on the Companys anticipated purchasing levels.

The Companys investing activities consist principally of investments in computer and office equipment. Capital expenditures for the six months
ended December 31, 2006 were approximately $233,000, compared to $112,000 for the same period in 2005.



---

For the six months ended December 31, 2006, net cash used in operating activities was $2,076,000, an
increase in the use of cash of $3,365,000 over the same period in 2005. The major difference between the periods was that the Company accounts and other receivables increased by $2,756,000 for the six months ended December 31, 2006 but
decreased by $254,000 during the same period in 2005. The accounts receivable grew due to the high level of December 2006 sales that were financed primarily by a $2,507,000 increase in the Companys borrowings under its line of credit. In
addition, accounts payable and accrued expenses decreased by $881,000 for the six months ended December 31, 2006 as compared with $641,000 during the same period in 2005.

For the six months ended December 31, 2006, the Company was provided with $2,269,000 of cash by financing activities compared with using cash of
$1,171,000 for the same period in 2005. The main reason for this difference is increased borrowings on the line of credit between periods.

The Company maintains a line of credit from a bank which provides for up to $5 million of borrowings limited to 80% of the Companys aggregate eligible accounts receivable. The loan bears interest at a rate tied to the banks
prime rate adjusted for changes in the Companys capital structure. The interest rate ranges from the banks prime rate plus two percent to a low of the banks prime rate plus 0.25%. Based on the Companys capital structure, the
interest rate for the quarter ended December 31, 2006 was the banks prime rate plus one and one-half percent. The loan was renewed prior to its December 31, 2006 expiration date with a two year extension through December 31,
2008 and is secured by all of the Companys assets, except inventory.

The total borrowings from the bank under this line of credit
were approximately $3.9 million and $1.4 million as of December 31, 2006 and 2005, respectively.

Outstanding long-term debt totaled
approximately $ 13,000 at December 31, 2006, and the Company had working capital of approximately $180,000.

As a result of its
profitable operations and the various equity offerings that closed in the Companys fourth fiscal quarter of 2006 and in January 2007, the Companys working capital needs have stabilized and management believes the Companys near-term
needs can be met from its available cash resources, cash flows from operations and its lines of credit.

Because the Company is one of the
largest resellers of Autodesk software and because Autodesk has continued to state its intention to continue to strengthen its relationships with its resellers, the Company expects to continue to be a leading seller of Autodesk software at margins
sufficient to grow its business and improve its financial results. The Company signed the new Channel Partner Agreement with Autodesk which designates the Company as an authorized reseller of Autodesk products through the expiration of the
Agreement, which is January 31, 2008.

Below is a summary of the Companys contractual obligations and commitments at
December 31, 2006:



|                                   |  |       |           |                 |   |             |  |             |           |                  |   |           |  |   |  
|---------------------------------- |  | ----- | --------- | --------------- | - | ----------- |  | ----------- | --------- | ---------------- | - | --------- |  | - | -
|                                   |  | Total |           | Less than 1year |   | 1  3 years |  | 3  5 years |           | More than 5years
|Contractual Obligations            |  |       |           |                 |   |             |  |             |           |                  |   |           |  |   |  
|Line of credit                     |  | $     | 3,916,000 |                 | $ | 3,916,000   |  | $           |          |                  | $ |          |  | $ | 
|Long-term obligations              |  |       | 63,000    |                 |   | 50,000      |  |             | 13,000    |                  |   |          |  |   | 
|Interest on fixed rate obligations |  |       | 1,000     |                 |   | 1,000       |  |             |          |                  |   |          |  |   | 
|Operating leases                   |  |       | 5,188,000 |                 |   | 1,676,000   |  |             | 2,181,000 |                  |   | 1,331,000 |  |   | 
|Capital lease obligations          |  |       | 64,000    |                 |   | 63,000      |  |             | 1,000     |                  |   |          |  |   | 
|                                   |  |       |           |                 |   |             |  |             |           |                  |   |           |  |   |  
|Total obligations                  |  | $     | 9,232,000 |                 | $ | 5,706,000   |  | $           | 2,195,000 |                  | $ | 1,331,000 |  | $ | 
|                                   |  |       |           |                 |   |             |  |             |           |                  |   |           |  |   |  



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------



---

The Company is exposed to market risk from changes in interest rates associated with its variable rate line-of-credit. At
December 31, 2006, virtually of the outstanding debt bore 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 change in the average interest rate under these borrowings, the Company estimates that its interest expense and net income would have changed by less than $10,000 for the six months ended December 31, 2006. In the
event of an adverse change in interest rates, management would likely take actions to further mitigate this 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
disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports filed under the Securities Exchange Act of 1934 with the SEC, such as this Quarterly Report, is recorded, processed, summarized
and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO),
as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the
control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future
conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of December 31, 2006 was carried out under the supervision and with the participation of management, including the CEO and the CFO. Based on that
evaluation, management, including the CEO and the CFO, has concluded that the Companys disclosure controls and procedures are effective.

During the most recently-completed quarter, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial
reporting.

PART II. OTHER INFORMATION



|ITEM 1A. | Risk Factors
|-------- | ------------

The risks and uncertainties to which
the Companys financial condition and operations are subject are discussed in detail in Item 1A of Part I of the Companys Annual Report on Form 10-K for the year ended June 30, 2006. Management does not believe that any material
changes in these risk factors have occurred since the filing of the Form 10-K.



|ITEM 4. | Submission of Matters to Vote of Security Holders
|------- | -------------------------------------------------

At the Annual Meeting of Stockholders held on November 8, 2006, the stockholders of the Company elected seven individuals to serve as directors until the 2007 Annual Meeting of Stockholders. The Board of Directors submitted this matter
to a vote through the solicitation of proxies. The results of the votes were as follows:



|                         |  |            |  |          |  |         |  |                 
|------------------------ |  | ---------- |  | -------- |  | ------- |  | ----------------
|Name                     |  | For        |  | Withheld |  | Abstain |  | Broker Non-Votes
|Garnett Y. Clark, Jr.    |  | 13,417,400 |  | 0        |  | 91,851  |  | 0               
|George Cox               |  | 13,416,119 |  | 0        |  | 93,132  |  | 0               
|George M. Davis          |  | 13,417,430 |  | 0        |  | 91,821  |  | 0               
|Eugene J. Fischer        |  | 13,415,228 |  | 0        |  | 94,023  |  | 0               
|W. James Hindman         |  | 13,497,978 |  | 0        |  | 11,273  |  | 0               
|Robert Post              |  | 13,488,497 |  | 0        |  | 20,754  |  | 0               
|Donald R. Scotty Walsh |  | 13,112,204 |  | 0        |  | 397,047 |  | 0               



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



---

The list of exhibits that immediately follows the Signatures to this report is incorporated herein by
reference.



---

SIGNATURES

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



|                        |  |                         |  |                                                     
|----------------------- |  | ----------------------- |  | ----------------------------------------------------
|                        |  | AVATECH SOLUTIONS, INC.
|                        |  |                        
|Date: February 14, 2007 |  | By                      |  | /s/ Donald R. Walsh                                 
|                        |  |                         |  | Donald R. Walsh                                     
|                        |  |                         |  | Chief Executive Officer                             
|                        |  |                        
|Date: February 14, 2007 |  | By                      |  | /s/ Lawrence Rychlak                                
|                        |  |                         |  | Lawrence Rychlak                                    
|                        |  |                         |  | Executive Vice President and Chief Financial Officer
|                        |  |                         |  | (Principal financial and accounting officer)        



---

EXHIBIT INDEX



|        |  |                                                                                                                                                                                                                                         
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                                                                             
|3.1     |  | Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)                                                                             
|        | 
|3.2     |  | First Amendment to Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)                                                          
|        | 
|3.3     |  | Reverse Split Amendment to Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386)                                                        
|        | 
|3.4     |  | Amendment of PlanetCADs Certificate of Incorporation to change the name of PlanetCAD, Inc. to Avatech Solutions, Inc. (incorporated by reference to our Registration Statement on form S-4
filed on May 30, 2002, File No. 333-89386)  
|        | 
|3.5     |  | Certificate of Designation, Preferences and Rights of Series D Convertible Preferred Stock (incorporated by reference to our Current Report on form 8-K, filed on May 28, 2002, File No.
001-31265)                                     
|        | 
|3.6     |  | Certificate of Amendment to Certificate of Designation of Series D Convertible Preferred Stock (incorporated by reference to our Quarterly Report on form 10-Q, filed on February 13, 2004, File
No. 001-31265)                         
|        | 
|3.7     |  | Certificate of Amendment to Amended and Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No.
333-114230)                                        
|        | 
|3.8     |  | Certificate of Designation, Preferences and Rights of Series E Convertible Preferred Stock (incorporated by reference to our Current Report on form 8-K, filed on August 9, 2005, File No.
001-31265)                                   
|        | 
|3.9     |  | Certificate of Designation, Preferences and Rights of Series F Convertible Preferred Stock (incorporated by reference to Exhibit 10.22 hereto)                                                                                          
|        | 
|3.10    |  | By-Laws (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)                                                                                                           
|        | 
|10.01   |  | Lease by and between Merritt-DM1, LLC and Avatech Solutions, Inc. effective June 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No.
333-114230)                             
|        | 
|10.02   |  | Form of Purchase Agreement for Series D Convertible Preferred Stock (incorporated by reference to our Quarterly Report on form 10-Q, filed on February 13, 2004, File No.
001-31265)                                                    
|        | 
|10.03   |  | 2002 Stock Option Plan (incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386)                                                                                                  
|        | 
|10.04   |  | Restricted Stock Award Plan (incorporated by reference to our Registration Statement on form S-1, filed on March 26, 2003, File No. 333-104035)                                                                                         
|        | 
|10.05   |  | Avatech Solutions, Inc. Employee Stock Purchase Plan (incorporated by reference to our Definitive Proxy Statement on form 14A, filed on May 7, 2004, File No. 001-31265)                                                                
|        | 
|10.06   |  | Employment Agreement by and between Donald R. Scotty Walsh and Avatech Solutions, Inc. dated July 1, 2003 (incorporated by reference to our Annual Report on form 10-K, filed on
October 3, 2003, File No. 001-31265)                 
|        | 
|10.07   |  | Employment Agreement by and between W. Scott Harris and Avatech Solutions Subsidiary, Inc. dated as of June 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on
July 19, 2004, File No. 333-114230)  
|        | 
|10.08   |  | Employment Agreement by and between Christopher D. Olander and Avatech Solutions Subsidiary, Inc. dated June 18, 2004 (incorporated by reference to our Registration Statement on form S-1, filed
on July 19, 2004, File No. 333-114230)



---

|      |  |                                                                                                                                                                                                                                                                                                                                                                         
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.09 |  | Warrants to purchase up to 51,828 shares of common stock issued by Avatech to W. James Hindman dated April 1, 2004 (incorporated by reference to our Registration Statement on form S-1,
filed on July 19, 2004, File No. 333-114230)                                                                                                                                   
|      | 
|10.10 |  | Asset Purchase Agreement by and among Avatech Solutions, Inc., Comtrex Corp., Richard L. Aquino, and Stanton L. Hilburn dated April 8, 2005 (incorporated by reference to our Quarterly Report on
form 10-Q, filed on May 13, 2005, File No. 001-31265)                                                                                                                 
|      | 
|10.11 |  | Letter Agreement between Avatech Solutions, Inc. and W. James Hindman, with stock purchase warrant, dated December 6, 2004 (incorporated by reference to our Quarterly Report on form 10-Q, filed
on February 15, 2005, File No. 001-31265)                                                                                                                             
|      | 
|10.12 |  | Warrants to purchase up to 38,878 shares of common stock issued by Avatech Solutions, Inc. to W. James Hindman, dated July 1, 2005 (incorporated by reference to our Annual Report on Form 10-K,
filed on November 14, 2005, File No. 001-31265)                                                                                                                        
|      | 
|10.13 |  | Amendment to Avatech Solutions, Inc. Restricted Stock Award Plan, dated August 23, 2005 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on November 14, 2005, File No
001-31265)                                                                                                                                                                 
|      | 
|10.14 |  | Warrant to purchase up to 100,000 shares of common stock issued by Avatech to W. James Hindman, dated October 22, 2005 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on
November 14, 2005, File No 001-31265)                                                                                                                                  
|      | 
|10.15 |  | Promissory Note issued by Avatech Solutions Subsidiary, Inc. to Mercantile Bank & Trust Co. dated January 27, 2006 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on
November 14, 2005, File No 001-31265)                                                                                                                                      
|      | 
|10.16 |  | Loan and Security Agreement by and between Avatech Solutions Subsidiary, Inc and Mercantile Bank & Trust Co., dated January 27, 2006 (incorporated by reference to our Quarterly Report on
Form 10-Q, filed on November 14, 2005, File No 001-31265)                                                                                                                    
|      | 
|10.17 |  | Guaranty Agreement by and between W. James Hindman and Mercantile Bank & Trust Co., dated January 27, 2006 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on November
14, 2005, File No 001-31265)                                                                                                                                              
|      | 
|10.18 |  | Channel Partner Agreement, dated February 1, 2006, by and between Avatech Solutions Subsidiary, Inc. and Autodesk, Inc (incorporated by reference to our Quarterly Report on Form 10-Q, filed on
November 14, 2005, File No 001-31265)                                                                                                                                  
|      | 
|10.19 |  | Stock Purchase Agreement, dated May 30, 2006, by and among Avatech Solutions, Inc., Sterling Systems & Consulting, Inc., Bruce White, and Shelly White (incorporated by reference to our
Registration Statement on Form S-1, filed on June 8, 2006, File No. 333-134862)                                                                                                
|      | 
|10.20 |  | Membership Interest Purchase Agreement, dated May 30, 2006, by and between Avatech Solutions, Inc., Sterling  Indiana LLC, and Bruce White (incorporated by reference to our Registration
Statement on Form S-1, filed on June 8, 2006, File No. 333-134862)                                                                                                           
|      | 
|10.21 |  | Membership Interest Purchase Agreement, dated May 30, 2006, by and among Avatech Solutions, Inc., Sterling  Ohio LLC, Bruce White, Steve Wludyga, Kevin Breslin, Ken Williams, Marcy
Nungesser, and Dave Press (incorporated by reference to our Registration Statement on Form S-1, filed on June 8, 2006, File No. 333-134862)                                       
|      | 
|10.22 |  | Certificate of Designation of the Powers, Preferences and Relative, Participating, Optional and Other Special Rights of Preferred Stock and Qualification, Limitations and Restriction Thereof of
Series F 10% Cumulative Convertible Preferred Stock (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)
|      | 
|10.23 |  | Preferred Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                                                                                                                                       
|      | 
|10.24 |  | Common Stock Purchase Warrants (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                                                                                                                                                       
|      | 
|10.25 |  | Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                                                                                                                                                            



---

|      |  |                                                                                                                                                                                                                          
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.26 |  | Common Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                           
|      | 
|10.27 |  | Form of Common Stock Purchase Warrants issued to Sigma Opportunity Fund LLC and Pacific Asset Partners (incorporated by reference to our Registration Statement on Form S-1, filed on June 22,
2006, File No. 333-134862)
|      | 
|10.28 |  | Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                             
|      | 
|10.29 |  | Second Modification Agreement by and between Avatech Solutions, Inc. and Avatech Solutions Subsidiary, Inc and Mercantile Bank & Trust Co., dated December 31, 2006 (filed
herewith)                                     
|      | 
|10.31 |  | Common Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)                                                        
|      | 
|10.32 |  | Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)                                                                          
|      | 
|10.33 |  | Common Stock Purchase Warrants (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)                                                                     
|      | 
|31.1  |  | Rule 15d-14(a) Certification of Chief Executive Officer (filed herewith)                                                                                                                                                 
|      | 
|31.2  |  | Rule 15d-14(a) Certification of Chief Financial Officer (filed herewith)                                                                                                                                                 
|      | 
|32.1  |  | Section 1350 Certifications (filed herewith)